SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended Commission file number: 0-15895
June 30, 1999
- -------------
DIGITAL MICROWAVE CORPORATION
---------------------------------------------------
(Exact name of registrant specified in its charter)
DELAWARE 77-0016028
- --------------------------------- ----------------------
(State or other jurisdiction (IRS employer
of incorporation or organization) identification number)
170 ROSE ORCHARD WAY
SAN JOSE, CA 95134
- --------------------------------- ---------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (408) 943-0777
---------------------
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 outstanding shares of the Registrant's common stock, par value
$.01 per share, was 63,890,557 on August 6, 1999.
INDEX
PAGE
COVER PAGE 1
INDEX 2
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6-11
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 12-18
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 18
PART II - OTHER INFORMATION
Item 4 - Submission of Matters to a Vote of Security Holders 19
Item 5 - Other Information 19
Item 6 - Exhibits and Reports on Form 8-K 19
SIGNATURE 21
Page 2 of 21
PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
DIGITAL MICROWAVE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
June 30, 1999 March 31, 1999
----------------------- -----------------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 17,461 $ 21,518
Short-term investments 5,923 5,745
Accounts receivable, net 75,659 60,253
Inventories 46,922 50,610
Deferred tax asset 2,901 3,009
Other current assets 7,793 12,827
----------------------- -----------------------
TOTAL CURRENT ASSETS 156,659 153,962
PROPERTY AND EQUIPMENT, NET 42,216 43,025
OTHER ASSETS 5,037 5,177
----------------------- -----------------------
TOTAL ASSETS $ 203,912 $ 202,164
----------------------- -----------------------
----------------------- -----------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 888 $ 725
Current maturities of capital lease obligations 686 862
Accounts payable 29,646 25,116
Income taxes payable 1,388 1,399
Accrued liabilities 36,002 40,613
----------------------- -----------------------
TOTAL CURRENT LIABILITIES 68,610 68,715
LONG-TERM LIABILITIES:
Long-term debt, net of current portion 1,733 1,896
Capital lease obligations, net of current maturities 306 340
----------------------- -----------------------
TOTAL LIABILITIES 70,649 70,951
----------------------- -----------------------
STOCKHOLDERS' EQUITY
Common stock and paid-in capital 253,291 251,135
Accumulated deficit (115,264) (115,424)
Accumulated other comprehensive loss (4,764) (4,498)
----------------------- -----------------------
TOTAL STOCKHOLDERS' EQUITY 133,263 131,213
----------------------- -----------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 203,912 $ 202,164
----------------------- -----------------------
----------------------- -----------------------
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
Page 3 of 21
DIGITAL MICROWAVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATION
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended
June 30,
-------------------------------------------
1999 1998
-------------------- --------------------
NET SALES $ 65,954 $ 63,211
Cost of sales 47,837 49,502
-------------------- --------------------
GROSS PROFIT 18,117 13,709
-------------------- --------------------
OPERATING EXPENSES:
Research and development 5,768 6,583
Selling, general and administrative 11,513 16,272
Merger and restructuring charges - 7,213
-------------------- --------------------
TOTAL OPERATING EXPENSES 17,281 30,068
-------------------- --------------------
OPERATING INCOME (LOSS) 836 (16,359)
OTHER INCOME (EXPENSE):
Interest income 247 417
Interest expense (245) (31)
Other income(expense), net (638) 519
-------------------- --------------------
TOTAL OTHER INCOME (EXPENSE), NET (636) 905
-------------------- --------------------
INCOME (LOSS) BEFORE INCOME TAXES 200 (15,454)
Provision for income taxes 40 28
-------------------- --------------------
NET INCOME (LOSS) $ 160 $ (15,482)
-------------------- --------------------
-------------------- --------------------
BASIC EARNINGS (LOSS) PER SHARE $ 0.00 $ (0.25)
-------------------- --------------------
-------------------- --------------------
DILUTED EARNINGS (LOSS) PER SHARE $ 0.00 $ (0.25)
-------------------- --------------------
-------------------- --------------------
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 62,886 61,351
Impact of diluted stock options and warrants 5,174 -
-------------------- --------------------
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 68,060 61,351
-------------------- --------------------
-------------------- --------------------
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
Page 4 of 21
DIGITAL MICROWAVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(In thousands)
(Unaudited)
Three Months Ended
June 30,
--------------------------------------
1999 1998
----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 160 $ (15,482)
Adjustments to reconcile net income (loss) to net cash
used for operating activities:
Adjustment to conform year-end of pooled company - 1,804
Depreciation and amortization 4,874 4,712
Provision for uncollectable accounts 201 1,838
Provision for inventory reserves 270 2,210
Provision for warranty reserves 1,968 1,975
Changes in assets and liabilities:
Decrease (increase) in accounts receivable (15,570) 10,351
Decrease (increase) in inventories 3,325 (18,057)
Decrease (increase) in other assets 5,844 (110)
Increase in accounts payable 4,574 663
Decrease in income tax payable (11) (565)
Decrease in other accrued liabilities (6,576) (7,734)
----------------- -----------------
NET CASH USED FOR OPERATING ACTIVITIES (941) (18,395)
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of available-for-sale securities (1,142) (6,042)
Proceeds from available-for-sale securities 964 27,723
Proceeds from sale of other assets - 461
Purchase of property and equipment (4,694) (12,829)
----------------- -----------------
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES (4,872) 9,313
----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of capital lease obligations (210) (698)
Proceeds from sale of Common Stock 2,126 351
----------------- -----------------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 1,916 (347)
----------------- -----------------
Effect of exchange rate changes in cash (160) 956
----------------- -----------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (4,057) (8,473)
Cash and cash equivalents at beginning of period 21,518 27,585
----------------- -----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 17,461 $ 19,112
----------------- -----------------
----------------- -----------------
SUPPLEMENTAL DATA
Interest paid 220 716
Income taxes paid - 27
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Page 5 of 21
DIGITAL MICROWAVE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of
Digital Microwave Corporation and its wholly owned subsidiaries.
Intercompany accounts and transactions have been eliminated. Prior-year
reported results have been restated to reflect the October 1998 merger
with Innova Corporation ("Innova").
While the financial information furnished is unaudited, the financial
statements included in this report reflect all adjustments (consisting
only of normal recurring adjustments) which the Company considers
necessary for a fair presentation of the results of operations for the
interim periods covered and of the financial condition of the Company at
the date of the interim balance sheet. The results for interim periods
are not necessarily indicative of the results for the entire year. The
condensed consolidated financial statements should be read in connection
with the Digital Microwave Corporation financial statements included in
the Company's annual report and Form 10-K for the fiscal year ended March
31, 1999.
CASH AND CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid debt instruments with an original maturity of
three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or
market where cost includes material, labor and manufacturing overhead.
Inventories consist of (in thousands):
June 30, 1999 March 31, 1999
------------- --------------
(Unaudited)
Raw materials $23,587 $25,616
Work in process 11,276 9,537
Finished goods 12,059 15,457
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$46,922 $50,610
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-------- -------
OTHER ASSETS
Included in other assets are goodwill and other intangibles which are
being amortized on a straight line basis over their useful lives
ranging from 5 to 10 years, as well as minority investments accounted
for using the cost method of accounting.
Page 6 of 21
RESTRUCTURING COSTS
Merger and restructuring charges of $29.9 million were recorded in
Fiscal 1999, of which $7.2 million was recorded in the first quarter of
Fiscal 1999 and consisted of $5.8 million related to the discontinuance
of several internal information technology systems projects and $1.4
million for severance and related costs associated with a reduction in
the Company's workforce. Total Fiscal 1999 charges consisted of $2.7
million for investment banker, legal, and accounting fees related to
the Innova merger consummated in October 1998, $4.2 million for
severance costs, $4.1 million for facility termination costs, a
write-off of $5.8 million related to the discontinuance of several
projects related to the implementation of software purchased for
internal use, and a write-off of goodwill and certain assets related to
the Company's subsidiary, Granger, Inc., totaling $13.1 million. The
assets of Granger, Inc. were sold in March 1999. Approximately $12.2
million of the $29.9 million in merger and restructuring charges will
be a cash outflow, of which $9.0 million has been paid as of June 30,
1999. The remaining amounts are expected to be paid before the end of
Fiscal 2000, and consist of $0.7 million for severance costs, $1.8
million for facility termination costs, and $0.8 million for purchased
commitments of software.
CURRENCY TRANSLATION
The functional currency of the Company's subsidiaries located in the
United Kingdom and Latin America is the U.S. dollar. Accordingly, all
of the monetary assets and liabilities of these subsidiaries are
remeasured into U.S. dollars at the current exchange rate as of the
applicable balance sheet date, and all non-monetary assets and
liabilities are remeasured at historical rates. Sales and expenses are
remeasured at the average exchange rate prevailing during the period.
Gains and losses resulting from the remeasurement of the subsidiaries'
financial statements are included in the Consolidated Statements of
Operations. The Company's other international subsidiaries use their
local currency as their functional currency. Assets and liabilities of
these subsidiaries are translated at the exchange rates in effect at
the balance sheet date, and income and expense accounts are translated
at the average exchange rates during the year. The resulting
translation adjustments are recorded directly to a separate component
of stockholders' equity.
FINANCIAL INSTRUMENTS
The Company enters into forward foreign exchange contracts to hedge
some of its firm committed backlog and certain assets and liabilities
denominated in foreign currencies. At June 30, 1999, the Company had
forward foreign exchange contracts to exchange various foreign
currencies for U.S. dollars in the gross amount of $38.3 million.
Market value gains and losses on forward foreign exchange contracts are
recognized as offsets to the exchange gains or losses on the hedged
transactions.
Page 7 of 21
NET INCOME (LOSS) PER SHARE
The Financial Accounting Standards Board (the "FASB") issued Statement
on Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per
Share." Under SFAS 128, basic earnings per share are computed by
dividing net income by the weighted average number of common shares
outstanding during the period. Diluted earnings per share are computed
by dividing net income by the weighted average number of common shares
and potentially dilutive securities outstanding during the period. Net
loss per share is computed using only the weighted average number of
common shares outstanding during the period, as the inclusion of
potentially dilutive securities would be anti-dilutive.
MERGERS AND ACQUISITIONS
In October 1998, stockholders approved the issuance of Common Stock of
the Company pursuant to an agreement to merge with Innova Corporation
("Innova"), a Washington corporation, which designs, manufactures,
markets, and supports digital microwave radio links for the worldwide
telecommunications market. Under the terms of the agreement, the
Company exchanged 1.05 shares of its Common Stock for each outstanding
share of Innova stock, stock options, and warrants. The Company issued
approximately 14.7 million shares to Innova shareholders upon
consummation of the merger. The combination qualified as a tax-free
reorganization accounted for as a pooling-of-interests transaction.
Accordingly, the historical financial statements of the Company have
been restated to reflect the results of Innova for all periods
presented.
The following table shows the reconciliation of the historical results
of the Company to the results presented in the accompanying Statements
of Operations for the quarter ended June 30, 1998 (in thousands).
Revenue:
Digital Microwave $ 53,003
Innova 10,208
Intercompany sales -
---------
Total $ 63,211
---------
---------
Net Income:
Digital Microwave $(13,962)
Innova (1,520)
Intercompany profit eliminations -
---------
Total $(15,482)
---------
---------
LITIGATION AND CONTINGENCIES
The Company is subject to legal proceedings and claims that arise in
the normal course of its business. In the opinion of management, these
proceedings will not have a material adverse effect on the financial
position and results of operations of the Company.
Page 8 of 21
CONCENTRATION OF CREDIT RISK
Trade receivables concentrated with certain customers primarily in the
telecommunications industry and in certain geographic locations
potentially subject the Company to concentration of credit risk. In
addition to sales in Western Europe and North America, the Company
actively markets and sells products in Asia, Eastern Europe, South
America, the Middle East and Africa. The Company performs on-going
credit evaluations of its customers' financial conditions and generally
requires no collateral, although sales to Asia, Eastern Europe, South
America, the Middle East and Africa are primarily paid through letters
of credit. During Fiscal 1999, the Company wrote off a $2.7 million
receivable related to an Asian customer that filed for bankruptcy
protection.
COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement on Financial Accounting
Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income," which
establishes standards for reporting and display of comprehensive income
and its components (revenue, expenses, gains and losses) in a full set
of general-purpose financial statements. The following table reconciles
comprehensive income under the provisions of SFAS 130 for the three
months ended June 30, 1999 and 1998 (in thousands).
For the Three Months Ended
June 30,
---------------------------
1999 1998
------ ---------
Net income (loss) $ 160 $(15,482)
Other comprehensive loss, net of tax
Unrealized currency loss (257) (2,176)
Unrealized holding loss on short-term investments (9) -
------- --------
Comprehensive loss $ (106) $(17,658)
------- --------
------- --------
NEW ACCOUNTING PRONOUNCEMENTS
In February 1998, the American Institute of Certified Public
Accountants issued Statement of Position (SOP) 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use,"
which is effective for fiscal years beginning after December 15, 1998.
This SOP requires capitalization of certain costs incurred in the
development of internal-use software, including external direct
material and service costs, employee payroll and payroll-related costs,
and interest. The Company has adopted of SOP 98-1 for the fiscal year
ending March 31, 2000. The adoption will not have a material effect on
the Company's financial statements.
Page 9 of 21
In June 1998, the FASB issued Financial Accounting Standards No. 133
("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities," which establishes standards for the reporting and display
of comprehensive income and its components in general purpose financial
statements. SFAS 133 is effective for companies with fiscal years
beginning after June 15, 2000. SFAS 133 requires the Company to
recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through
income. If the derivative is a hedge, depending on the nature of the
hedge, changes in the fair value of derivatives will either be offset
against the change in fair value of the hedged assets, liabilities or
firm commitments through earnings, or recognized in other comprehensive
income until the hedged item is recognized in earnings. The Company
believes that the adoption of this new pronouncement will not have a
material effect on the Company's financial statements.
OPERATING SEGMENT AND GEOGRAPHIC INFORMATION
The Company is organized into two operating segments; Products and
Services. The Chief Executive Officer has been identified as the Chief
Operating Decision-Maker as defined by SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information." Resources are
allocated to each of these groups using information on their revenues
and operating profits before interest and taxes.
The products operating segment includes the SPECTRUM II, XP4, DART,
Altium and digital microwave systems for digital transmission markets
and designs, develops, and manufactures these products in Seattle,
Washington; San Jose, California; and, Wellington, New Zealand. The
Services operating segment includes, but is not limited to
installation, repair, network design, path surveys, integration, and
other services.
The following table sets forth revenues and operating profit (loss)
by operating segments for the quarters ended June 30 (in thousands):
1999 1998
---- ----
Products:
Revenues $62,641 $57,194
Operating profit (loss) 796 (15,515)
Services:
Revenues 3,313 6,017
Operating profit (loss) 40 (844)
Total:
Revenues $65,954 $63,211
Operating profit (loss) 836 (16,359)
Page 10 of 21
The following table sets forth revenues from unaffiliated customers by
product for the quarters ended June 30 (in thousands):
1999 1998
----- ----
SPECTRUM II $29,520 $30,789
XP4 13,074 10,208
DXR 11,008 5,020
Altium 5,242 520
Quantum 408 2,743
M-Series 338 1,714
Other Products 3,051 6,200
------- -------
Total Products 62,641 57,194
Total Services 3,313 6,017
------- -------
Total Revenue $65,954 $63,211
------- -------
------- -------
The following table sets forth revenues from unaffiliated customers by
geographic region for the quarters ended June 30 (in thousands):
1999 1998
---- ----
United States $11,855 $9,541
Other Americas 7,567 11,598
Europe 18,739 26,745
Africa 7,263 1,555
China 11,435 2,573
Other Asia/Pacific 9,095 11,199
------ -------
Total Revenue $65,954 $63,211
------ -------
------ -------
Long-lived assets by country and consisting of net property and
equipment was as follows (in thousands):
June 30, 1999 March 31, 1999
------------- --------------
United States $27,820 $28,043
United Kingdom 11,001 11,621
Other foreign countries 3,395 3,361
------- -------
Total property and equipment, net $42,216 $43,025
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Page 11 of 21
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following table sets forth the percentage relationships of certain items
from the Company's Condensed Consolidated Statements of Operations as
percentages of net sales:
Three Months Ended
June 30,
-----------------------
1999 1998
----- -----
Net sales 100.0% 100.0%
Cost of sales 72.5 78.3
----- -----
Gross profit 27.5 21.7
Research & development 8.7 10.4
Selling, general & administrative 17.5 25.8
Restructuring costs - 11.4
----- -----
Operating income (loss) 1.3 (25.9)
Other income (expense), net (1.0) 1.4
----- ------
Income (loss) before provision for income taxes 0.3 (24.5)
Provision for income taxes 0.1 0.0
----- -----
Net income (loss) 0.2% (24.5)%
----- -----
----- -----
Net sales for the first quarter of Fiscal 2000 were $66.0 million, compared to
$63.2 million reported in the same quarter of Fiscal 1999. The increase in net
sales was primarily due to increased sales of the Altium (TM) and DXR product
lines. Sales in the Asia/Pacific region increased 49% to $20.5 million in the
first quarter of Fiscal 2000 compared to $13.8 million in the same quarter of
Fiscal 1999. Sales to China, included in the Asia/Pacific region, were $11.4
million in the first quarter of Fiscal 2000 and $2.6 million in the comparable
quarter of the prior year. The Company also saw a substantial increase in sales
in Africa, $7.3 million in the first quarter of Fiscal 2000 compared to $1.6
million in the first quarter of Fiscal 1999. The Company experienced sales
declines in Europe, $18.7 million in the first quarter of Fiscal 2000 compared
to $26.7 million in the first quarter of Fiscal 1999. Sales decreased slightly
in the Americas, $19.4 million in the first quarter of Fiscal 2000 compared to
$21.1 million in the first quarter of Fiscal 1999. Sales to U.S. customers,
included in the Americas region, were $11.9 million in the first quarter of
Fiscal 2000 compared to $9.5 million in the first quarter of Fiscal 1999.
During the first quarter of Fiscal 2000, the Company received $67.8 million in
new orders shippable over the next twelve months, compared to $54.3 million in
the first quarter of Fiscal 1999, an increase of 25%. Twelve-month backlog at
June 30, 1999 was $65.7 million, compared to $63.9 million at March 31, 1999.
Page 12 of 21
The Company includes in its backlog purchase orders with respect to which a
delivery schedule has been specified for product shipment within one year.
Orders in the Company's current backlog are subject to changes in delivery
schedules or to cancellation at the option of the purchaser without significant
penalty. Accordingly, although useful for scheduling production, backlog as of
any particular date may not be a reliable measure of sales for any future
period.
Gross profit as a percentage of net sales for the first quarter of Fiscal 2000
was 27.5% compared to 21.7% in the same quarter of Fiscal 1999. The increase in
gross profit was primarily the result of improved manufacturing capacity
utilization.
Research and development expenses decreased by $0.8 million, to $5.8 million in
the first quarter of Fiscal 2000 from $6.6 million in the same period in Fiscal
1999. As a percentage of net sales, research and development expenses were 8.7%
in the first quarter of Fiscal 2000 compared to 10.4% in the first quarter of
Fiscal 1999. Such decrease was due primarily to workforce reductions in the
first and third quarters of Fiscal 1999. See page 7, "Notes to Condensed
Consolidated Financial Statements - Restructuring Costs." Research and
development expense in the first quarter of Fiscal 2000 was primarily for
further development of the Altium product line. The Company remains committed to
continuing its new product rollouts in order to maintain and enhance its
competitive position.
Selling, general and administrative expenses decreased to $11.5 million in the
first quarter of Fiscal 2000 from $16.3 million in the first quarter of Fiscal
1999. As a percentage of net sales, selling, general and administrative expenses
were 17.5% in the first quarter of Fiscal 2000 compared to 25.5% in the
comparable quarter of Fiscal 1999. The decrease in selling, general and
administrative expenses in absolute dollars was attributable to workforce
reductions and other cost initiatives taken in the first and third quarters of
Fiscal 1999. See page 7, " Notes to Condensed Consolidated Financial Statements
- - Restructuring Costs."
The restructuring costs of $7.2 million in the first quarter of Fiscal 1999
consisted of a write off of $5.8 million related to the discontinuance of
several internal information technology ("IT") systems projects and $1.4 million
for severance and related costs associated with a reduction in the Company's
workforce. See page 7, " Notes to Condensed Consolidated Financial Statements
Restructuring Costs."
Interest income decreased to $0.2 million in the first quarter of Fiscal 2000
from $0.4 million in the similar quarter of Fiscal 1999. This decrease was due
primarily to lower average cash balances available for investing. The increase
in interest expense in the first quarter of Fiscal 2000 was primarily
attributable to higher debt balances as compared to the same quarter of the
prior year. Other income (expense), net changed to $0.6 million income in the
first quarter of Fiscal 2000 from $0.5 million expense in the first quarter of
Fiscal 1999 primarily due to foreign exchange gains and losses.
In the first quarter of Fiscal 2000, the Company recorded a provision for income
taxes at less than the statutory rate primarily due to the anticipated
utilization of net operating loss carry forwards in Fiscal 2000. The Company did
not record a tax benefit in the first quarter of Fiscal 1999, as it could not be
certain of profitability in Fiscal 1999.
Page 13 of 21
LIQUIDITY AND CAPITAL RESOURCES
Net cash used for operating activities in the first quarter of Fiscal 2000 was
$0.9 million, compared to net cash used for operating activities of $18.4
million in the first quarter of Fiscal 1999. The decline in cash used for
operations was primarily the result of a substantial net loss for the first
quarter of Fiscal 1999 compared to net income for the first quarter of Fiscal
2000. In addition, inventories decreased $3.3 million in the first quarter of
Fiscal 2000 compared to an increase of $18.1 million in the same period of
Fiscal 1999 as a result of improved inventory management.
Accounts receivable increased $15.6 million in the first quarter of Fiscal 2000
due to some extended payment terms and the timing of shipments as 55% of the
Company's shipments occurred in the last month of the quarter.
Purchases of property and equipment decreased to $4.7 million in the first
quarter of Fiscal 2000 from $12.8 million in the first quarter of Fiscal 2000
and was mostly attributable to test equipment purchases by the Company's Seattle
manufacturing location and payments on the Company's new manufacturing facility
in the United Kingdom in the first quarter of Fiscal 1999. Partially offsetting
cash used for operating activities and investing activities, the Company
received $2.1 million from the exercise of employee stock options and warrants.
At June 30, 1999, the Company's principal sources of liquidity consisted of
$23.4 million in cash and cash equivalents and short-term investments and a
$40.0 million asset-based borrowing facility with a U.S. lender. As of June 30,
1999, based on certain calculations, approximately $33.1 million was available
for borrowing under this agreement, of which $2.6 million was outstanding. This
credit facility does not require the maintenance of financial covenants.
In the future, the Company may require additional financing from other sources,
however, there can be no assurance that the Company will be able to obtain such
additional financing in the required time frame on commercially reasonable
terms, or at all. Management has implemented plans to reduce the Company's cash
requirements through a combination of reductions in working capital, equipment
purchases and operating expenditures. Management believes that such plans
combined with existing cash balances and other sources of liquidity will enable
the Company to meet its cash requirements through Fiscal 2000. However, there
can be no assurance that the Company will be able to implement these plans or
that it will be able to do so without a material adverse effect on the Company's
business, financial results or results of operations.
YEAR 2000 READINESS
The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. The "Year 2000" problem
is concerned with whether computer systems will properly recognize date
sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Year 2000 problem is pervasive and complex, as virtually
every company's computer operation will be affected in some way. The Company's
computer programs, which process its operational and financial transactions,
were designed and developed without considering the impact of the upcoming
change in century. If not corrected, the
Page 14 of 21
Company's computer programs and products could fail or create erroneous
results by or at the year 2000.
The Company is taking steps to ensure that its products and computer programs
will continue to operate on and after January 1, 2000. The Company formed a
project team consisting of staff from Manufacturing, Customer Service, Finance,
Human Resources, Sales, Marketing, Legal, Engineering, and Information
Technology (IT) departments, led by a project manager. A five-phase solution
process has been established consisting of (1) awareness, (2) assessment, (3)
renovation, (4) validation, and (5) implementation. The Company has
substantially completed this five-phase process with respect to most of its Year
2000 issues. The remaining open issues consist of completing major vendor site
reviews and contingency plans for each major location. The Company's Year 2000
project team identified its manufacturing IT system as its highest priority and
has implemented Year 2000 upgrades to its manufacturing systems. The Company's
network operating systems also are Year 2000-ready. The Company's personal
computers have been evaluated and upgrades were installed to correct
noncompliance. Some older personal computers were replaced or taken out of
service.
The Company has completed an assessment of most of its products. Most of its
hardware products are not affected by the Year 2000 issue because no internal
clock exists in these products. Year 2000 readiness testing has been completed
for newer products, including the Altium product line and network software
products. Some older network software products are not Year 2000-ready, and the
Company has developed an upgrade plan for customers who are using this software.
The Company mailed letters to its primary suppliers and subcontractors to
determine whether they are developing plans to address processing transactions
in the Year 2000 and to monitor their progress toward Year 2000 capability.
Approximately 50% of the vendors contacted have responded, and the Year 2000
team is currently arranging site visits with critical vendors to ensure that
processes are actually in place as represented.
The Company believes that it will expend approximately $0.8 million
investigating and remedying issues related to Year 2000 readiness involving
internal operations. Approximately $0.3 million has been expensed to date for
purchases of software test tools, software upgrades, and upgrading a security
system related to Year 2000 readiness. In addition, the Company estimates that
$0.3 million of internal personnel costs have been incurred to date supporting
the Company's Year 2000 readiness plan.
If systems critical to the Company's operations have not been made Year
2000-ready by the completion of the project, the Year 2000 issue could have a
material adverse effect on the Company's financial statements. The Company is
currently developing a contingency plan to operate in the event that any
noncompliant critical systems are not remedied by January 1, 2000. The Company
expects to finalize its contingency plan by September 30, 1999.
Based on the steps being taken to address this issue and the progress to date,
the Company's management believes that the Year 2000 readiness expenses will not
have a material adverse effect on the Company's earnings. However, there can be
no assurance that Year 2000 problems will not occur with respect to the
Company's computer systems. Furthermore, the Year 2000 problem may impact other
entities with which the Company transacts business, and the Company cannot
predict the effect of the Year 2000 problem on such entities or the resulting
effect on the
Page 15 of 21
Company. As a result, if preventative and/or corrective actions by the
Company or those the Company does business with are not made in a timely
manner, the Year 2000 issue could have a material adverse effect on the
Company's business, financial condition, and results of operations.
EUROPEAN MONETARY UNION
In January 1999, a new currency called the "euro" was introduced in certain
Economic and Monetary Union ("EMU") countries. During 2002, all EMU countries
are expected to be operating with the euro as their single currency. Uncertainty
exists as to the effect the euro currency will have on the marketplace.
Additionally, all of the rules and regulations have not yet been defined and
finalized by the European Commission with regard to the euro currency. However,
the Company has assessed the effect the euro formation will have on its internal
systems and the sale of its products. The Company's European sales and operating
transactions are based primarily in U.S. dollars or U.K. pounds sterling,
neither of which are subject to the euro conversion. While the Company does have
some sales denominated in the European Currency Unit, this currency is
successfully being converted in the market to the new European Monetary Unit at
parity. In addition, the Company upgraded its internal computer systems to
convert the European currency to the euro. The cost of upgrading the Company's
systems in connection with the euro conversion was not material and no material
adverse effect on the Company's business, financial condition, and results of
operations is expected due to the upgrade.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
It is Digital Microwave's policy not to enter into derivative financial
instruments except for hedging of foreign currency exposures. The Company hedges
certain portions of its exposure to foreign currency fluctuations through the
use of forward foreign exchange contracts. The Company enters into forward
foreign exchange contracts for purposes other than trading; however, the Company
does not engage in any foreign currency speculation. Forward foreign exchange
contracts represent agreements to buy or sell a specified amount of foreign
currency at a specified price in the future. These contracts generally have
maturities that do not exceed one month. At June 30, 1999, the Company had
forward foreign exchange contracts to exchange various foreign currencies for
U.S. dollars in the aggregate amount of $38.3 million, primarily in New Zealand
dollars, British pounds, and European Monetary Units. Gains and losses
associated with currency rate changes on forward foreign exchange contracts are
recorded currently in income as they offset corresponding gains and losses on
the foreign currency-denominated assets and liabilities being hedged. Therefore,
the carrying value of forward foreign exchange contracts approximates their fair
value. The Company believes that the credit risk with respect to its forward
foreign exchange contracts is minimal because the Company enters into contracts
with major financial institutions. Market risk with respect to forward foreign
exchange contracts is offset by the corresponding exposure related to the
underlying assets and liabilities.
FOREIGN CURRENCY RATE RISK
Although nearly all of Digital Microwave's sales and expenses are denominated in
U.S. dollars, Digital Microwave has experienced some foreign exchange gains and
losses to date, and expects to incur additional gains and losses in Fiscal 2000.
Digital Microwave did engage in foreign currency hedging activities during the
quarter ended June 30, 1999, as explained above, and intends to continue doing
so as needed.
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FACTORS THAT MAY AFFECT FUTURE FINANCIAL RESULTS
The statements in this Form 10-Q concerning the Company's future products,
expenses, revenues, gross margins, liquidity and cash needs, as well as the
Company's plans and strategies, contain forward-looking statements concerning
the Company's future operations and financial results within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. These
forward-looking statements are based on current expectations and the Company
assumes no obligation to update this information. Numerous factors, such as
economic and competitive conditions, timing and volume of incoming orders,
shipment volumes, product margins, and foreign exchange rates, could cause
actual results to differ materially from those described in these statements,
and prospective investors and stockholders should carefully consider the factors
set forth below in evaluating these forward-looking statements.
Sales of the Company's products are concentrated in a small number of customers.
For the first quarter ended June 30, 1999, the top three customers accounted for
29% of the net sales. As of June 30, 1999, three of the Company's customers
accounted for 28% of the backlog. The worldwide telecommunications industry is
dominated by a small number of large corporations, and the Company expects that
a significant portion of its future product sales will continue to be
concentrated in a limited number of customers. The loss of any existing
customer, a significant reduction in the level of sales to any existing
customer, or the failure of the Company to gain additional customers could have
a material adverse effect on the Company's business, financial condition and
results of operations. In addition, a substantial portion of shipments may occur
near the end of each quarter. Accordingly, the Company's results are difficult
to predict and delays in product delivery or closing of a sale can cause
revenues and net income to fluctuate significantly from anticipated levels and
from quarter to quarter.
Manufacturers of digital microwave telecommunications equipment are
experiencing, and are likely to continue to experience, intense price pressure
which has resulted, and is expected to continue to result, in downward pricing
pressure on the Company's products. As a result, the Company has experienced,
and expects to continue to experience, declining average sales prices for its
products. The Company's ability to maintain its gross profit margins is
dependent upon its ability and to continue to introduce new products and product
enhancements. Any inability of the Company to respond to increased price
competition would have a material adverse effect on the Company's business,
financial condition and results of operations.
The markets for the Company's products are extremely competitive, and the
Company expects that competition will increase. The Company's existing and
potential competitors include established and emerging companies, such as, L.M.
Ericsson, Siemens AG, Microwave Communications Division of Harris Corporation,
P-COM, Alcatel, Nokia, NERA, NEC, and SIAE, many of which have more extensive
engineering, manufacturing, and marketing capabilities and significantly greater
financial, technical, and personnel resources than the Company. The Company
believes that its ability to compete successfully will depend on a number of
factors, both within and outside its control, including price, quality,
availability, customer service and support, breadth of product line, product
performance and features, rapid delivery, reliability, timing of new product
introductions by the Company, its customers and its competitors, and the ability
of its customers to obtain financing.
Page 17 of 21
The Company expects that international sales will continue to account for the
majority of its net product sales for the foreseeable future. As a result, the
Company is subject to the risks of doing business internationally, including
unexpected changes in regulatory requirements, fluctuations in foreign currency
exchange rates, such as recently experienced in Asia, imposition of tariffs and
other barriers and restrictions, the burdens of complying with a variety of
foreign laws, and general economic and geopolitical conditions, including
inflation and trade relationships. In addition, recent events in Asia, including
depreciation of certain Asian currencies, failures of financial institutions,
stock market declines, and reduction in planned capital investment as key
enterprises, may continue to adversely impact the Company's revenues in Asian
markets. There can be no assurance that currency fluctuations, changes in the
rate of inflation or any of the aforementioned factors will not continue to have
a material adverse effect on the Company's business, financial condition and
results of operations.
The Company's manufacturing operations are highly dependent upon the delivery of
materials by outside suppliers in a timely manner. In addition, the Company
depends in part upon subcontractors to assemble major components and subsystems
used in its products in a timely and satisfactory manner. The Company does not
generally enter into long-term or volume purchase agreements with any of these
suppliers, and no assurance can be given that such materials, components, and
subsystems will be available in the quantities required by the Company, if at
all. The inability of the Company to develop alternative sources of supply
quickly and on a cost-effective basis could materially impair the Company's
ability to manufacture and deliver its products in a timely manner. There can be
no assurance that the Company will not experience material supply problems or
component or subsystem delays in the future.
The Company has pursued, and will continue to pursue, growth opportunities
through internal development and acquisitions of complementary businesses and
technologies. Acquisitions may involve difficulties in the retention of
personnel, diversion of management's attention, unexpected legal liabilities,
and tax and accounting issues. There can be no assurance that the Company will
be able to successfully identify suitable acquisition candidates, complete
acquisitions, integrate acquired businesses into its operations, or expand into
new markets. Once integrated, acquired businesses may not achieve comparable
levels of revenues, profitability, or productivity as the existing business of
the Company or otherwise perform as expected. The Company's failure to manage
its growth effectively could have a material adverse effect on the Company's
business, financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a description of the Company's market risks, see page 16, "Item 2 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Quantitative and Qualitative Disclosures About Market Risk."
Page 18 of 21
PART II - OTHER INFORMATION
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company held a Special Meeting of Stockholders on June 8, 1999.
(b) At the Special Meeting of Stockholders, the following matter was voted
upon:
1. A proposal to approve the adoption of the Digital Microwave
Corporation 1999 Employee Stock Purchase Plan.
Affirmative votes: 44,375,016
Negative votes: 5,575,143
Abstain: 94,032
Non-votes: 0
ITEM 5 - OTHER INFORMATION
None
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
For a list of exhibits to this Form 10-Q, see the exhibit index
located on page 20.
(b) Reports on Form 8-K
None
Page 19 of 21
EXHIBIT INDEX
Exhibit
Number Description
27.1 Financial Data Schedule for the quarter ended June 30, 1999.
27.2 Restated Financial Data Schedule for the quarter ended June 30, 1998.
Page 20 of 21
SIGNATURE
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.
DIGITAL MICROWAVE CORPORATION
Date: AUGUST 16, 1999 By /s/ Carl A. Thomsen
----------------------- --------------------------------------
Carl A. Thomsen
Senior Vice President, Chief Financial
Officer and Secretary
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