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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
----------------
For the Quarter Ended March 31, 1999
Commission File Number 333-48817
----------------
PHASE METRICS, INC.
(registrant)
----------------
Incorporated in the State of Delaware
I.R.S. Employer Identification Number 33-0328048
10260 Sorrento Valley Road, San Diego, California 92121
(619) 646-4800
----------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
The number of shares outstanding of the Registrant's securities as of March
31, 1999 are as follows:
Common Stock............................................. 5,622,309 shares
Series A Preferred Stock................................. 8,250,000 shares
Series B Preferred Stock................................. 3,857,280 shares
Series C Preferred Stock................................. 7,610,000 shares
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PHASE METRICS, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999
INDEX
PART I. FINANCIAL INFORMATION
Page
----
ITEM 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of December 31, 1998
and March 31, 1999............................................. 3
Condensed Consolidated Statements of Operations for the three
months ended March 31, 1998 and 1999........................... 4
Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 1998 and 1999........................... 5
Notes to Condensed Consolidated Financial Statements........... 6
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 13
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk..... 26
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings.............................................. 26
ITEM 2. Changes in Securities.......................................... 26
ITEM 3. Defaults Upon Senior Securities................................ 26
ITEM 4. Submission of Matters to a Vote of Security Holders............ 26
ITEM 5 Other Information.............................................. 26
ITEM 6. Exhibits and Reports on Form 8-K............................... 26
Signatures.............................................................. 27
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHASE METRICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31, March 31,
1998 1999
------------ -----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 24,714 $ 17,659
Accounts receivable, net........................... 13,577 13,624
Inventories........................................ 25,222 22,553
Prepaid expenses and other......................... 2,189 1,485
Income taxes receivable............................ 6,062 --
--------- ---------
Total current assets............................. 71,764 55,321
Property, plant and equipment, net................... 17,793 16,357
Intangible and other assets.......................... 6,558 6,385
--------- ---------
Total assets..................................... $ 96,115 $ 78,063
========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable................................... $ 6,682 $ 4,703
Accrued expenses and other liabilities............. 17,825 12,350
Current portion of debt............................ 1,374 1,251
--------- ---------
Total current liabilities........................ 25,881 18,304
Long-term liabilities:
Long-term debt..................................... 115,257 114,880
Accrued expenses and interest...................... 9,591 10,684
Series B redeemable preferred stock.................. 11,331 11,510
Series C redeemable preferred stock.................. 31,212 31,927
Commitments and contingencies (Note 4)
Stockholders' deficit:
Series A preferred stock........................... 3 3
Common stock....................................... 6,498 6,600
Retained deficit................................... (103,298) (114,955)
Accumulated other comprehensive loss............... (360) (890)
--------- ---------
Total stockholders' deficit...................... (97,157) (109,242)
--------- ---------
Total liabilities, redeemable preferred stock and
stockholders' deficit............................... $ 96,115 $ 78,063
========= =========
See accompanying notes to unaudited condensed consolidated financial
statements.
3
PHASE METRICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, unaudited)
Three Months Ended
March 31,
-------------------
1998 1999
--------- ---------
Net sales................................................ $ 32,502 $ 11,355
Cost of sales............................................ 19,617 9,582
-------- ---------
Gross profit......................................... 12,885 1,773
Operating expenses:
Research and development............................... 9,469 6,390
Selling, general and administrative.................... 4,462 3,002
Amortization of intangible assets...................... 1,638 93
-------- ---------
Total operating expenses............................. 15,569 9,485
-------- ---------
Loss from operations..................................... (2,684) (7,712)
Interest expense......................................... 3,431 3,338
Other (income) expense, net.............................. 95 (287)
-------- ---------
Loss before income taxes and extraordinary item.......... (6,210) (10,763)
Income tax benefit....................................... 2,733 --
-------- ---------
Loss before extraordinary item........................... (3,477) (10,763)
Extraordinary loss, net of income taxes.................. (941) --
-------- ---------
Net loss................................................. $ (4,418) $ (10,763)
======== =========
Accretion for redemption value and dividends on Series B
and C redeemable preferred stock........................ (556) (894)
-------- ---------
Net loss attributable to common stockholders............. $ (4,974) $ (11,657)
======== =========
See accompanying notes to unaudited condensed consolidated financial
statements.
4
PHASE METRICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
Three Months Ended
March 31,
--------------------
1998 1999
--------- ---------
OPERATING ACTIVITIES:
Net cash used for operating activities............... $ (4,670) $ (6,289)
--------- --------
INVESTING ACTIVITIES:
Acquisition of property, plant and equipment........... (750) (703)
Proceeds from sale of property, plant and equipment.... -- 328
--------- --------
Net cash used for investing activities............... (750) (375)
--------- --------
FINANCING ACTIVITIES:
Proceeds from senior notes............................. 110,000 --
Repayment of term notes................................ (79,200) --
Revolving loans, net................................... (22,400) --
Payment of debt issuance costs......................... (4,820) --
Payments on capital lease obligations.................. (234) (351)
Proceeds from issuance of common stock, net of
repurchases........................................... (15) 2
--------- --------
Net cash provided by (used for) financing
activities.......................................... 3,331 (349)
--------- --------
Effect of exchange rate changes on cash and cash
equivalents............................................. 32 (42)
--------- --------
Net decrease in cash and cash equivalents................ (2,057) (7,055)
Cash and cash equivalents, beginning of period........... 2,977 24,714
--------- --------
Cash and cash equivalents, end of period................. $ 920 $ 17,659
========= ========
See accompanying notes to unaudited condensed consolidated financial
statements.
5
PHASE METRICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Phase Metrics, Inc. (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments considered necessary for a fair
presentation (consisting of normal recurring accruals) have been included.
Operating results for the three months ended March 31, 1999 are not
necessarily indicative of the results that may be expected for the fiscal year
ending December 31, 1999. For further information, refer to the consolidated
financial statements and footnotes thereto for the year ended December 31,
1998 included in the Company's 1998 Annual Report on Form 10-K. The Company's
first, second and third fiscal quarters end on the Sunday closest to March 31,
June 30 and September 30, respectively. For ease of reference, such quarter
end dates are used herein.
Note 2. Inventories
Inventories consist of the following (in thousands):
December 31, March 31,
1998 1999
------------ ---------
Raw materials and components.......................... $ 7,277 $ 8,538
Work-in-process....................................... 8,237 7,349
Finished goods........................................ 9,708 6,666
-------- --------
$ 25,222 $ 22,553
======== ========
Note 3. Property, Plant and Equipment
Property, plant and equipment consist of the following (in thousands):
December 31, March 31,
1998 1999
------------ ---------
Equipment and furniture............................... $ 32,753 $30,813
Leasehold improvements................................ 5,500 5,436
Construction in progress.............................. 171 169
-------- -------
38,424 36,418
Accumulated depreciation and amortization............. (20,631) (20,061)
-------- -------
$ 17,793 $16,357
======== =======
Note 4. Commitments and Contingencies
Letter of Credit--As of December 31, 1998 and March 31, 1999, the Company
had a letter of credit outstanding to a third party beneficiary totaling $2.1
million. The letter of credit is secured by a certificate of deposit included
in non-current assets on the accompanying condensed consolidated balance
sheet.
Receivables Sold with Recourse--During the first quarter of 1999, the
Company's Japanese subsidiary sold certain trade receivables to a third party
financial institution. The arrangement with the financial institution contains
certain recourse provisions under which the Company remains contingently
liable. As of March 31, 1999, the Company's contingent liability under such
recourse provisions was approximately $1.6 million.
6
PHASE METRICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Note 5. Comprehensive Loss
In January, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income," which requires an enterprise to report, by major components and as a
single total, the change in its net assets during the period from non-owner
sources.
The components of comprehensive loss are as follows (in thousands):
Three Months
Ended March 31,
-----------------
1998 1999
------- --------
Net loss................................................. $(4,418) $(10,763)
Foreign currency translation adjustments................. (32) (530)
------- --------
Comprehensive loss....................................... $(4,450) $(11,293)
======= ========
Note 6. Industry and Geographic Information
The Company operates in one reportable segment. Sales to customers outside
the United States (primarily Asia) totaled 52% and 54% of net sales for the
three months ended March 31, 1998 and 1999, respectively. As of December 31,
1998 and March 31, 1999, balances due from foreign customers (primarily
located in Asia) were $4.0 million and $4.4 million, respectively.
The Company had sales to individual customers in excess of 10% of net sales,
as follows:
Three Months Ended
March 31,
------------------
1998 1999
--------- ---------
Customer:
A .................................................... 15% 33%
B..................................................... -- 13%
C..................................................... -- 12%
D..................................................... 22% --
E..................................................... 13% --
As of December 31, 1998 and March 31, 1999, accounts receivable from
individual customers with balances due in excess of 10% of total accounts
receivable totaled $12.3 million (5 customers) and $8.6 million (3 customers),
respectively.
For the three months ended March 31, 1999, the Company recorded revenue from
customers in the United States and Asia. The following presents net sales for
the three months ended March 31, 1998 and 1999 and long-lived assets as of
December 31, 1998 and March 31, 1999 by geographic territory:
Long-Lived Assets Net Sales
---------------------- -----------------------------
Three Months Ended March 31,
December 31, March 31, ----------------------------
1998 1999 1998 1999
------------ --------- -------------- --------------
United States
operations:
Domestic.............. $23,589 $21,992 $ 15,601 $ 5,223
Foreign............... -- -- 15,045 4,841
Asia operations......... 762 750 1,856 1,291
------- ------- -------------- --------------
Total................... $24,351 $22,742 $ 32,502 $ 11,355
======= ======= ============== ==============
7
PHASE METRICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Note 7. Financial Information for Guarantor Subsidiaries and Non-Guarantor
Subsidiaries
Phase metrics conducts all of its business through the parent company and
its domestic and foreign subsidiaries. Phase Metrics' Senior Notes are fully
and unconditionally guaranteed, on a joint and several basis, by all of Phase
Metrics' wholly-owned domestic subsidiaries (the "Guarantor Subsidiaries").
Presented below is condensed consolidating financial information for Phase
Metrics, Inc. (the "Parent Company"), the Guarantor Subsidiaries and the
wholly-owned foreign subsidiaries (the "Non-Guarantor Subsidiaries") for the
three months ended March 31, 1998 and 1999. Separate financial statements for
the Guarantor Subsidiaries are not presented based on management's
determination that they would not provide additional information that is
material to investors.
The supplemental condensed consolidating financial information reflects the
investments of the Parent Company in the Guarantor and Non-Guarantor
Subsidiaries using the equity method of accounting.
8
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
March 31, 1998
(Unaudited)
Foreign Non-
Parent Guarantor Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------- ------------ ------------ ----------- ------------
(in thousands)
ASSETS
Accounts receivable,
net.................... $ 30,973 $ 550 $ 600 $ -- $ 32,123
Inventories............. 45,590 4,752 5,689 (4,003) 52,028
Other current assets.... 16,690 75 1,146 -- 17,911
Property, plant and
equipment, net......... 33,949 2,156 291 -- 36,396
Intercompany balances... (4,789) 12,196 (7,407) -- --
Investment in
subsidiaries........... 13,702 -- -- (13,702) --
Other................... 10,319 315 473 -- 11,107
-------- ------- ------- -------- --------
Total assets.......... $146,434 $20,044 $ 792 $(17,705) $149,565
======== ======= ======= ======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Other current
liabilities............ $ 28,138 $ 2,044 $ 540 $ -- $ 30,722
Current portion of
debt................... 961 -- -- -- 961
Long-term debt.......... 123,938 -- -- -- 123,938
Redeemable preferred
stock.................. 9,793 -- -- -- 9,793
Other................... 6,398 -- 547 -- 6,945
Stockholders' equity
(deficit).............. (22,794) 18,000 (295) (17,705) (22,794)
-------- ------- ------- -------- --------
Total liabilities,
redeemable preferred
stock and stockholder's
equity (deficit)....... $146,434 $20,044 $ 792 $(17,705) $149,565
======== ======= ======= ======== ========
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended March 31, 1998
(Unaudited)
Foreign Non-
Parent Guarantor Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------- ------------ ------------ ----------- ------------
(in thousands)
Net sales............... $ 29,410 $ 4,495 $ 2,908 $ (4,311) $ 32,502
Cost of sales........... 19,003 2,401 2,650 (4,437) 19,617
-------- ------- ------- -------- --------
Gross profit.......... 10,407 2,094 258 126 12,885
Research and development
expense................ 8,650 819 -- -- 9,469
Selling, general and
administrative
expense................ 3,502 607 362 (9) 4,462
Amortization and write-
downs of intangibles... 1,638 -- -- -- 1,638
-------- ------- ------- -------- --------
Income (loss) from
operations........... (3,383) 668 (104) 135 (2,684)
Interest expense........ 3,432 (4) 3 -- 3,431
Other (income) expense--
net.................... 103 14 (22) -- 95
-------- ------- ------- -------- --------
Income (loss) before
equity in
subsidiaries, taxes
and extraordinary
items................ (6,918) 658 (85) 135 (6,210)
Equity in net income of
subsidiaries........... 455 -- -- (455) --
Income tax expense
(benefit).............. (2,986) 290 (37) -- (2,733)
-------- ------- ------- -------- --------
Net income (loss)
before extraordinary
items................ (3,477) 368 (48) (320) (3,477)
Extraordinary loss, net
of income taxes........ (941) -- -- -- (941)
-------- ------- ------- -------- --------
Net income (loss)....... $ (4,418) $ 368 $ (48) $ (320) $ (4,418)
======== ======= ======= ======== ========
9
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Three Months Ended March 31, 1998
(Unaudited)
Foreign Non-
Parent Guarantor Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------- ------------ ------------ ----------- ------------
(in thousands)
Net income (loss)....................... $ (4,418) $ 368 $ (48) $(320) $ (4,418)
Depreciation and amortization and
write-downs of intangibles............ 3,577 200 21 -- 3,798
Equity in net income of subsidiaries... (455) -- -- 455 --
Other non-cash adjustments............. 726 -- -- -- 726
Extraordinary loss, net of income
taxes................................. 941 -- -- -- 941
Changes in working capital............. (5,015) 3,879 (4,446) (135) (5,717)
-------- ------- ------ ----- --------
Net cash provided by (used for)
operating activities................... (4,644) 4,447 (4,473) -- (4,670)
-------- ------- ------ ----- --------
Investing activities:
Acquisition of property, plant and
equipment............................. (710) (39) (1) -- (750)
-------- ------- ------ ----- --------
Net cash used for investing activities.. (710) (39) (1) -- (750)
-------- ------- ------ ----- --------
Financing activities:
Proceeds from senior notes............. 110,000 -- -- -- 110,000
Repayment of term and subordinated
notes................................. (79,200) -- -- -- (79,200)
Revolving loans--net................... (22,400) -- -- -- (22,400)
Payment of debt issuance costs......... (4,820) -- -- (4,820)
Other.................................. 85 (5,138) 4,804 (249)
-------- ------- ------ ----- --------
Net cash provided by (used for)
financing activities................... 3,665 (5,138) 4,804 -- 3,331
-------- ------- ------ ----- --------
Effect of exchange rate on cash and cash
equivalents............................ -- -- 32 -- 32
Net increase (decrease) in cash and cash
equivalents............................ (1,689) (730) 362 -- (2,057)
Cash and cash equivalents at beginning
of period.............................. 1,757 780 440 -- 2,977
-------- ------- ------ ----- --------
Cash and cash equivalents at end of
period................................. $ 68 $ 50 $ 802 $ -- $ 920
======== ======= ====== ===== ========
10
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
March 31, 1999
(Unaudited)
Foreign Non-
Parent Guarantor Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------- ------------ ------------ ----------- ------------
(in thousands)
ASSETS
Cash and cash
equivalents............ $ 16,860 $ 146 $ 653 $ -- $ 17,659
Accounts receivable,
net.................... 12,499 123 1,002 -- 13,624
Inventories............. 20,699 709 4,758 (3,613) 22,553
Other current assets.... 1,338 3 144 -- 1,485
Property, plant and
equipment, net......... 15,379 647 331 -- 16,357
Intercompany balances... (2,194) 9,433 (7,239) -- --
Investment in
subsidiaries........... 6,428 -- -- (6,428) --
Other................... 5,964 2 419 -- 6,385
-------- ------- ------- -------- --------
Total assets.......... $ 76,973 $11,063 $ 68 $(10,041) $ 78,063
======== ======= ======= ======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Other current
liabilities............ $ 16,543 $ 148 $ 362 $ -- $ 17,053
Current portion of
debt................... 1,251 -- -- -- 1,251
Long-term debt.......... 114,880 -- -- -- 114,880
Redeemable preferred
stock.................. 43,437 -- -- -- 43,437
Other................... 10,104 -- 580 -- 10,684
Stockholders' equity
(deficit).............. (109,242) 10,915 (874) (10,041) (109,242)
-------- ------- ------- -------- --------
Total liabilities,
redeemable preferred
stock and
stockholders' equity
(deficit)............ $ 76,973 $11,063 $ 68 $(10,041) $ 78,063
======== ======= ======= ======== ========
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended March 31, 1999
(Unaudited)
Non-
Parent Guarantor Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------- ------------ ------------ ----------- ------------
(in thousands)
Net sales............... $ 10,875 $ 553 $ 1,620 $ (1,693) $ 11,355
Cost of sales........... 9,605 169 1,736 (1,928) 9,582
-------- ------- ------- -------- --------
Gross profit.......... 1,270 384 (116) 236 1,773
Research and development
expense................ 6,313 77 -- -- 6,390
Selling, general and
administrative
expense................ 2,391 155 456 -- 3,002
Amortization and write-
downs of intangibles... 93 -- -- -- 93
-------- ------- ------- -------- --------
Income (loss) from
operations........... (7,527) 152 (572) 235 (7,712)
Interest expense........ 3,334 -- 4 -- 3,338
Other (income) expense--
net.................... (325) -- 38 -- (287)
-------- ------- ------- -------- --------
Income (loss) before
equity in
subsidiaries and
taxes................ (10,536) 152 (614) 235 (10,763)
Equity in net income of
subsidiaries........... (227) 0 0 227 --
-------- ------- ------- -------- --------
Net income (loss)..... $(10,763) $ 152 $ (614) $ 462 $(10,763)
======== ======= ======= ======== ========
11
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Three Months Ended March 31, 1999
(Unaudited)
Foreign Non-
Parent Guarantor Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------- ------------ ------------ ----------- ------------
(in thousands)
OPERATING ACTIVITES:
Net income (loss)....... $(10,763) $152 $ (614) $ 462 $(10,763)
Depreciation and
amortization and
write-downs of
intangibles........... 2,009 55 22 -- 2,086
Equity in net income of
subsidiaries.......... 227 -- -- (227) --
Other non-cash
adjustments........... 462 -- -- -- 462
Changes in working
capital............... 526 (16) 1,651 (235) 1,926
-------- ---- ------- ----- --------
Net cash used for
operating activities... (7,539) 191 1,059 -- (6,289)
-------- ---- ------- ----- --------
Investing activities:
Acquisition of
property, plant and
equipment............. (596) -- (107) -- (703)
Proceeds from sale of
property, plant and
equipment............. 328 -- -- -- 328
-------- ---- ------- ----- --------
Net cash provided by
(used for) investing
activities............. (268) -- (107) -- (375)
-------- ---- ------- ----- --------
Financing activities:
Payments on capital
lease obligations..... (351) -- -- -- (351)
Proceeds from issuance
of preferred stock.... 2 -- -- -- 2
Intercompany balances
and other............. 1,385 (58) (1,327) -- --
-------- ---- ------- ----- --------
Net cash provided by
financing activities... 1,036 (58) (1,327) -- (349)
-------- ---- ------- ----- --------
Effect of exchange rate
on cash and cash
equivalents............ -- -- (42) -- (42)
Net increase (decrease)
in cash and cash
equivalents............ (6,771) 133 (417) -- (7,055)
Cash and cash
equivalents at
beginning of year...... 23,631 13 1,070 -- 24,714
-------- ---- ------- ----- --------
Cash and cash
equivalents at end of
period................. $ 16,860 $146 $ 653 $ -- $ 17,659
======== ==== ======= ===== ========
12
PHASE METRICS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ITEM 2.
Statements in this discussion and analysis and elsewhere in this report,
including, but not limited to, statements regarding our strategy, financial
performance and revenue sources, are forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, Section 21E
of the Securities Exchange Act of 1934, as amended, and Section 27A of the
Securities Act of 1933, as amended, and are subject to the safe harbors
created by those sections. These and any other forward-looking statements
contained in this report are based on current expectations and involve various
risks and uncertainties that could cause actual results to differ materially
from those expressed in such forward-looking statements. Our actual results
could differ materially from the results anticipated in these forward-looking
statements as a result of certain factors set forth under "Risk Factors" and
elsewhere in this report. Readers are also urged to carefully review and
consider the various risk factor disclosures made in our other reports and
filings with the SEC, including our 1998 Annual Report on Form 10-K. Readers
are cautioned not to place undue reliance on these forward-looking statements
to reflect events or circumstances occurring after the date of this filing.
The following discussion should be read in conjunction with our condensed
consolidated financial statements and notes thereto included elsewhere in this
report.
Overview
We are a leading supplier of process and production-test equipment for the
data storage industry. Our systems are used primarily by manufacturers of disk
drives, thin-film disks and read/write heads to manage and improve their
respective product yields by analyzing product and process quality at critical
stages in their production processes. We were formed in 1989 as a single
product supplier to the data storage industry. Since 1993, we expanded our
product lines through the acquisition of seven specialized suppliers of
complementary systems for the disk drive and disk drive component industries.
Recent Events
The data storage industry in general has recently experienced significant
weakness in demand for products, intense competition, pricing erosion and
overcapacity. Such adverse market conditions have resulted, and may in the
future result in, the delay, deferral or cancellation of orders for our
products. Delays, deferrals and cancellations of orders for our products have
had a material adverse effect on our operating results and financial condition
over the last several quarters and fluctuations in demand for our products is
expected to continue through 1999. Under current or future market conditions,
there can be no assurance that our business will generate adequate cash flow
or that any growth can be achieved. Because we must incur expenses and
purchase inventory based on anticipated and actual customer orders, any
significant delay, deferral or cancellation of such orders will have a
material adverse effect on our operating results.
As indicated above, our business, operating results and financial condition
have been adversely and materially affected by a downturn in the data storage
industry and reduced or delayed capital equipment expenditures by our
customers. In light of these circumstances, and our expectation that the data
storage industry's adverse market conditions will extend for the foreseeable
future, we implemented two major restructurings of our operations in June and
November, 1998. While we believe our restructurings were appropriate given our
anticipated levels of net sales, there can be no assurance that such measures
will be sufficient and that additional restructurings will not be necessary,
or that the June and November 1998 Restructurings, or future restructurings
will not have a material adverse effect on our ability to increase net sales.
13
We believe that period-to-period comparisons of our results of operations
are not necessarily meaningful and should not be relied upon as indicators of
future performance. Quarterly results in the future may fluctuate due to the
factors discussed above or other factors.
Customer Concentration
There are a relatively small number of data storage manufacturers throughout
the world and we derive a significant portion of our net sales from a
relatively small number of customers. We expect that our dependence on
relatively few key customers will continue in the future. Approximately 57.9%
of our net sales were derived from sales to our three largest customers for
the three months ended March 31, 1999. Even though our customer mix will
likely change from period to period in the future, for the three months ended
March 31, 1999, Seagate, Komag and Read-Rite accounted for 32.6%, 13.4% and
11.9% of net sales, respectively. If net sales to these or any of our other
significant customers were to decrease in any material amount in the future,
our business, operating results and financial condition would be materially
adversely affected.
Results of Operations
Net Sales
Net sales consist primarily of revenue from sales of our process and
production-test equipment and, to a lesser extent, related upgrades, parts and
services. Net sales decreased 64.9% from $32.5 million for the first quarter
of 1998 to $11.4 million for the first quarter of 1999. This decrease was
primarily due to decreased unit sales of our products due to the adverse
market conditions in the data storage industry.
Gross Profit
Cost of sales includes material costs, direct labor and overhead costs
related to the production and installation of our products, including warranty
and other service costs. Gross profit decreased from $12.9 million for the
first quarter of 1998 to $1.8 million for the first quarter of 1999. Gross
profit as a percentage of net sales ("gross margin") decreased from 39.6% for
the first quarter of 1998 to 15.6% for the first quarter of 1999. The decrease
was primarily due to (1) higher unit costs resulting from lower production
volumes, (2) underutilization of manufacturing capacity, and (3) lower gross
profit on products shipped in connection with the settlement agreement
discussed below
In April 1998, we entered into a settlement agreement to reimburse a major
customer for costs incurred in connection with the customer's cancellation of
a contract with a third party to purchase upgrades to certain production test
equipment originally purchased from us. We took this action to protect our
intellectual property and preserve a valued customer relationship. We
concluded that such action was necessary in order to discourage further
unauthorized use of our intellectual property in the future by this or other
third parties. We made the reimbursement provided for under the settlement
agreement by providing a credit to the customer for products purchased by the
customer. Products purchased under the settlement agreement were at favorable
pricing which negatively impacted our gross profit margin during the first
quarter of 1999.
We are unable to control with any degree of certainty our product sales
volume, linearity or mix from period to period and therefore our gross margin
in future periods may fluctuate from those achieved in past periods. In any
period when we experience an unfavorable product sales volume, linearity or
mix and/or provide significant volume pricing discounts or provision for
warranty costs, our gross margin may decrease.
Research and Development Expense
Research and development expense consists primarily of salaries and related
costs of personnel and consultants, project materials and other costs
associated with our ongoing research and product development. Research and
development expense decreased from $9.5 million for the first quarter of 1998
to $6.4 million for
14
the first quarter of 1999. Research and development expense as a percentage of
net sales increased from 29.1% for the first quarter of 1998 to 56.3% for the
first quarter of 1999. The percentage increase was primarily due to the
decrease in net sales, partially offset by a decrease in personnel costs as a
result of workforce reductions in connection with the June and November 1998
restructurings, along with a decrease in project material costs. We anticipate
that we will continue to devote a significant amount of financial resources to
research and development for the foreseeable future.
Selling, General and Administrative Expense
Selling, general and administrative expense consists primarily of salaries
and related costs of personnel and professional services, including certain
acquisition related earnout costs. Selling, general and administrative expense
decreased from $4.5 million for the first quarter of 1998 to $3.0 million for
the first quarter of 1999. Selling, general and administrative expense as a
percentage of net sales increased from 13.7% for the first quarter of 1998 to
26.4% for the first quarter of 1999. This percentage increase was primarily
due to the decrease in net sales, partially offset by a decrease in personnel
costs as a result of workforce reductions in connection with the June and
November 1998 restructurings, as well as a decrease in the provision for
doubtful accounts.
Amortization of Intangible Assets
Amortization of intangible assets decreased from $1.6 million for the first
quarter of 1998 to $0.1 million for the first quarter of 1999. This decrease
was due to intangible assets becoming fully amortized.
Interest Expense
Interest expense for the first quarter of 1998 and 1999 relates primarily to
interest incurred on the senior and subordinated notes.
Other (Income) Expense, Net
Other (income) expense was $0.1 million for the first quarter of 1998 as
compared to $(0.3) million for the first quarter of 1999. In the first quarter
of 1999, the amount consisted primarily of earnings on invested funds.
Income Taxes
Income tax benefit was $2.7 million for the first quarter of 1998 and none
for the first quarter of 1999. For the first quarter of 1998, the effective
income tax rate differed from the applicable statutory rate due primarily to
utilization of income tax credits available for research and development
expenses.
Extraordinary Loss, Net of Income Taxes
Extraordinary loss, net of income taxes, was $0.9 million for the first
quarter of 1998, and consisted of the write-off of unamortized debt issuance
costs in connection with the January 30, 1998 repayment of debt outstanding
under our then-existing credit agreements.
Liquidity and Capital Resources
We have financed our capital requirements through sales of common and
preferred stock, and borrowings under senior and subordinated notes, as well
as term and revolving credit facilities. Our principal requirements for cash
are operating costs, debt service, working capital and capital expenditures.
As of March 31, 1999, our outstanding indebtedness included $105.7 million
of senior notes, net of $4.3 million of unamortized debt issuance costs, $8.0
million of convertible subordinated notes and $2.5 million of capital lease
obligations. At March 31, 1999, we had $1.9 million and $7.3 million of
accrued interest
15
outstanding on the senior notes and convertible subordinated notes,
respectively. The convertible subordinated notes, including all accrued
interest, are convertible into 5,142,720 shares of common stock at the option
of the holders and will automatically convert upon a public equity offering.
As of the date of this filing, we do not have a working capital credit
facility in place.
The senior notes and the related indenture do not contain ongoing quarterly
or annual financial covenant requirements but do contain customary covenants
restricting our ability to, among other things, incur additional indebtedness,
create liens or other encumbrances, pay dividends or make other restricted
payments, make investments, loans and guarantees or sell or otherwise dispose
of a substantial portion of assets to, or merge or consolidate with, another
entity.
Cash used for operating activities was $4.7 million and $6.3 million for the
three months ended March 31, 1998 and 1999, respectively. Period to period
fluctuations in operations impacting these amounts were a larger net loss, a
decrease in depreciation and amortization, a decrease in deferred income
taxes, a decrease in extraordinary loss, a smaller increase in accounts
receivable, smaller decreases in inventories and income taxes receivable,
decreases in prepaid expenses, other assets and accounts payable and a smaller
decrease in customer deposits, accrued expenses and other liabilities.
Cash used for investing activities was $0.8 million for the first quarter of
1998 and $0.4 million for the first quarter of 1999 and consisted of
acquisition of property, plant and equipment, net of proceeds from sale of
property, plant and equipment. Cash provided by (used for) financing
activities was $3.3 million for the first quarter of 1998 and $(0.3) million
for the first quarter of 1999. In the first quarter of 1998, financing
activities consisted primarily of the issuance of senior notes, and repayment
of borrowings under our previous term notes and revolving loans. In the first
quarter of 1999, financing activities consisted of payments on capital lease
obligations.
Based on currently available information, and subject to the success of our
working capital and inventory management, we believe that our available cash
and cash generated from operations will be adequate to fund our operations
through 1999. While operating activities may provide cash in certain periods
depending on the timing of any recovery in demand for our products, we may
require additional sources of financing. We may also from time to time
consider additional acquisitions of complementary businesses, products or
technologies, which may require additional financing. Additional sources of
funding could include additional debt and/or equity financings. However, we
continue to have limited capital resources and significant future obligations,
including our future principal and interest payments under the senior notes.
The existence of certain restrictive covenants in the indenture for the senior
notes may inhibit our ability to raise additional financing. There can be no
assurance we will be able to obtain alternative sources of financing on
favorable terms, if at all, at such time or times as we may require such
capital. See "Risk Factors--Because We Have a Substantial Amount of
Indebtedness, We May Be Unable to Pay Interest or Principal on The Senior
Notes."
16
RISK FACTORS
Because We Have a Substantial Indebtedness, We May Be Unable to Pay Interest
or Principal on The Senior Notes
At March 31, 1999, we had indebtedness of $116.1 million. Subject to certain
limitations, we may also incur additional indebtedness in the future under the
terms of the indenture related to the senior notes. Our ability to make
scheduled payments of principal and interest on, or to refinance, our
indebtedness (including the senior notes), and to fund our operations,
including planned capital expenditures and research and development expenses,
depends on our future performance and financial results, which, to a certain
extent, are subject to general conditions in the data storage industry as well
as general economic, financial, competitive and other factors that are beyond
our control. For the three months ended March 31, 1999, earnings were
inadequate to cover fixed charges by $11.7 million.
Over the past several quarters, the data storage industry and the production
and process-test equipment industry have been experiencing significant
weakness in demand for products, intense competition and pricing erosion, and
overcapacity. Such adverse market conditions have resulted, and may continue
to result in, the deferral or cancellation of orders for our products. Delays
or declines in product orders have had a material adverse effect on our
operating results and financial condition over the last several quarters and
fluctuations in demand for our products are expected to continue for the
foreseeable future. We cannot be certain that our business will generate
adequate cash flow or that any growth can be achieved under current or future
market conditions. If we are unable to generate sufficient cash flow from
operations to pay our debts and operate our business, including making
necessary capital expenditures, we may be required to refinance all or a
portion of our existing debt, including the senior notes, to sell assets or to
obtain additional financing. We cannot be certain that any such action would
be accomplished on acceptable terms.
Our high level of debt will have several important effects on our future
operations, including, but not limited to:
. making it more difficult for us to satisfy our obligations with
respect to the Senior Notes;
. increasing our vulnerability to general adverse economic and industry
conditions;
. limiting our ability to obtain additional financing to fund future
working capital, capital expenditures, research and development and
other general corporate requirements;
. requiring a substantial portion of our cash flow from operations to
pay the principal of, and interest on, our indebtedness, thereby
reducing the availability of such cash flow to fund working capital,
capital expenditures, research and development or other operating
needs and uses; and
. limiting our flexibility in planning for, or reacting to, changes in
our business.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources."
Existing Financing Covenants Impose Restrictions on Our Operations Which We
May Not Be Able to Comply With Due to Reasons Beyond Our Control
The indenture related to the senior notes contains a number of covenants
that significantly restrict our operations, such as our ability to:
. incur indebtedness;
. make prepayments of certain indebtedness;
. pay dividends;
. make investments;
. engage in transactions with stockholders and affiliates;
17
. create liens;
. sell assets; and
. engage in mergers and other consolidations.
We cannot be certain that we will be able to comply with such covenants or
restrictions in the future. Our ability to comply with such covenants and
restrictions may be affected by events beyond our control, including
prevailing economic and financial conditions and general conditions in the
data storage industry.
Proceeds May Become Unavailable to Make Payments to Holders of the Notes Due
to Senior Rights of Other Existing and Future Indebtedness
As of March 31, 1999, the senior notes and the note guarantees were
effectively subordinated to approximately $2.5 million of secured indebtedness
under our capital lease obligations.
If we incur any additional senior indebtedness in the future that is not
subordinated to the indebtedness outstanding under the senior notes, even if
such indebtedness were not secured, the holder of such debt would be entitled
to share ratably with the holders of the senior notes in any proceeds
distributed in connection with any insolvency, liquidation, reorganization,
dissolution or other winding-up of our business. This may have the effect of
reducing the amount of proceeds available to pay to holders of the Senior
Notes upon the occurrence of any such events.
We Have Experienced Significant Losses
We had a net loss of approximately $10.8 million for the three months ended
March 31, 1999. Such loss and accrual of certain preferred stock dividends and
accretion for the redemption value and dividends of such preferred stock have
contributed to a retained deficit of approximately $114.9 million as of March
31, 1999. In addition, we used cash for operating activities of approximately
$6.3 million for the three months ended March 31, 1999. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Our Operating Results are Subject to Wide Variations and Continued Losses
In the past, we have experienced wide fluctuations in our quarterly and
annual operating results and have experienced net losses for the past several
quarters. We may continue to experience net losses and fluctuations in our
business due to a number of factors, not all of which are in our control.
These factors include, without limitation, the following:
. the continuing downturn in the data storage industry;
. the size, timing and rescheduling or cancellation of orders from, and
shipments to, major customers;
. the timing of introductions of our new products and product
enhancements or our competitors' introduction of such products;
. our ability to develop, introduce and market new, technologically
advanced products;
. the cyclicality of the data storage industry;
. the rescheduling or cancellation of capital expenditures by our
customers;
. variations in our customer base and product mix;
. the level of any of our significant volume pricing discounts;
. the availability and cost of key production materials and components;
. our ability to effectively manage our inventory and control costs;
. the financial stability of our major customers;
. personnel changes;
. expenses associated with acquisitions;
. restructurings;
. fluctuations in amortization and write-downs of intangible assets;
and
18
. foreign currency exchange rate fluctuations and general economic
factors in the United States and certain foreign countries, including
Japan, South Korea, Singapore, Malaysia and other parts of Southeast
Asia.
Quarterly results in the future may fluctuate due to the factors discussed
above or other factors. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Dependence on and Cyclicality of Data Storage Industry May Lead to Continued
Losses
Our business depends almost entirely upon capital expenditures by our
customers, which in turn depend upon market demand for their products. Our
industry is cyclical and historically has experienced varying growth rates and
periods of oversupply like the one currently being experienced causing higher
than anticipated inventory levels and intense price competition. The data
storage industry is currently experiencing one of its most severe and
prolonged downturns with continuing weakness in demand for products, intense
competition, significant price erosion and overcapacity. As a result of this
downturn, there is significantly reduced demand for our products. The current
downturn in the disk storage industry generally, and the slowdown in our
customers' orders in the last several quarters has had a material adverse
effect on our business, operating results and financial condition. It is
likely that this downturn in our market will continue for the foreseeable
future and, as a result, our customers will likely continue to delay or cancel
orders for our products and our business, operating results and financial
condition will be materially adversely affected. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
We Have Had to Restructure Operations and May Have to Again in the Future
In light of the continued downturn in the data storage industry, and our
expectation that the data storage industry's adverse market conditions will
extend for the foreseeable future, we implemented two restructurings of our
operations in June and November, 1998. While we believe our cost-cutting
measures were appropriate given our anticipated levels of net sales, there can
be no assurance that such measures will be sufficient and that additional
cost-cutting measures will not be necessary, or that the June and November
1998 Restructurings, or future cost-cutting measures will not have a material
adverse effect on our ability to increase its net sales.
If We Are Not Able to Adapt to Rapid Technological Change, We May Lose
Customers
Rapid technological changes and evolving industry standards characterize the
data storage industry. Our customers frequently introduce new products and
enhancements, with relatively short product life cycles, typically between
nine and 18 months. In addition, our customers often develop multiple products
simultaneously, such that new products could be introduced as frequently as
every three months. Our customers' new product introductions typically result
in new technological challenges for us, both with respect to our installed
base and with respect to our next generation products. As a result, we must
continue to enhance our existing products and develop and manufacture new
products with improved capabilities. These technological changes require us to
make substantial investments in research and development. Although we
continually develop new products, there can be no assurance that we will be
able to accurately anticipate technological advances in the disk drive market
and develop products incorporating such advances in a timely manner or at all.
Our failure to develop, manufacture and market new or enhanced products, would
have a material adverse effect on our business, operating results and
financial condition. In addition, we are highly dependent on our close working
relationships with our key customers to advance our technologies. The
termination of any one of these key relationships could have a material
adverse effect on our ability to anticipate and develop necessary
technological changes to our products.
Our customers are constantly striving to improve their production processes,
including improving the manufacturing of substrates, the deposition of
material on the substrate, the finish processing of magnetic media, and head
fabrication. If our customers modify their own design and internal production
processes without our
19
products, demand for our equipment would likely decline. Further, unless we
are able to effectively respond to such changes, manufacturing process changes
for disk drives, disks and read/write heads could also have a material adverse
effect on our business, operating results and financial condition.
Future technological innovations may reduce demand for disk drives.
Competing technologies to disk drive based data storage exist, including solid
state memory (flash memory), tape memory and re-writable optical technology
(CD and DVD technology). Although the current core technology for rotating
magnetic disk drive data storage has been the predominant technology in the
industry for many years, it is likely that some day this technology will be
replaced by an alternate technology. Our products may not be adaptable to any
successor technology. Our business, operating results and financial condition
could be materially adversely affected by any significant migration toward
technology that would replace disk drives as a computer data storage medium.
Because We Depend on a Small Number of Customers, Any Decrease in Net Sales
to or a Loss of a Customer Will Have an Adverse Impact on Our Business
There are a relatively small number of data storage manufacturers throughout
the world and we derive a significant portion of our net sales from a
relatively small number of customers. We expect that our dependence on
relatively few key customers will continue in the future. Approximately 57.9%
of our net sales were derived from sales to our three largest customers for
the three months ended March 31, 1999. Even though our customer mix will
likely change from period to period in the future, for the three months ended
March 31, 1999, Seagate, Komag and Read-Rite accounted for 32.6%, 13.4% and
11.9% of net sales, respectively. If net sales to these or any of our other
significant customers were to decrease in any material amount in the future,
our business, operating results and financial condition would be materially
adversely affected.
In general, we do not enter into long-term purchase agreements with our
customers. If completed orders are not replaced on a timely basis by new
orders from the same or other customers, our net sales would be materially
adversely affected. In addition, the following could have a material adverse
effect on our business, operating results and financial condition:
. the loss of a key customer;
. any reduction, cancellation or rescheduling of an order from any key
customer, including reductions, delays or cancellations due to
customer departures from recent buying patterns; and
. economic or competitive conditions in our industry.
Any failure to collect or delay in collecting receivables could have a
material adverse effect on our business, operating results and financial
condition. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
There has been a trend toward consolidation in the disk drive industry which
may result in a change in a current customer's purchasing habits, including a
loss of the customer, a decrease in orders from that customer or a
rescheduling or cancellation of orders previously made by a customer.
Moreover, acquisitions involving existing customers may cause the
concentration of our customer revenues to increase thereby increasing our
dependence on fewer customers.
We Have a High Risk of Inventory Obsolescence Which Can Adversely Effect
Operating Results by Increasing Cost of Sales
Due to the cyclical nature of and rapid technological change in our
industry, our inventory is subject to substantial risk of obsolescence. To
address these risks, we monitor our inventories on a periodic basis and
provide inventory write-downs intended to cover these risks. Despite our
precautions, we may be required to take significant inventory charges which,
in turn, could materially and adversely affect our business, operating results
and financial condition due to the following:
. our dependence on a few customers and a limited number of product
programs for each customer;
. the magnitude of our commitment to support our customers' programs;
20
. our limited remedies in the event a customer cancels or materially
reduces one or more product orders; and
. the possibility that a customer may experience financial
difficulties.
The significant downturn in the data storage industry has negatively
impacted our operations. For example, during 1998 we recorded a $19.8 million
charge to cost of sales to write down excess and obsolete inventory. We may be
required to take additional inventory write-downs in the future due to our
inability to obtain necessary product acceptance, or due to further
cancellations by customers.
Our Industry is Highly Competitive
The disk drive process and production-test equipment industry is highly
competitive. In each of our product lines, we face substantial competition
from established merchant suppliers of process and production-test equipment,
some of which have greater financial, engineering, manufacturing, research and
development and marketing resources. For example, we face competition from
Zyratex, General Disk and Hitachi DECO for servowriters; Hitachi DECO and Sony
Techtronics for disk certifiers; Integral Solutions International for
quasi-static MR head testers; Koyo Precision Instruments, Inc. and Zygo
Corporation for flying height testers, and Technistar for automation
technology. Historically, there has also been competition from entrepreneurs
with focused market knowledge and new technology. We experience intense
competition world-wide from Hitachi DECO, a large, full-line manufacturer of
process and production-test equipment. Hitachi DECO has substantially greater
financial, technical, marketing, manufacturing, research and development and
other resources. We also experience competition from other full-line and
partial-line manufacturers of process and production-test equipment. Our
competitors may develop enhancements to, or future generations of, competitive
products that will offer price or performance features superior to our
products, or new competitors may enter our markets. Finally, as many of our
competitors are based in foreign countries, they have cost structures and
equipment prices based on foreign currencies. Accordingly, currency
fluctuations could cause our dollar-priced products to be less competitive
than our competitors' products priced in other currencies.
Many of our competitors are investing heavily in the development of new and
enhanced products aimed at applications currently addressed by our products.
We expect our competitors to continue to improve the design and performance of
their products and to introduce new products with competitive
price/performance characteristics. Competitive pressures often necessitate
price reductions which can adversely affect operating results. We will be
required to make significant investments in product development and research,
sales and marketing and ongoing customer service and support to remain
competitive. We cannot be certain that we will have sufficient resources to
continue to make such investments or that we will be able to achieve the
technological advances necessary to maintain our competitive position.
We believe that our future success will be dependent, in part, upon our
ability to compete successfully in the Japanese, South Korean and Southeast
Asian markets. Our largest competitor, Hitachi DECO, is headquartered in Japan
which gives it a competitive advantage in that market to the extent buying
decisions are influenced by Hitachi DECO's local presence. In addition, our
ability to compete in Japan, South Korea and Southeast Asia in the future is
dependent upon continuing free trade between these countries and the United
States, our continuing ability to develop in a timely manner products that
meet the technical requirements of our foreign customers and our continuing
ability to develop and maintain satisfactory relationships with leading
companies in our industry in these areas. Moreover, our sales in these areas
will be affected by the overall economies of Japan, South Korea and Southeast
Asia. To the extent that recent economic troubles in Asian markets have
negatively impacted the capacity expansion and upgrade plans of our customers
or potential customers in affected regions, then such economic troubles have
also negatively impacted our operations. With respect to existing customers,
we do not believe that such Asian economic troubles have had a significant
impact on our operations. With respect to potential customers, we are unable
to quantify the impact that such Asian economic troubles will have on our
operations.
21
In addition to the competition from our competitors, most of our customers
develop at least a portion of their own process and production-test equipment
needs internally, especially servowriters and read/write head test equipment.
Accordingly, we must compete against the internal development efforts of this
captive market. Manufacturers within this captive market are often reluctant
to change their production lines to incorporate merchant-supplied process and
production-test technology. Moreover, rapid changes in data storage
technology, and the development of new process and production-test equipment
may be so closely linked to our customers' product development cycles that
certain customers and potential customers will find it more efficient to
develop their own process and production-testing equipment needs internally,
thereby placing us at a competitive disadvantage.
Because of the foregoing competitive factors, we may not be able to compete
successfully in the future. Increased competitive pressure could cause us to
lower our prices which would have an adverse effect on our business, financial
condition and results of operations.
Because We Sell a Small Number of Products, a Reduction in Demand for Any One
of These Products May Have a Material Adverse Effect on Our Business
We have historically derived a significant portion of our net sales from a
relatively small number of products. For the three months ended March 31,
1999, we derived approximately 31.7% of our net sales from sales of our media
certifier products (excluding parts and service). Although we expect that net
sales from our media certifier products, including our MG series and our MC
series, will continue to account for a substantial portion of our total net
sales in the foreseeable future, we realize that the downturn in the data
storage industry is caused, in part, by the overcapacity of media certifiers
in the market today. Any material reduction in demand for our media certifier
products would have a material adverse effect on our business, operating
results and financial condition.
We May Not Be Able to Adequately Protect Our Proprietary Technology or May Be
Subject to Claims of Infringement
Our success is heavily dependent upon the establishment and maintenance of
proprietary technologies. We currently attempt to protect our intellectual
property rights through patents, copyrights, trade secrets and other measures.
These efforts may not be adequate to prevent misappropriation by third parties
and may not be adequate under the laws of some foreign countries which may not
protect our proprietary rights to the same extent as do laws of the United
States. Our competitors may be able to independently develop products that are
substantially equivalent or superior to our products, or design around our
patents. Any such adverse circumstances could have a material adverse effect
on our business, operating results and financial condition.
Although we do not believe any of our products or proprietary rights
infringe the rights of third parties, infringement claims may be asserted
against us in the future. Any such claims, with or without merit, could divert
the attention of management, result in costly litigation, cause product
shipment delays or require us to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on
acceptable terms, or at all. If infringement were established, we could be
required to pay damages or be enjoined from making, using or selling the
infringing product. Likewise, a third party's product, if infringing on our
proprietary rights, may not be prevented from doing so without litigation. Any
of the foregoing could have a material adverse effect on our business,
operating results and financial condition.
We cannot be certain that the claims allowed on any of our patents will be
sufficiently broad to protect our technology. Moreover, any patent we own
could be invalidated, deemed unenforceable, circumvented or challenged. Also,
we cannot be certain that our patent rights will provide us competitive
advantages or that any of our pending or future patent applications will be
issued with claims of the scope that we desire, if at all. Furthermore, others
may develop similar products, duplicate our products or design around the
patents we own.
22
In addition, foreign intellectual property laws or our agreements may not
protect our intellectual property rights in any foreign country. Any failure
to protect our intellectual property rights could have a material adverse
effect on our business, operating results and financial condition.
The Complexity and Customization of Our Products May Lead to Technical
Difficulties and Unanticipated Costs
Our products have a large number of components and are highly complex. We
have experienced and may continue to experience manufacturing delays due to
technical difficulties. In addition, many of our products must be semi-
customized to meet individual product specification requirements. The
customization of a customer order may require new technical capabilities not
previously incorporated successfully into our products. As a result, we may be
unable to complete our customers' customized development or technical
specifications in a timely manner. Any significant failure in this regard
would have a material adverse effect on our business, operating results and
financial condition as well as our customer relationships. In addition, due to
the semi-customized nature of many of our products, we have incurred and may
continue to incur substantial unanticipated costs in a product's development
and production which cannot be passed on to the customer. Such unanticipated
costs include the increased cost of components due to expediting charges,
other purchasing inefficiencies and greater than expected engineering, quality
control, installation, upgrade, post-installation service and support and
warranty costs. The occurrence of any of these events could materially
adversely affect our business, operating results and financial condition.
Dependence on a Limited Group of Suppliers May Cause Delays in Product
Delivery
In certain instances we rely on a single source or a limited group of
suppliers for certain components and subassemblies used in our products. The
partial or complete loss of these sources could have at least a temporary
material adverse effect on our results of operations and damage customer
relationships due to the complexity of the products they supply and the
significant amount of time required to qualify new suppliers. In addition,
long lead times are often required to obtain critical components and
subassemblies used in certain of our products from these and other suppliers
which could impede our ability to quickly respond to changes in demand and
product specifications.
Shortages of critical components and subassemblies used in our products have
occurred in the past and may occur in the future. Also, the availability of
materials may have longer lead times. In addition, our manufacture and timely
delivery of products is often dependent on the ability of certain suppliers to
deliver sub assemblies and other components in a timely manner. The failure of
such suppliers to deliver these components in a timely manner may delay our
product delivery until alternative sourcing may be developed. Alternative
sources may not be located in time to avoid penalties or cancellation of our
product orders. If a significant order or orders were canceled for this reason
it could have a material adverse effect on our business, operating results and
financial condition. Further, a significant increase in the price of one or
more components used to produce our products would increase our production
costs.
Risks Associated with Acquisitions
While we currently have no commitments, agreements or understandings with
respect to any future acquisitions, our business strategy includes the
expansion of our business, product lines and technology through acquisitions.
We regularly review various acquisition prospects, including companies,
technologies or products complementary to our business and periodically engage
in discussions regarding such possible acquisitions. Acquisitions involve
numerous risks, including:
. evaluating new technologies;
. difficulties in the assimilation of the operations, products,
personnel and cultures of the acquired companies;
. the ability to manage geographically remote units;
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. the diversion of management's attention from other day-to-day
business concerns;
. the risks of entering markets in which we have limited or no direct
experience;
. the potential loss of key employees of the acquired companies;
. dilutive issuances of equity securities;
. the incurrence of additional debt;
. reduction of existing cash balances; and
. amortization expenses related to goodwill and other intangible assets
and other charges to operations that may materially adversely affect
our results of operations.
Moreover, any equity or debt financings proposed in connection with any
acquisition may not be available to us on acceptable terms or at all, when,
and if, suitable strategic acquisition opportunities arise. Although
management expects to carefully analyze any opportunity before committing our
resources, there can be no assurance that any completed acquisition will
result in long-term benefits or that our management will be able to manage
effectively the resulting business.
Any Future Inability to Obtain Additional Financing Will Have a Material
Adverse Effect on Our Business
To achieve our long-term strategic objectives and maintain our competitive
position, we will need additional financial resources over the next several
years to fund acquisitions, service debt, make capital expenditures, fund
working capital and pay for research and development. We are continually
investing in new technologies and our international infrastructure and, as a
result, our fixed costs may increase in the foreseeable future, depending on
the timing of any recovery in demand for our products. Our fixed costs may
also increase if we expand our infrastructure in South Korea, Japan, other
parts of Asia, or other locations. Any liquidity deficiency in the future
could delay or change our management's plans, including curtailing our
acquisition strategy, capital expenditures, facilities expansion and research
and development expenditures, which could materially adversely affect our
ability to pay our debts and our business, operating results and financial
condition. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources."
Because We are Subject to Many Environmental Regulations, Any Violation Will
Subject Us to Significant Liabilities
We are subject to a variety of governmental regulations relating to the use,
storage, discharge, handling, emission, generation, manufacture, treatment and
disposal of toxic or other hazardous substances, chemicals, materials or
waste. We believe that we are in compliance, in all material respects, with
such regulations. Any failure to comply with current or future regulations
could result in civil penalties or criminal fines being imposed upon us, or
our officers, directors or employees, suspension of production, alteration of
our manufacturing process or cessation of operations. Such regulations could
require expensive remediation or abatement actions to comply with
environmental regulations. Any failure to properly manage the use, disposal or
storage of, or adequately restrict the release of, hazardous or toxic
substances could subject us to significant liabilities.
Risks Related to the "Year 2000" Issue May Lead to Unanticipated Losses
Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or create erroneous results. We are in the
process of assessing the readiness of our internal systems and our products
for handling the Year 2000 issue. Our ongoing assessment includes
identification of exposures, repair or replacement of deficient systems,
testing, implementation and contingency planning. Based on the assessments
performed to date, we believe that all of our critical internal systems are
Year 2000 ready. We are continuing to monitor the Year 2000 readiness of our
products, including our installed base of products. If it is ultimately
determined that any of our installed base of products have Year 2000 readiness
issues, we currently plan to offer to our customers upgrades for certain of
such products. To date, we have not incurred any material costs in connection
with our assessment of our Year 2000 readiness. We
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do not believe that the costs of any actions required as a result of our
assessment to date will have a material adverse effect on our business,
operating results or financial condition. There can be no assurance, however,
that we will successfully implement the correct solutions or that there will
be no delay in or increased costs associated with our Year 2000 readiness. Our
inability to successfully implement such changes could have a material adverse
effect on our business, operating results or financial condition. In addition,
there can be no assurance that our critical product and service providers, and
their critical providers and so on, are or will become Year 2000 ready on a
timely basis. The failure of such critical product and service providers and
integrated information systems to be or become Year 2000 ready could have a
material adverse effect on our business, operating results or financial
condition. In addition, it is possible that our revenue may be adversely
affected if current and prospective customers direct their spending resources
away from purchasing our products over the next two years in order to correct
or replace information systems which are not Year 2000 ready.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes during the three months ended March 31,
1999.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There have been no material developments in the legal proceeding as
previously reported in the Company's 1998 Annual Report on Form 10-K.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)Exhibits
Financial Data Schedule
(b)Reports on Form 8-K
Not applicable
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PHASE METRICS, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHASE METRICS, INC.
(Registrant)
By: /s/ BRAD LALUZERNE
---------------------------------
Brad LaLuzerne,
Vice President, Finance, Chief
Financial Officer and Assistant
Secretary
Date: May 14, 1999
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