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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
----------------
For the Quarter Ended September 30, 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
September 30, 1999 are as follows:
Common Stock.............................................. 5,619,138 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 SEPTEMBER 30, 1999
INDEX
PART I. FINANCIAL INFORMATION
Page
----
ITEM 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of December 31, 1998
and September 30, 1999.......................................... 3
Condensed Consolidated Statements of Operations for the three
and nine months ended September 30, 1998 and 1999............... 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 1998 and 1999........................ 5
Notes to Unaudited Condensed Consolidated Financial Statements.. 6
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 9
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk...... 23
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings............................................... 23
ITEM 2. Changes in Securities........................................... 23
ITEM 3. Defaults Upon Senior Securities................................. 23
ITEM 4. Submission of Matters to a Vote of Security Holders............. 23
ITEM 5 Other Information............................................... 23
ITEM 6. Exhibits and Reports on Form 8-K................................ 23
Signatures.............................................................. 24
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHASE METRICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31, September 30,
1998 1999
------------ -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents................ $ 24,714 $ 6,908
Accounts receivable, net................. 13,577 5,032
Inventories.............................. 25,222 15,141
Prepaid expenses and other............... 2,189 1,272
Income taxes receivable.................. 6,062 --
--------- ---------
Total current assets................... 71,764 28,353
Property, plant and equipment, net......... 17,793 11,553
Intangible and other assets................ 6,558 5,822
--------- ---------
Total assets........................... $ 96,115 $ 45,728
========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable......................... $ 6,682 $ 2,308
Accrued expenses and other liabilities... 16,966 10,039
Customer deposits........................ 859 1,401
Current portion of debt.................. 1,374 1,222
--------- ---------
Total current liabilities.............. 25,881 14,970
Long-term liabilities:
Long-term debt........................... 107,257 106,652
Convertible subordinated notes........... 8,000 8,000
Accrued expenses and interest............ 9,591 10,290
Series B redeemable preferred stock........ 11,331 11,885
Series C redeemable preferred stock........ 31,212 33,402
Stockholders' deficit:
Series A preferred stock................. 3 3
Common stock............................. 6,498 6,799
Retained deficit......................... (103,298) (145,658)
Accumulated other comprehensive loss..... (360) (615)
--------- ---------
Total stockholders' deficit............ (97,157) (139,471)
--------- ---------
Total liabilities, redeemable preferred
stock and stockholders' deficit........... $ 96,115 $ 45,728
========= =========
See accompanying notes to unaudited condensed consolidated financial
statements.
3
PHASE METRICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1998 1999 1998 1999
-------- -------- -------- --------
Net sales............................. $ 22,432 $ 6,633 $ 86,334 $ 26,493
Cost of sales......................... 20,084 5,304 72,556 26,149
-------- -------- -------- --------
Gross profit........................ 2,348 1,329 13,778 344
Operating expenses:
Research and development............ 7,850 5,620 27,008 18,789
Selling, general and
administrative..................... 3,832 2,940 13,518 9,207
Amortization of intangibles......... 89 93 3,369 279
Settlement charge................... -- -- 5,872 --
Restructuring charge................ -- -- 3,046 1,995
-------- -------- -------- --------
Total operating expenses.......... 11,771 8,653 52,813 30,270
-------- -------- -------- --------
Loss from operations.................. (9,423) (7,324) (39,035) (29,926)
Interest expense...................... 3,621 3,408 10,822 10,206
Other (income) expense, net........... (349) (57) (229) (516)
-------- -------- -------- --------
Loss before income taxes and
extraordinary items.................. (12,695) (10,675) (49,628) (39,616)
Income tax expense.................... -- -- 8,701 0
-------- -------- -------- --------
Loss before extraordinary items....... (12,695) (10,675) (58,329) (39,616)
Extraordinary loss, net of income
taxes................................ 404 -- 1,345 0
-------- -------- -------- --------
Net loss.............................. $(13,099) $(10,675) $(59,674) $(39,616)
======== ======== ======== ========
Accretion for redemption value and
dividends on Series B and C
redeemable preferred stock........... (1,103) (948) (2,216) (2,744)
-------- -------- -------- --------
Net loss attributable to common
stockholders......................... $(14,202) $(11,623) $(61,890) $(42,360)
======== ======== ======== ========
See accompanying notes to unaudited condensed consolidated financial
statements.
4
PHASE METRICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
Nine months ended
September 30,
------------------
1998 1999
-------- --------
OPERATING ACTIVITIES:
Net cash provided by (used for) operating activities..... $ (8,483) $(16,253)
-------- --------
INVESTING ACTIVITIES:
Acquisition of property, plant and equipment............. (1,406) (934)
Proceeds from sale of property plant and equipment....... -- 328
Other.................................................... (182) --
-------- --------
Net cash used for investing activities................. (1,588) (606)
-------- --------
FINANCING ACTIVITIES:
Proceeds from senior notes............................... 110,000 --
Repayment of term notes.................................. (79,200) --
Revolving loans--net..................................... (30,700) --
Payment of debt issuance costs........................... (4,968) --
Payments on capital lease obligation..................... (766) (974)
Issuance (repurchase) of common stock.................... (9) 2
Proceeds from issuance of preferred stock................ 30,020 --
-------- --------
Net cash provided by (used for) financing activities..... 24,377 (972)
-------- --------
Effect of exchange rate changes on cash and cash
equivalents............................................. (26) 25
-------- --------
Net increase (decrease) in cash and cash equivalents..... 14,280 (17,806)
Cash and cash equivalents, beginning of period........... 2,977 24,714
-------- --------
Cash and cash equivalents, end of period................. $ 17,257 $ 6,908
======== ========
See accompanying notes to unaudited condensed consolidated financial
statements.
5
PHASE METRICS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 and nine months ended September 30, 1999 are
not necessarily indicative of the results that may be expected for the 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, September 30,
1998 1999
------------ -------------
Raw materials and components.................... $ 10,611 $ 8,710
Work-in-process................................. 4,903 2,810
Finished goods.................................. 9,708 3,621
-------- --------
$ 25,222 $ 15,141
======== ========
Note 3. Property, Plant and Equipment
December 31, September 30,
1998 1999
------------ -------------
Equipment and furniture......................... $ 32,753 $ 31,211
Leasehold improvements.......................... 5,500 5,462
Construction in progress........................ 171 122
-------- --------
38,424 36,795
Accumulated depreciation and amortization......... (20,631) (25,242)
-------- --------
$ 17,793 $ 11,553
======== ========
Note 4. Restructuring Charge
The data storage industry has experienced prolonged and significant weakness
in demand for data storage products, intense competition and pricing erosion,
and overcapacity. Such adverse market conditions have resulted, and may in the
future result, in the delay, deferral or cancellation of orders and
fluctuation in demand for our products. These adverse market conditons have
had a material adverse effect on our results of operations and financial
condition over the last several quarters and are expected to continue through
1999 and beyond. In June 1999, we consolidated a significant portion of our
Fremont facilities. In July 1999 we implemented a workforce reduction of
approximately 25 employees. While we believe our cost-cutting measures are
appropriate given the current and 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 any current or future
cost-cutting measures will not have a material adverse effect on our ability
to increase net sales.
6
PHASE METRICS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In the second quarter of 1998, we recorded $3.0 million of restructuring
charges. The significant components included $0.9 million for employee
severance costs, $2.0 million in asset impairment costs related to property,
plant and equipment obsoleted due to restructuring activities, and $0.1
million of other costs. In the second quarter of 1999, we recorded $2.0
million of restructuring charges. The significant components included
$0.7 million for future lease costs of consolidated facilities and $1.3
million in asset impairment costs related to facilities consolidation. As of
September 30, 1999, $0.6 million was recorded as an accrued liability related
to the restructuring activities.
Note 5. Commitments and Contingencies
Letter of Credit--As of December 31, 1998 and September 30, 1999, the
Company had a letter of credit outstanding to a third party beneficiary
totaling $2.1 and $2.0 million, respectively. The letter of credit is secured
by a certificate of deposit included in non-current assets on the accompanying
condensed consolidated balance sheet.
Note 6. Comprehensive Loss
The components of comprehensive loss are as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ------------------
1998 1999 1998 1999
--------- --------- -------- --------
Net loss......................... $ (13,099) $ (10,675) $(59,674) $(39,616)
Foreign currency translation
adjustments..................... 119 336 69 (255)
--------- --------- -------- --------
Comprehensive loss............... $ (12,980) $ (10,339) $(59,605) $(39,871)
========= ========= ======== ========
Note 7. Industry and Geographic Information
The Company operates in one reportable segment. Sales to customers outside
the United States (primarily Asia) totaled approximately 44% and 54% of net
sales for the nine months ended September 30, 1998 and 1999, respectively. As
of December 31, 1998 and September 30, 1999, balances due from foreign
customers (primarily located in Asia) were $4.0 million and $3.6 million,
respectively.
The Company had sales to individual customers in excess of 10% of net sales,
as follows:
Nine Months Ended
September 30,
-----------------
1998 1999
-------- --------
Customer:
A....................................................... 14% 32%
B....................................................... -- 11%
C....................................................... 20% --
D....................................................... 17% --
As of December 31, 1998 and September 30, 1999, accounts receivable from
individual customers with balances due in excess of 10% of total accounts
receivable totaled $12.3 million (5 customers) and $2.9 million (2 customers),
respectively.
7
PHASE METRICS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following presents net sales and long-lived assets by geographic
territory:
Long-Lived Assets Net Sales
-------------------------- -------------------------------
Nine Months Ended September 30,
December 31, September 30, -------------------------------
1998 1999 1998 1999
------------ ------------- --------------- ---------------
United States
operations:
Domestic.............. $23,589 $16,604 $48,713 $12,109
Foreign............... -- -- 30,779 9,785
Asia operations......... 762 771 6,842 4,599
------- ------- ------- -------
Total................... $24,351 $17,375 $86,334 $26,493
======= ======= ======= =======
Note 8. Reclassifications
Certain prior year amounts have been reclassified to conform with the current
period presentation.
8
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 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 has experienced prolonged and 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 and fluctuations in demand for
our products. These adverse market conditions have had a material adverse
effect on our operating results and financial condition over the last several
quarters and are expected to continue through 1999 and beyond. 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.
In October 1999, we implemented plans to further consolidate our Fremont and
Concord facilities, and we implemented a workforce reduction of approximately
22 employees. While we believe our cost-cutting measures are appropriate given
the current and 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 any current or future cost-cutting
measures will not have a material adverse effect on our ability to increase
net sales.
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
9
on relatively few key customers will continue in the future. Approximately
50.3% of our net sales were derived from sales to our three largest customers
for the nine months ended September 30, 1999. Even though our customer mix
will likely change from period to period in the future, for the nine months
ended September 30, 1999, Seagate, Read-Rite and Nissho Iwai accounted for
31.6%, 10.5% and 9.0% 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 71% from $22.4 million for the third quarter of
1998 to $6.6 million for the third quarter of 1999 and decreased 69% from
$86.3 million for the nine months ended September 30, 1998 to $26.5 million
for the nine months ended September 30, 1999. These decreases were 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 $2.3 million for the
third quarter of 1998 to $1.3 million for the third quarter of 1999 and from
$13.8 million for the nine months ended September 30, 1998 to $0.3 million for
the nine months ended September 30, 1999. Gross profit as a percentage of net
sales ("gross margin") increased from 10.5% for the third quarter of 1998 to
20.0% for the third quarter of 1999, and decreased from 16.0% for the nine
months ended September 30, 1998 to 1.3% for the nine months ended September
30, 1999. These changes were primarily due to higher unit costs resulting from
lower production volumes and underutilization of manufacturing capacity,
partially offset by an inventory write down of $1.3 million in the third
quarter of 1998 and inventory write downs of $14.8 million as compared to $5.0
million for the nine months ended Sepember 30, 1998 and 1999, respectively,
and lower gross profit on products shipped in 1998 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 through 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 $7.9 million for the third quarter of 1998
to $5.6 million for the third quarter of 1999 and from $27.0 million for the
nine months ended September 30, 1998 to $18.8 million for the nine months
ended September 30, 1999. Research and development expense as a percentage of
net sales increased from 35.0% for the third quarter of 1998 to 84.7% for the
third quarter of 1999, and from 31.3% for
10
the nine months ended September 30, 1998 to 70.9% for the nine months ended
September 30, 1999. These percentage increases were primarily due to the
decrease in net sales, partially offset by a decrease in personnel costs as a
result of workforce reductions, including those 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 $3.8 million for the third quarter of 1998 to $2.9 million for
the third quarter of 1999 and from $13.5 million for the nine months ended
September 30, 1998 to $9.2 million for the nine months ended September 30,
1999. Selling, general and administrative expense as a percentage of net sales
increased from 17.1% for the third quarter of 1998 to 44.3% for the third
quarter of 1999 and from 15.7% for the nine months ended September 30, 1998 to
34.8% for the nine months ended September 30, 1999. These percentage increases
were primarily due to the decrease in net sales, partially offset by a
decrease in personnel costs as a result of workforce reductions, including
those in connection with the June and November 1998 restructurings.
Amortization of Intangible Assets
Amortization of intangible assets was $0.1 million in the third quarter of
1998 and 1999. Amortization decreased from $3.4 million for the nine months
ended September 30, 1998 to $0.3 million for the nine months ended September
30, 1999. This decrease was due to intangible assets becoming fully amortized.
Settlement Charge
In connection with the Settlement Agreement, discussed under "Results of
Operations Gross Profit," the Company recorded a $5.9 million charge to
earnings in the second quarter of 1998.
Restructuring Charge
The data storage industry has experienced prolonged and significant weakness
in demand for data storage products, intense competition and pricing erosion,
and overcapacity. Such adverse market conditions have resulted, and may in the
future result, in the delay, deferral or cancellation of orders and
fluctuation in demand for our products. These adverse market conditions have
had a material adverse effect on our results of operations and financial
condition over the last several quarters and are expected to continue through
1999 and beyond. In June 1998 we implemented a workforce reduction of
approximately 115 employees, relocated and consolidated much of our Concord,
California operations to our Fremont, California facility and consolidated our
San Diego, California facility. In June 1999, we consolidated a significant
portion of our Fremont facilities. In July 1999 we implemented a workforce
reduction of approximately 25 employees. In October, 1999, we implemented
plans to further consolidate our Fremont and Concord facilities and we
implemented a workforce reduction of approximately 22 employees. While we
believe our cost-cutting measures are appropriate given the current and
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 any current or future cost-cutting measures will not have a
material adverse effect on our ability to increase net sales.
In the second quarter of 1998, we recorded $3.0 million of restructuring
charges. The significant components included $0.9 million for employee
severance costs, $2.0 million in asset impairment costs related to property,
plant and equipment obsoleted due to restructuring activities, and $0.1
million of other costs. In the second quarter of 1999, we recorded $2.0
million of restructuring charges. The significant components included
$0.7 million for future lease costs of consolidated facilities and $1.3
million in asset impairment costs related to facilities consolidation. As of
September 30, 1999, $0.6 million was recorded as an accrued liability related
to the restructuring activities.
11
Interest Expense
Interest expense for the third quarters of 1998 and 1999 and the nine months
ended September 30, 1998 and 1999 relates primarily to interest incurred on
the senior and subordinated notes.
Other (Income) Expense, Net
Other (income) expense was $(0.3) million for the third quarter of 1998
compared to $(0.1) million for the third quarter of 1999 and $(0.2) million
for the nine months ended September 30, 1998 compared to ($0.5) million for
the nine months ended September 30, 1999. The amounts consist primarily of
earnings on invested funds.
Income Taxes
There was no income tax expense for the third quarters of 1998 and 1999.
Income tax expense was $8.7 million for the nine months ended September 30,
1998 and none for the nine months ended September 30, 1999.
For the nine months ended September 30, 1998, the effective income tax rate
differed from the applicable statutory rate due primarily to the charge taken
in the second quarter of 1998 for a valuation allowance against our entire
deferred tax asset balance. Such charge was taken due to factors which gave
rise to uncertainty as to whether the net deferred tax asset was realizable,
including the lack of history of consistent earnings and the significant
losses in the second and third quarters of 1998.
Extraordinary Loss, Net of Income Taxes
Extraordinary loss, net of income taxes, was $0.4 million for the third
quarter of 1998 and $1.3 million for the nine months ended September 30, 1998,
and consisted of the write-off of unamortized debt issuance costs in
connection with the January 30, 1998 and August 4, 1998 repayments 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 September 30, 1999, our outstanding indebtedness included $106.0
million of senior notes, net of $4.0 million of unamortized debt issuance
costs, $8.0 million of convertible subordinated notes and $1.8 million of
capital lease obligations. At September 30, 1999, we had $1.9 million and $7.8
million of accrued interest 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 increased from $8.5 million to $16.3
million for the nine months ended September 30, 1998 and 1999, respectively.
Period to period fluctuations in operations impacting this increase were a
smaller net loss for the nine months ended September 30, 1999, decreases in
depreciation and amortization, deferred income taxes and extraordinary loss, a
loss on disposal of property, plant and equipment
12
in 1998 as compared to a gain in 1999, a larger decrease in accounts
receivable, a smaller decrease in inventories, increases in prepaid expenses,
other assets, and income taxes receivable in 1998 compared to decreases in
1999, and decreases in accounts payable, customer deposits, accrued expenses
and other liabilities.
Cash used for investing activities was $1.6 million and $0.6 million for the
nine months ended September 30, 1998 and 1999, and consisted of acquisition of
property, plant and equipment, net of proceeds from the sale of property,
plant and equipment. Cash provided by (used for) financing activities was
$24.4 million for the nine months ended September 30, 1998 and $(1.0) million
for the nine months ended September 30, 1999. For the nine months ended
September 30, 1998, financing activities consisted primarily of the issuance
of senior notes and repayment of borrowings under our previous term notes and
revolving loans. For the nine months ended September 30, 1999, financing
activities consisted primarily 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."
13
RISK FACTORS
Because We Have Substantial Indebtedness, We May Be Unable to Pay Interest or
Principal on The Senior Notes
At September 30, 1999, we had indebtedness of $115.8 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 and nine months ended September 30, 1999, earnings
were inadequate to cover fixed charges by $11.6 million and $42.4 million,
respectively.
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 years 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;
. create liens;
. sell assets; and
. engage in mergers and other consolidations.
14
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 September 30, 1999, the Senior Notes and the note guarantees were
effectively subordinated to approximately $1.8 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 net losses of approximately $10.7 million and $39.6 million for the
three and nine months ended September 30, 1999. Such losses 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 $145.7 million as of September 30, 1999. In addition, we used
cash for operating activities of approximately $16.3 million for the nine
months ended September 30, 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
. 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."
15
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
The data storage industry has experienced prolonged and significant weakness
in demand for data storage products, intense competition and pricing erosion,
and overcapacity. Such adverse market conditions have resulted, and may in the
future result, in the delay, deferral or cancellation of orders and
fluctuation in demand for our products. These adverse market conditons have
had a material adverse effect on our results of operations and financial
condition over the last several quarters and are expected to continue through
1999 and beyond. In June 1998 we implemented a workforce reduction of
approximately 115 employees, relocated and consolidated much of our Concord,
California operations to our Fremont, California facility and consolidated our
San Diego, California facility. In June 1999, we consolidated a significant
portion of our Fremont facilities. In July 1999 we implemented a workforce
reduction of approximately 25 employees. In October, 1999, we implemented
plans to further consolidate our Fremont and Concord facilities and we
implemented a workforce reduction of approximately 22 employees. While we
believe our cost-cutting measures are appropriate given the current and
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 any current or future cost-cutting measures will not have a
material adverse effect on our ability to increase net sales.
In the second quarter of 1998, we recorded $3.0 million of restructuring
charges. The significant components included $0.9 million for employee
severance costs, $2.0 million in asset impairment costs related to property,
plant and equipment obsoleted due to restructuring activities, and $0.1
million of other costs. In the second quarter of 1999, we recorded $2.0
million of restructuring charges. The significant components included
$0.7 million for future lease costs of consolidated facilities and $1.3
million in asset impairment costs related to facilities consolidation. As of
September 30, 1999, $0.6 million was recorded as an accrued liability related
to the restructuring activities.
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.
16
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 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 a Significant Negative 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 50.3%
of our net sales were derived from sales to our three largest customers for
the nine months ended September 30, 1999. Even though our customer mix will
likely change from period to period in the future, for the nine months ended
September 30, 1999, Seagate, Read-Rite, and Nissho Iwai accounted for 31.6%,
10.5% and 9.0% 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 Affect
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
17
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;
. 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 the three months ended June 30,
1999 we recorded a $5.0 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 worldwide 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 products in a timely manner
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
18
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.
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 Significant Negative Effect on Our Business
We have historically derived a significant portion of our net sales from a
relatively small number of products. For the nine months ended September 30,
1999, we derived approximately 22.6% 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 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.
19
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 manufacturing process
and timely delivery of products is often dependent on the ability of certain
suppliers to deliver subassemblies 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;
. the diversion of management's attention from other day-to-day
business concerns;
20
. 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
effectively manage the resulting business.
Any Future Inability to Obtain Additional Financing Will Have a Significant
Negative 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.
Because We Depend on Key Personnel, The Loss of Any One of Them Could Have A
Material Adverse Effect on Our Business
Our future performance depends in significant part upon the continued
service of our chief executive officer, other senior management personnel and
our key technical personnel. We are dependent on our ability to identify,
hire, train, retain and motivate high quality personnel, especially highly
skilled engineers involved in the ongoing developments required to develop and
enhance our products and introduce new and enhanced future products and
applications. Our industry is characterized by a high level of employee
mobility and aggressive recruiting of skilled personnel. Our employees may
terminate their employment at any time. Accordingly, there can be no assurance
that any of our current employees will continue to work for us. The loss of
key employees could have a material adverse effect on our business, operating
results and financial condition. We have an employment agreement with our
chief executive officer, but we do not maintain key-man life insurance with
respect to such individual. The employment agreement is terminable at will by
either party upon 30-days written notice and contains a covenant not to
compete during the term of the agreement and for two years thereafter.
21
Our International Operations are Subject to Inherent Risks
Our sales and operating activities outside of the United States are subject
to inherent risks, including:
. fluctuations in the value of the United States dollar relative to
foreign currencies;
. tariffs;
. quotas;
. taxes and other market barriers;
. political, economic and monetary instability;
. restrictions on the export or import of technology;
. potentially limited intellectual property protection;
. difficulties in staffing and managing international operations; and
. potentially adverse tax consequences.
These factors could have a material adverse effect on our business,
operating results or financial condition. In addition, although substantially
all of our export sales to date have been denominated in United States
dollars, such sales may not be denominated in dollars in the future. As a
result, currency exchange fluctuations in countries where we conduct business
could have a material adverse effect on our business, operating results and
financial condition. In this regard, several Asian countries, including South
Korea, Japan and Thailand, have recently experienced significant economic
downturns and significant declines in the value of their currencies relative
to the U.S. dollar. Due to these conditions, some of our customers may delay,
reschedule or cancel significant current or future product orders. If any such
orders are delayed, rescheduled or cancelled, our business, operating results
and financial condition would be adversely affected. 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.
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 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 nine months ended September
30, 1999.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Phase Metrics is subject to various legal matters in the normal course of its
business. While the results of litigation and claims cannot be predicted with
certainty, Phase Metrics believes that the final outcome of these other matters
will not have a material adverse effect on its business, operating results or
financial condition.
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)
/s/ Dewey Hockemeyer
By:__________________________________
Dewey Hockemeyer
Vice President, Finance, Chief
Financial Officer
and Assistant Secretary
Date: November 15, 1999
24