<PAGE> 1
This filing is made pursuant
to Rule 424(b)(3) under
the Securities Act of
Prospectus Supplement 1933 in connection with
(To Prospectus Dated October 19, 1998) Registration No. 333-48817
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, 1998
Commission File Number ___________
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, 1998 are as follows:
Common Stock -- 5,600,060 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
<PAGE> 2
PHASE METRICS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
<S> <C>
ITEM 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of December 31, 1997 and September 30, 1998....... 3
Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 1997 and 1998.......................................................... 4
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30,
1997 and 1998.............................................................................. 5
Notes to 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 ..................................... 22
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
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHASE METRICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
December 31, September 30,
1997 1998
------------ -------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,977 $ 17,257
Accounts receivable, net 28,730 20,983
Inventories 55,585 32,664
Prepaid expenses and other 7,131 7,727
Deferred tax assets 8,952 --
--------- ---------
Total current assets 103,375 78,631
Property, plant and equipment, net 38,023 31,445
Intangible assets, net 4,966 1,778
Deferred tax assets 5,269 --
Other 3,097 2,521
--------- ---------
Total assets $ 154,730 $ 114,375
========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 10,419 $ 8,224
Accrued expenses and other liabilities 16,058 16,911
Customer deposits 9,038 1,467
Current portion of debt 1,785 1,011
--------- ---------
Total current liabilities 37,300 27,613
Long-term liabilities:
Long-term debt 119,272 115,462
Accrued expenses and interest 6,794 9,223
Series B redeemable preferred stock 9,237 10,926
Series C redeemable preferred stock -- 30,566
Stockholders' deficit:
Series A preferred stock 3 3
Common stock 6,090 6,381
Retained deficit (23,166) (85,068)
Accumulated translation adjustments (800) (731)
--------- ---------
Total stockholders' deficit (17,873) (79,415)
--------- ---------
Total liabilities, redeemable preferred stock and
stockholders' deficit $ 154,730 $ 114,375
========= =========
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
3
<PAGE> 4
PHASE METRICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1997 1998 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net sales $ 43,923 $ 22,432 $ 148,159 $ 86,334
Cost of sales 24,243 20,084 79,551 72,556
--------- --------- --------- ---------
Gross profit 19,680 2,348 68,608 13,778
Operating expenses:
Research and development 11,017 7,850 32,668 27,008
Selling, general and administrative 5,843 3,832 18,231 13,518
Amortization and writedowns of
intangible assets 3,442 89 12,168 3,369
Settlement charge -- -- -- 5,872
Restructuring charge -- -- -- 3,046
--------- --------- --------- ---------
Total operating expenses 20,302 11,771 63,067 52,813
--------- --------- --------- ---------
Income (loss) from operations (622) (9,423) 5,541 (39,035)
Interest expense 2,881 3,621 8,274 10,822
Other (income) expense, net (37) (349) 439 (229)
--------- --------- --------- ---------
Loss before income taxes and extraordinary
items (3,466) (12,695) (3,172) (49,628)
Income tax expense (benefit) (1,040) -- (952) 8,701
--------- --------- --------- ---------
Loss before extraordinary items (2,426) (12,695) (2,220) (58,329)
Extraordinary loss, net of income taxes -- (404) -- (1,345)
--------- --------- --------- ---------
Net loss (2,426) (13,099) (2,220) (59,674)
Accretion for redemption value and
dividends on Series B and C redeemable
preferred stock (750) (1,103) (2,250) (2,216)
--------- --------- --------- ---------
Net loss attributable to common
stockholders $ (3,176) $ (14,202) $ (4,470) $ (61,890)
========= ========= ========= =========
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
4
<PAGE> 5
\
PHASE METRICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS, UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------
1997 1998
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES:
Net cash used for operating activities $ (4,037) $ (8,483)
--------- ---------
INVESTING ACTIVITIES:
Acquisition of property, plant and equipment (14,784) (1,588)
--------- ---------
Net cash used for investing activities (14,784) (1,588)
--------- ---------
FINANCING ACTIVITIES:
Proceeds from senior notes -- 110,000
Repayment of term notes (1,400) (79,200)
Net proceeds (repayment) of revolving loans 19,500 (30,700)
Payment of debt issuance costs (331) (4,968)
Payments on capital lease obligations and proceeds from
issuance of common stock, net of repurchases (591) (775)
Net proceeds from issuance of preferred stock -- 30,020
--------- ---------
Net cash provided by financing activities 17,178 24,377
--------- ---------
Effect of exchange rate changes on cash and cash
equivalents -- (26)
--------- ---------
Net increase (decrease) in cash and cash equivalents (1,643) 14,280
Cash and cash equivalents, beginning of period 2,737 2,977
--------- ---------
Cash and cash equivalents, end of period $ 1,094 $ 17,257
========= =========
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
5
<PAGE> 6
PHASE METRICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Phase
Metrics, Inc. (the "Company") have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments considered necessary for a fair presentation
(consisting of normal recurring accruals) have been included. Operating results
for the three and nine months ended September 30, 1998 are not necessarily
indicative of the results that may be expected for the fiscal year ending
December 31, 1998. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and footnotes thereto for
the year ended December 31, 1997 included in the Company's Registration
Statement on Form S-4 (No. 333-48817). 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. COMPREHENSIVE LOSS
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income", which requires an enterprise to report, by major
components and as a single total, the change in net assets during the period
from non-owner sources. For the three months ended September 30, 1997 and 1998
and nine months ended September 30, 1997 and 1998, comprehensive loss was ($2.4)
million, ($13.0) million, ($4.5) million and ($59.6) million, respectively. The
difference between net loss and comprehensive loss arises due to changes in
accumulated translation adjustments.
NOTE 3. INVENTORIES
Inventories consist of the following:
December 31, September 30,
1997 1998
------------ -------------
Raw materials and components $30,915 $ 7,873
Work-in-process 9,796 11,323
Finished goods 14,874 13,468
------- -------
$55,585 $32,664
NOTE 4. DEBT
On January 30, 1998, the Company sold $110.0 million of its 10.75% Senior Notes
due 2005 (the "Notes"), in a private offering. The Notes bear interest at 10.75%
per annum, payable semiannually in arrears on February 1 and August 1 of each
year, commencing August 1, 1998. The Notes are senior unsecured obligations of
the Company, and are redeemable at the option of the Company, in whole or in
part, at any time on or after January 15, 2002, in cash at redemption prices set
forth in the Indenture relating to such Notes. In addition, at any time prior to
January 15, 2001, the Company may redeem up to 33% of the Notes at a redemption
price as set forth in the Indenture relating to such Notes, with the net
proceeds of a public equity offering, as set forth in the Indenture relating to
such Notes.
Concurrently with closing the sale of the Notes, the Company entered into a $25
million revolving credit facility with a group of banks (the "Credit Facility").
The Company used the net proceeds of the Notes of $105.9 million, together with
existing cash and an initial draw of $1.6 million under the Credit Facility to
repay in full its then existing term loans and revolving credit facility and all
accrued interest, as well as to pay fees of $0.3 million for the Credit
Facility.
6
<PAGE> 7
PHASE METRICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In connection with the January 30, 1998 repayment of its then existing term
loans and revolving credit facility and all accrued interest thereon, the
related unamortized debt issuance costs were written off. This write-off, net of
related tax benefit of $0.7 million, has been reported as an extraordinary loss
in the accompanying condensed consolidated statements of operations.
On August 4, 1998, with the proceeds from the sale of its Series C Preferred
Stock, the Company repaid in full the Credit Facility and accrued interest,
totaling $7.1 million, and terminated the Credit Facility effective August 5,
1998. See Note 7 below. In connection with this repayment, in the third quarter
of 1998 the Company recorded a $0.4 million write-off of the related unamortized
debt issuance costs, as an extraordinary loss in the accompanying condensed
consolidated financial statements.
The Notes and the related Indenture do not contain ongoing quarterly or annual
financial covenant requirements but do contain customary covenants restricting
the Company's 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.
NOTE 5. SETTLEMENT CHARGE
In April 1998, the Company entered into an agreement (the "Settlement
Agreement") to reimburse a major customer for costs incurred in connection with
the customer's cancellation of a contract with a third party, whose employees
included certain former employees of the Company, to purchase upgrades to
certain production test equipment originally purchased from the Company. The
Company took this action to protect its intellectual property and preserve a
valued customer relationship. The Company concluded that such actions were
necessary in order to discourage further unauthorized use of its intellectual
property in the future by this or other third parties. The Company recorded a
$5.9 million charge to earnings in the second quarter of 1998 in connection with
the Settlement Agreement. The Company is making the reimbursement provided for
under the Settlement Agreement by providing a credit to the customer for
products purchased by the customer. In connection with the Settlement Agreement,
the Company had initially secured a $3.7 million standby letter of credit from a
bank in favor of the customer. As of September 30, 1998, the letter of credit
balance had been reduced to $0. Products purchased under the Settlement
Agreement are at favorable pricing which have negatively impacted the Company's
gross profit margin during the third quarter of 1998. Such negative impact is
expected to continue through the first quarter of 1999.
NOTE 6. RESTRUCTURING AND VALUATION CHARGES
The data storage industry in general, including many of the Company's customers,
is currently experiencing significant weakness in demand for data storage
products, intense competition, pricing erosion and overcapacity in manufacturing
operations. Such adverse market conditions have resulted in the rescheduling or
cancellation of orders by several of the Company's major customers and have had
a material adverse effect on the Company's business, results of operations and
financial condition. In light of these circumstances, and the Company's
expectation that the data storage industry's adverse market conditions will
extend for the foreseeable future, on June 18, 1998, the Company announced to
employees and implemented the June Restructuring. The June Restructuring
included a workforce reduction of approximately 115 employees (16%), relocation
and consolidation of much of its Concord, California operation to the Company's
Fremont, California facility, and the intended sale of its San Diego, California
facility and real property. The Company and a prospective buyer have executed a
non-binding purchase and sale agreement related to the San Diego facility and
real property. The prospective buyer's obligation to purchase the San Diego
facility and real property is subject to customary pre-closing conditions,
including the prospective buyer's determination, in its sole and absolute
discretion, of the economic viability of the purchase for its intended use. The
prospective buyer includes an entity which is affiliated with a number of the
Company's major stockholders. There can be no assurance that the Company will
complete the sale of its San Diego facility and real property to this or any
other buyer. The Company does not expect to incur a loss on the sale of the San
Diego facility. Upon completion of such sale, the Company intends to lease back
from the buyer a portion of the San Diego facility in which to conduct its
operations.
In the second quarter of 1998, the Company recorded a charge of $3.0 million
related to the June Restructuring. The significant components of the
restructuring charge are $0.9 million for employee severance costs, $0.7 million
for contractual lease buyouts and $1.4 million in asset impairment related to
assets obsoleted due to restructuring activities. As of September 30, 1998, all
termination benefits had been paid to affected employees and $0.6 million was
recorded as an accrued liability related to the June
7
<PAGE> 8
PHASE METRICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Restructuring. Relocation of the Concord operation was complete as of September
30, 1998. Period costs incurred in connection with these activities were not
significant.
In connection with the impact of the industry downturn on the Company's
operations in the second quarter of 1998 the Company recorded a $13.5 million
charge to cost of sales to write-down excess and obsolete inventory. Also in the
second quarter of 1998, the Company recorded a $22.7 million charge to income
tax expense for a valuation allowance against its entire deferred tax asset
balance. Such charge was taken due to factors which give rise to uncertainty as
to whether the deferred tax asset is realizable, including the lack of history
of consistent earnings and the significant losses in the second and third
quarters of 1998.
NOTE 7. SERIES C REDEEMABLE PREFERRED STOCK
On August 3, 1998, the Company authorized and sold its Series C Convertible
Redeemable Preferred Stock (the "Series C Preferred") as follows: (i) 3,750,000
shares to a new shareholder, (ii) 2,500,000 shares to current shareholders, and
(iii) a total of 110,000 shares to members of its Board of Directors. On
September 4, 1998, the Company authorized and sold an additional 1,250,000
shares to the new shareholder. The sales price for all Series C Preferred was $4
per share. The proceeds of approximately $30.4 million have been used to repay
in full the Company's Credit Facility and accrued interest totaling $7.1
million, with the remainder to be used for general operating purposes.
Each share of Series C Preferred is: (i) voting, (ii) convertible at the option
of the holder into one share of voting Common Stock of the Company, subject to
adjustment, (iii) entitled to receive a preference to the holders of the
Company's Common Stock, Series A Preferred Stock, Series B Redeemable Preferred
Stock and the Convertible Subordinated Notes in the event of liquidation, as
defined, and depending upon the timing and nature of such liquidation, (iv)
entitled to antidilution rights, (v) automatically converted into one share of
Common Stock upon the effectiveness of a registration statement under the
Securities Act of 1933 of Common Stock with a minimum purchase price of $6 per
share and net proceeds to the Company of $15,000,000, (vi) to have approval
rights on new issuances of Preferred Stock, (vii) mandatorily redeemable by the
Company on or after July 15, 2005 at a redemption price of $5 per share,
including accrued and unpaid dividends, without interest, and (viii) entitled to
cumulative dividends beginning August, 2000, at a rate equal to the greater of
12.5% of the stated value per share of $4 and the stated value per share
multiplied by the sum of the prime rate plus 2%.
NOTE 8. SUBSEQUENT EVENTS
Due to the continued downturn in the data storage industry, as more fully
described in Note 6 above, on November 2, 1998, the Company announced to
employees and implemented a restructuring plan (the "November Restructuring").
The November Restructuring includes a workforce reduction of approximately 60
employees (10%), and a reduction and consolidation of facilities at the
Company's Fremont, California location.
In the fourth quarter of 1998, the Company will record a charge of between $0.8
million and $1.2 related to the November Restructuring. The significant
components of the restructuring charge are employee severance costs, contractual
lease buyouts related to existing facilities and equipment and asset impairment
related to assets obsoleted due to the restructuring activities.
8
<PAGE> 9
PHASE METRICS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ITEM 2.
Certain statements in this discussion and analysis and elsewhere in this report,
including, but not limited to, statements regarding the Company's 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. The Company's actual results could
differ materially from the results anticipated in these forward-looking
statements as a result of certain factors set forth under "Risk Factors" and
elsewhere in this report. Readers are also urged to carefully review and
consider the various risk factor disclosures made in the Company's other reports
and filings with the SEC, including the Company's Final Prospectus dated October
14, 1998, filed as part of its Registration Statement on Form S-4 (No.
333-48817). Readers are cautioned not to place undue reliance on these
forward-looking statements to reflect events or circumstances occurring after
the date hereof. The following discussion should be read in conjunction with the
Company's financial statements and notes thereto included elsewhere in this
report.
OVERVIEW
Phase Metrics is the leading supplier of process and production-test equipment
for the data storage industry. The Company's 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. The Company was formed in 1989
as a single product supplier to the data storage industry. Since 1993, the
Company has significantly expanded its product line through the acquisition of
seven specialized suppliers of complementary systems for the disk drive and disk
drive component industries.
Recent Events
The data storage industry in general, including many of the Company's customers,
is currently experiencing significant weakness in demand for data storage
products, intense competition, pricing erosion and overcapacity in manufacturing
operations. Such adverse market conditions have resulted in the rescheduling or
cancellation of orders by several of the Company's major customers and have had
a material adverse effect on the Company's business, results of operations and
financial condition. If these market conditions continue, the Company's results
of operations will continue to be materially and adversely effected in the
future.
In light of these circumstances, and the Company's expectation that the data
storage industry's adverse market conditions will extend for the foreseeable
future, on June 18, 1998, the Company announced to employees and implemented the
June Restructuring. The June Restructuring included a workforce reduction of
approximately 115 employees (16%), relocation and consolidation of much of its
Concord, California operation to the Company's Fremont, California facility, and
the intended sale of its San Diego, California facility and real property. The
Company and a prospective buyer have executed a non-binding purchase and sale
agreement related to the San Diego facility and real property. The prospective
buyer's obligation to purchase the San Diego facility and real property is
subject to customary pre-closing conditions, including the prospective buyer's
determination, in its sole and absolute discretion, of the economic viability of
the purchase for its intended use. The prospective buyer includes an entity
which is affiliated with a number of the Company's major stockholders. There can
be no assurance that the Company will complete the sale of its San Diego
facility and real property to this or any other buyer. The Company does not
expect to incur a loss on the sale of the San Diego Facility. Upon completion of
such sale, the Company intends to lease back from the buyer a portion of the San
Diego Facility in which to conduct its operations.
In connection with the impact on the Company's operations of the industry
downturn, in the second quarter of 1998, the Company recorded a $13.5 million
charge to cost of sales to write-down excess and obsolete inventory, as well as
a $22.7 million valuation allowance against its entire deferred tax balance.
In August and September 1998, the Company completed the issuance and sale of
7,610,000 shares of its Series C Preferred Stock totaling approximately $30.4
million. On August 4, 1998, the Company repaid in full all outstanding
indebtedness under the Credit Facility and accrued interest thereon, totaling
$7.1 million, and terminated the Credit Facility effective August 5, 1998.
Due to the continued downturn in the data storage industry, on November 2, 1998,
the Company announced to employees and implemented the November Restructuring.
The November Restructuring includes a workforce reduction of approximately 60
employees (10%), and a reduction and consolidation of facilities at the
Company's Fremont, California location.
Customer Concentration
There are a relatively small number of data storage manufacturers throughout the
world and the Company derives a significant portion of its net sales from a
relatively small number of customers. The Company expects that its dependence on
relatively few key customers will continue in the future. Approximately 51.2% of
the Company's net sales were derived from sales to the Company's three largest
customers for the nine months ended September 30, 1998. Even though the
Company's customer mix will likely change from period to period in the future,
HMT Technology, Western Digital and Seagate Technology, Inc. accounted for
19.6%, 17.3% and 14.3%, respectively, of net sales. If net sales to these or any
other significant customer were to decrease in any material amount in the
future, the Company's business, results of operations and financial condition
would be materially adversely affected.
9
<PAGE> 10
PHASE METRICS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
YEAR 2000
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 as a result of this issue.
The Company is in the process of assessing the readiness of its internal
computer systems, its products and its vendors for handling the Year 2000 issue.
The Company has contacted critical third party suppliers in connection with its
assessment. The Company believes that all of its critical internal business
applications are Year 2000 compliant, and that all Company products shipped
after June 30, 1999 will be Year 2000 compliant. The Company does not believe
that the costs of any actions required as a result of such assessment will have
a material adverse effect on the Company's business, financial condition or
results of operations. There can be no assurance, however, that the Company will
successfully implement the correct solutions or that there will be no delay in
or increased costs associated with the Company's Year 2000 readiness programs.
The Company's inability to successfully implement such changes could have a
material adverse effect on the Company's business, financial condition or
results of operations. In addition, there can be no assurance that the Company's
critical product and service providers, and their critical providers and so on,
are or will become Year 2000 compliant on a timely basis both individually and
as a group, including information systems integrated among businesses, financial
institutions, government agencies, utilities, etc. The failure of such critical
product and service providers and integrated information systems to be or become
Year 2000 compliant could have a material adverse effect on the Company's
business, financial condition or results of operations. In addition, it is
possible that the Company's revenue may be adversely affected if current and
prospective customers direct their spending resources away from purchasing the
Company's products over the next two years in order to correct or replace
information systems which are not Year 2000 compliant.
RESULTS OF OPERATIONS
Net Sales
Net sales consist primarily of revenue from sales of the Company's process and
production-test equipment and, to a lesser extent, related upgrades, parts and
services. Net sales decreased 49.0% from $43.9 million for the third quarter of
1997 to $22.4 million for the third quarter of 1998 and decreased 41.8% from
$148.2 million for the nine months ended September 30, 1997 to $86.3 million for
the nine months ended September 30, 1998. These decreases were primarily due to
decreased sales of the Company's products due to the adverse market conditions
previously mentioned.
Gross Profit
Cost of sales includes material costs, direct labor and overhead costs related
to the production and delivery of the Company's products, including warranty and
other service costs. Gross profit decreased from $19.7 million for the third
quarter of 1997 to $2.3 million for the third quarter of 1998 and from $68.6
million for the nine months ended September 30, 1997 to $13.8 million for the
nine months ended September 30, 1998. Gross profit as a percentage of net sales
("gross margin") decreased from 44.9% for the third quarter of 1997 to 10.3% for
the third quarter of 1998 and from 46.3% for the nine months ended September 30,
1997 to 16.0% for the nine months ended September 30, 1998. For the quarter
ended September 30, 1998 the decrease was primarily due to (i) lower gross
profit on products shipped in connection with the Settlement Agreement discussed
below, (ii) two other customer contracts involving lower than average sales
prices which will also negatively impact the Company's gross profit in the
fourth quarter of 1998, (iii) underutilization of manufacturing capacity, and
(iv) higher costs resulting from lower production volumes. For the nine months
ended September 30, 1998 the decrease was primarily due to the $13.5 million and
$1.3 million inventory write-downs recorded in the second and third quarters of
1998, respectively, as a result of the downturn in the data storage industry and
its impact on the Company's operations, as well as the factors previously
mentioned in connection with the quarter ended September 30, 1998, partially
offset by decreases in personnel costs as a result of workforce reductions in
August 1997, and January and June, 1998. (See "Restructuring Charge: below).
In April 1998, the Company entered into the Settlement Agreement to reimburse a
major customer for costs incurred in connection with the customer's cancellation
of a contract with a third party, whose employees included certain former
employees of the Company, to purchase upgrades to certain production test
equipment originally purchased from the Company. The Company took this action to
protect its intellectual property and preserve a valued customer relationship.
The Company concluded that such actions were necessary in order to discourage
further unauthorized use of its intellectual property in the future by this or
other third parties. The Company is making 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 are
at favorable pricing which have negatively impacted the Company's gross profit
margin during the third quarter of 1998. Such negative impact is expected to
continue through the first quarter of 1999.
The Company is unable to control with any degree of certainty its product sales
volume, linearity or mix from period to period and therefore the Company's gross
margin in future periods may fluctuate from those achieved in past periods. In
any period when the Company experiences an unfavorable product sales
10
<PAGE> 11
PHASE METRICS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
volume, linearity or mix and/or provides significant volume pricing discounts,
the Company's gross margin may decrease.
Research and Development Expense
Research and development expense consists primarily of salaries and related
costs of personnel and contract labor, project materials and other costs
associated with the Company's ongoing research and product development. Research
and development expense decreased from $11.0 million for the third quarter of
1997 to $7.9 million for the third quarter of 1998 and from $32.7 million for
the nine months ended September 30, 1997 to $27.0 million for the nine months
ended September 30, 1998. Research and development expense as a percentage of
net sales increased from 25.1% for the third quarter of 1997 to 35.0% for the
third quarter of 1998, and from 22.1% for the nine months ended September 30,
1997 to 31.3% for the nine months ended September 30, 1998. The 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 in August 1997,
and January and June, 1998. The Company anticipates that it 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 personnel costs, including certain acquisition related earnout costs.
Selling, general and administrative expense decreased from $5.8 million for the
third quarter of 1997 to $3.8 million for the third quarter of 1998 and from
$18.2 million for the nine months ended September 30, 1997 to $13.5 million for
the nine months ended September 30, 1998. Selling, general and administrative
expense as a percentage of net sales increased from 13.2% for the third quarter
of 1997 to 17.0% for the third quarter of 1998 and from 12.3% for the nine
months ended September 30, 1997 to 15.6% for the nine months ended September 30,
1998. These percentage increases were primarily due to decreases in net sales,
partially offset by decreases in personnel costs as a result of workforce
reductions in August 1997, and January and June, 1998.
Amortization and Write Downs of Intangible Assets
Amortization and write downs of intangible assets decreased from $3.4 million
for the third quarter of 1997 to $0.1 million for the third quarter of 1998 and
from $12.2 million for the nine months ended September 30, 1997 to $3.4 million
for the nine months ended September 30, 1998. These decreases were due to more
intangible assets becoming fully amortized prior to or during the three and nine
months ended September 30, 1998, respectively, as well as a write down to fair
value of $2.0 million in the nine months ended September 30, 1997 related to
impairment of certain intangible assets recorded in connection with one of the
Company's acquisitions.
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 in general, including many of the Company's customers,
is currently experiencing a weakness in demand for data storage products,
intense competition, pricing erosion and overcapacity in manufacturing
operations. Such adverse market conditions have resulted in the rescheduling or
cancellation of orders by several of the Company's major customers and has had a
material adverse effect on the Company's business, results of operations and
financial condition. In light of these circumstances, and the Company's
expectation that the data storage industry's adverse market conditions will
extend for the foreseeable future, on June 18, 1998, the Company announced to
employees and implemented the June Restructuring. The June Restructuring
included a workforce reduction of approximately 115 employees (16%), relocation
and consolidation of much of its Concord, California operation to the Company's
Fremont, California facility, and the intended sale of its San Diego, California
facility and real property. The Company and a prospective buyer have executed a
non-binding purchase and sale agreement related to the San Diego facility and
real property. The prospective buyer's obligation to purchase the San Diego
facility and real property is subject to customary pre-closing conditions,
including the prospective buyer's determination, in its sole and absolute
discretion, of the economic viability of the purchase for its intended use. The
prospective buyer includes an entity which is affiliated with a number of the
Company's major stockholders. There can be no assurance that the Company will
complete the sale of its San Diego facility and real property to this or any
other buyer. The Company does not expect to incur a loss on the sale of the San
Diego facility. Upon completion of such sale, the Company intends to lease back
from the buyer a portion of the San Diego facility in which to conduct its
operations.
11
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PHASE METRICS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In the second quarter of 1998, the Company recorded a charge of $3.0 million
related to the June Restructuring. The significant components of the
restructuring charge are $0.9 million for employee severance costs, $0.7 million
for contractual lease buyouts and $1.4 million in asset impairment related to
assets obsoleted due to restructuring activities. As of September 30, 1998, all
termination benefits had been paid to affected employees and $0.6 million was
recorded as an accrued liability related to the June Restructuring. Relocation
of the Concord operation was complete as of September 30, 1998. Period costs
incurred in connection with these activities were not significant.
Interest Expense
Interest expense increased from $2.9 million for the third quarter of 1997 to
$3.6 million for the third quarter of 1998, and from $8.3 million for the nine
months ended September 30, 1997 to $10.8 million for the nine months ended
September 30, 1998. These increases primarily reflect the increased debt levels
outstanding and higher interest rates during the respective periods.
Income Taxes
Income tax expense (benefit) was ($1.0) million for the third quarter of 1997
and none for the third quarter of 1998. Income tax expense (benefit) was ($1.0)
million for the nine months ended September 30, 1997 and $8.7 million for the
nine months ended September 30, 1998.
For the 1997 periods, the effective income tax rates differed from the
applicable statutory rates due primarily to utilization of income tax credits
available for research and development expenses. For the 1998 periods, the
effective income tax rates differed from the applicable statutory rates due
primarily to the valuation allowance against the Company's entire deferred tax
asset balance. Such charge was taken due to factors which give rise to
uncertainty as to whether the deferred tax asset is 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 the
Company's then-existing credit agreements.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its capital requirements through sales of Common and
Preferred Stock, and borrowings under subordinated, term and revolving credit
facilities. The Company's principal requirements for cash are debt service,
capital expenditures and working capital.
12
<PAGE> 13
PHASE METRICS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Debt
On January 30, 1998, the Company sold $110.0 million of its 10.75% Senior Notes
due 2005 (the "Notes"), in a private offering. The Notes bear interest at 10.75%
per annum, payable semiannually in arrears on February 1 and August 1 of each
year, commencing August 1, 1998. The Notes are senior unsecured obligations of
the Company, and are redeemable at the option of the Company, in whole or in
part, at any time on or after January 15, 2002, in cash at redemption prices as
defined. In addition, at any time prior to January 15, 2001, the Company may
redeem up to 33% of the Notes at a redemption price as defined, with the net
proceeds of a public equity offering, as defined. The Company used the net
proceeds of the Notes of $105.9 million, together with existing cash and an
initial draw of $1.6 million under the Credit Facility to repay in full its
existing term loans and revolving credit facility and all accrued interest
thereon, as well as to pay fees of $0.3 million for the Credit Facility.
Concurrently with closing the sale of the Notes, the Company entered into a $25
million revolving credit facility with a group of banks (the "Credit Facility").
On August 4, 1998, with the proceeds from the sale of its Series C Preferred
Stock, the Company repaid in full the Credit Facility and all accrued interest
thereon, totaling $7.1 million, and terminated the Credit Facility effective
August 5, 1998. In connection with this repayment, in the third quarter of 1998
the Company recorded a $0.4 million write-off of the related unamortized debt
issuance costs, as an extraordinary loss in the consolidated financial
statements.
The Notes and the related Indenture do not contain ongoing quarterly or annual
financial covenant requirements but do contain customary covenants restricting
the Company's 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.
As of September 30, 1998, the Company's outstanding indebtedness included $105.9
million under the Notes, $8.0 million under its Convertible Subordinated Notes
and $2.6 million under capital lease obligations. As of September 30, 1998, the
Company also had $6.9 million of accrued interest on indebtedness outstanding
under the Convertible Subordinated Notes. The Convertible Subordinated Notes
(including all accrued interest thereon) are convertible into a total of
5,142,720 shares of Common Stock at the option of the holders thereof and will
automatically convert upon the consummation of an initial public offering of the
Company's Common Stock.
Series C Preferred Stock
On August 3, 1998, the Company authorized and sold its Series C Convertible
Redeemable Preferred Stock (the "Series C Preferred") as follows: (i) 3,750,000
shares to a new shareholder, (ii) 2,500,000 shares to current shareholders, and
(iii) a total of 110,000 shares to members of its Board of Directors. On
September 4, 1998 the Company authorized and sold an additional 1,250,000 shares
to the new shareholder. The sales price for all Series C Preferred was $4 per
share. The proceeds of approximately $30.4 million have been used to repay in
full the Credit Facility and accrued interest totaling $7.1 million, with the
remainder to be used for general operating purposes.
13
<PAGE> 14
PHASE METRICS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Operating, Investing and Financing Activities
Cash used for operating activities was $4.0 million for the nine months ended
September 30, 1997 and $8.5 million for the nine months ended September 30,
1998. Period to period fluctuations in operations impacting these amounts were
the net losses for the nine months ended September 30, 1997 and 1998, a decrease
in amortization and write downs of intangible assets, a decrease in deferred
income tax assets, a smaller increase period to period in accounts receivable, a
decrease in 1998 inventories compared to an increase in 1997 and increases in
1998 income taxes receivable and accrued expenses compared to decreases in 1997.
Cash used for investing activities was $14.8 million for the nine months ended
September 30, 1997 and $1.6 million for the nine months ended September 30,
1998, and consisted primarily of cash used in connection with purchases of
property and equipment. The Company plans no material capital expenditures for
the remainder of 1998, nor does the Company have any material outstanding
commitments with respect to expenditures. Cash provided by financing activities
was $17.2 million for the nine months ended September 30, 1997 and $24.4 million
for the nine months ended September 30, 1998, and consisted primarily of
revolving loan activity in 1997, while 1998 included the net proceeds from
issuance of the Notes, net of repayment of borrowings under the Company's
previous term notes and revolving loans, as well as the issuance of the Series C
Preferred.
Based on currently available information, the Company believes that its
available cash and cash generated from operations will be adequate to fund its
operations for the foreseeable future, and for no less than the next 12 months.
The Company and a prospective buyer have executed a non-binding purchase and
sale agreement related to the San Diego Facility and real property. The buyer's
obligation to purchase the San Diego Facility and real property is subject to
customary pre-closing conditions, including the prospective buyer's
determination, in its sole and absolute discretion, of the economic viability of
the purchase for its intended use. The prospective buyer includes an entity
which is affiliated with a number of the Company's major stockholders. The
Company does not expect to incur a loss on the sale of the San Diego facility.
The Company also plans to secure a new revolving credit facility in 1998. There
can be no assurance that the Company will be successful in selling its San Diego
facility or securing a new revolving credit facility. While operating activities
may provide cash in certain periods, the Company may require additional sources
of financing. The Company 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. The Company continues to have limited
capital resources and significant future obligations and expects that it will
require additional capital to support future growth, if any. The existence of
certain restrictive covenants in the indenture for the Notes may inhibit the
Company's ability to raise additional financing. There can be no assurance the
Company will be able to obtain alternative sources of financing on favorable
terms, if at all, at such time or times as the Company may require such capital.
See "Risk Factors - Substantial Leverage; Ability to Service Indebtedness."
14
<PAGE> 15
PHASE METRICS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
SUBSTANTIAL LEVERAGE; ABILITY TO SERVICE INDEBTEDNESS
The Company is highly leveraged. At September 30, 1998, the Company had
indebtedness of $116.5 million. Subject to certain limitations, the Company may
also incur additional indebtedness in the future under the terms of the
Indenture related to the Notes.
The Company's ability to make scheduled payments of principal and interest on,
or to refinance, its indebtedness (including the Notes), and to fund its
operations, including capital expenditures and research and development
expenses, depends on its 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 its control. For the three and nine months ended September 30, 1998,
earnings were inadequate to cover fixed charges by $13.8 million and $51.8
million, respectively. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -Liquidity and Capital Resources." There can
be no assurance, however, that the Company's business will generate adequate
cash flow or that any growth can be achieved. If the Company is unable to
generate sufficient cash flow from operations in the future to service its debt
and operate its business, including making necessary capital expenditures, the
Company may be required to refinance all or a portion of its existing debt,
including the Notes, to sell assets or to obtain additional financing. There can
be no assurance that any such action would be accomplished on terms acceptable
to the Company or at all.
The Company's high level of debt will have several important effects on its
future operations, including, but not limited to, (i) making it more difficult
for the Company to satisfy its obligations with respect to the Notes, (ii)
increasing the Company's vulnerability to general adverse economic and industry
conditions, (iii) limiting the Company's ability to obtain additional financing
to fund future working capital, capital expenditures, research and development
and other general corporate requirements, (iv) requiring the dedication of a
substantial portion of the Company's cash flow from operations to the payment of
principal of, and interest on, its 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 (v) limiting the
Company's flexibility in planning for, or reacting to, changes in its business.
RESTRICTIVE FINANCING COVENANTS
The Notes contain a number of covenants that will significantly restrict the
operations of the Company, such as the ability of the Company 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. There can be
no assurance that the Company will be able to comply with such conditions,
covenants or restrictions in the future. The Company's ability to comply with
such conditions, covenants and restrictions may be affected by events beyond its
control, including prevailing economic and financial conditions and general
conditions in the data storage industry.
EFFECTIVE SUBORDINATION; ENCUMBRANCES ON ASSETS
If the Company incurs any additional senior indebtedness which would rank pari
passu in right of payment with the Notes, and even if such indebtedness were not
secured, the holder of such debt would be entitled to share ratably with the
holders of the Notes in any proceeds distributed in connection with any
insolvency, liquidation, reorganization, dissolution or other winding-up of the
Company. This may have the effect of reducing the amount of proceeds available
to pay to holders of the Notes upon the occurrence of any such events.
15
<PAGE> 16
PHASE METRICS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT NET LOSSES; RETAINED DEFICIT; CASH USED FOR OPERATING ACTIVITIES
The Company had a net loss of approximately $13.1 and $59.7 million for the
three months and nine months ended September 30, 1998, respectively. Such loss
and accrual of certain Preferred Stock dividends and accretion for the
redemption value of such Preferred Stock have contributed to a retained deficit
of approximately $85.1 million as of September, 30, 1998. In addition, the
Company used cash for operating activities of approximately $4.0 million and
$8.5 million for the three and nine months ended September 30, 1998,
respectively. There can be no assurance that the Company will achieve
profitability or that it will generate positive cash flow from operating
activities in the future.
FLUCTUATIONS IN OPERATING RESULTS
The Company's operating results have fluctuated in the past and the Company
expects that its operating results will continue to fluctuate in the future from
quarter to quarter and year to year. These fluctuations have resulted from a
number of factors, including the size, timing and rescheduling or cancellation
of orders from, and shipments to, major customers; the timing of introductions
of new products and product enhancements by the Company or its competitors; the
Company's ability to develop, introduce and market new, technologically advanced
products; the cyclicality of the data storage industry; the rescheduling of
capital expenditures by the Company's customers; variations in the Company's
customer base and product mix; the level of any significant volume pricing
discounts provided by the Company; the availability and cost of key production
materials and components; the Company's ability to effectively manage its
inventory and to control costs; the financial stability of major customers; the
Company's success in expanding its operations overseas; personnel changes;
expenses associated with acquisitions; fluctuations in amortization and
write-downs of intangible assets; 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.
In addition to the foregoing, the Company's period-to-period operating results
may fluctuate in the future due to the rescheduling or cancellation of specific
orders by its major customers. The Company expects order delays and
reschedulings to occur in the future. Because the Company must incur expenses
and purchase inventory based on anticipated and actual customer orders, any
significant delay, rescheduling or cancellation of such orders would have a
material adverse effect on the Company's operating results.
The Company believes that period-to-period comparisons of its 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. Further, the Company's
historical operating results for 1993 through the second quarter of 1998 are not
necessarily indicative of future performance for any particular period in light
of the Company's acquisition activity during those periods. There can be no
assurance that any past revenue growth or past results of operations will
continue.
DEPENDENCE ON AND CYCLICALITY OF DATA STORAGE INDUSTRY
The Company's business depends almost entirely upon capital expenditures by
manufacturers of disk drives and disk drive components, which in turn depend
upon market demand for their products. Although the data storage industry has
consistently shown growth, the industry is cyclical and experiences periods of
oversupply. The disk drive industry is currently experiencing weakness in demand
for its products, as well as increased competition resulting in significant
price pressures. This in turn causes reduced demand for and pricing pressures on
capital equipment used in the disk drive and disk drive component production
processes, including the type of equipment sold by the Company. In addition,
since the third quarter of 1997, certain of the Company's customers delayed
purchases of certain of the Company's products due to overcapacity of certain
process and production-test equipment at these customers. In the event the
weakness in demand for disk drives continues or customers continue to delay the
purchase of the Company's products, the Company's business, financial condition
and results of operations would be materially adversely affected.
16
<PAGE> 17
PHASE METRICS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company's future operating results will continue to be heavily dependent on
capital expenditures by manufacturers of disk drives and disk drive components.
In this regard, several major manufacturers of disk drives and disk drive
components have recently announced earnings that fell below expectations. These
earnings announcements have been accompanied by reduced earnings expectations
for future periods. There can be no assurance that these announcements do not
indicate the beginning of a slowdown in the growth of the data storage industry.
The Company's business, results of operations and financial condition have been
adversely affected by previous downturns in the data storage industry. No
assurance can be given that the Company's sales and operating results will not
continue to be adversely affected by periodic downturns in world-wide capital
equipment expenditures by data storage companies. Any such slowdown would have a
material adverse effect on the Company's business, operating results and
financial condition.
RESTRUCTURING
The data storage industry in general, including many of the Company's customers,
is currently experiencing significant weakness in demand for data storage
products, intense competition, pricing erosion and overcapacity in manufacturing
operations. Such adverse market conditions have resulted in the rescheduling or
cancellation of orders by several of the Company's major customers and have had
a material adverse effect on the Company's business, results of operations and
financial condition. In light of these circumstances, and the Company's
expectation that the data storage industry's adverse market conditions will
extend for the foreseeable future, on June 18, 1998, the Company announced to
employees and implemented the June Restructuring. The June Restructuring
included a workforce reduction of approximately 115 employees (16%), relocation
and consolidation of much of its Concord, California operation to the Company's
Fremont, California facility, and the intended sale of its San Diego, California
facility and real property. The Company and a prospective buyer have executed a
non-binding purchase and sale agreement related to the San Diego facility and
real property. The prospective buyer's obligation to purchase the San Diego
facility and real property is subject to customary pre-closing conditions,
including the prospective buyer's determination, in its sole and absolute
discretion, of the economic viability of the purchase for its intended use. The
prospective buyer includes an entity which is affiliated with a number of the
Company's major stockholders. There can be no assurance that the Company will
complete the sale of its San Diego facility and real property to this or any
other buyer. The Company does not expect to incur a loss on the sale of the San
Diego facility. Upon completion of such sale, the Company intends to lease back
from the buyer a portion of the San Diego facility in which to conduct its
operations.
In the second quarter of 1998, the Company recorded a charge of $3.0 million
related to the June Restructuring. The significant components of the
restructuring charge are $0.9 million for employee severance costs, $0.7 million
for contractual lease buyouts and $1.4 million in asset impairment related to
assets obsoleted due to restructuring activities. As of September 30, 1998, all
termination benefits had been paid to affected employees and $0.6 million was
recorded as an accrued liability related to the June Restructuring. Relocation
of the Concord operation was complete at September 30, 1998. Period costs
incurred in connection with these activities were not significant.
In connection with the impact of the industry downturn on the Company's
operations in the second quarter of 1998 the Company recorded a $13.5 million
charge to cost of sales to write-down excess and obsolete inventory. Also in the
second quarter of 1998, the Company recorded a $22.7 million charge to income
tax expense for a valuation allowance against its entire deferred tax asset
balance. Such charge was taken due to factors which give rise to uncertainty as
to whether the deferred tax asset is realizable, including the lack of history
of consistent earnings and the significant losses in the second and third
quarters of 1998.
Due to the continued downturn in the data storage industry, as more fully
described in Note 6 above, on November 2, 1998, the Company announced to
employees and implemented the November Restructuring Plan (the "November
Restructuring"). The November Restructuring includes a workforce reduction of
approximately 60 employees (10%), and a reduction and consolidation of
facilities at the Company's Fremont, California location.
In the fourth quarter of 1998, the Company will record a charge of between $0.8
million and $1.2 related to the November Restructuring. The significant
components of the restructuring charge are employee severance costs, contractual
lease buyouts related to existing facilities in Fremont, California and asset
impairment related to assets obsoleted due to the restructuring activities.
RAPID TECHNOLOGICAL CHANGE
The data storage industry is characterized by rapid technological changes and
evolving industry standards. The Company's customers strive to introduce new
products and enhancements frequently, with relatively short product life cycles,
typically between nine and 18 months. In addition, the Company's customers often
develop multiple products simultaneously, such that new products could be
introduced as frequently as every three months. New product introductions by the
Company's customers typically result in new technological challenges for the
Company, both with respect to its installed base and with respect to next
generation products. As a result, the Company must continue to enhance its
existing products and develop and manufacture new products with improved
capabilities. This has required and will continue to require substantial
investments by the Company in research and development. Although the Company
continually develops new products, there can be no assurance that the Company
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. The Company's failure to develop, manufacture and market new or enhanced
products, would have a material adverse effect on its business, financial
condition and results of operations. The Company is highly dependent on its
close working relationships with certain of its key customers to advance its
technologies. The termination of any one of these key relationships for any
reason could have a material adverse effect on the Company's ability to
anticipate and develop necessary technological changes to its products.
The Company's 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. To the extent that the Company's customers can improve product
quality by modifying their own design and internal production processes without
the need to add process and production-test equipment, demand for the Company's
equipment would likely decline. Further, unless the Company is 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
the Company's business, financial condition and results of operations.
There can be no assurance that future technological innovations will not reduce
demand for disk drives. Competing technologies to disk drive based data storage
do 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 someday
this technology will be replaced by an alternate technology. There can be no
assurance that the Company's products will be adaptable to any successor
technology. The Company's business, financial condition and results of
operations could be materially adversely affected by any significant migration
toward technology that would replace disk drives as a computer data storage
medium.
During 1995 and continuing through the first six months of 1997, the Company
experienced significant development and design problems and delays during the
attempted introduction of its MC950 series next
17
<PAGE> 18
PHASE METRICS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
generation disk certifier product. These development and design problems
diverted significant research and development resources which could have been
utilized for the development of new products and various enhancements for other
products. There can be no assurance that the Company will not experience the
same or similar problems with future introductions of new products or
enhancements.
CUSTOMER CONCENTRATION
There are a relatively small number of data storage manufacturers throughout the
world and the Company derives a significant portion of its net sales from a
relatively small number of customers. The Company expects that its dependence on
relatively few key customers will continue in the future. Approximately 51.2% of
the Company's net sales were derived from sales to the Company's three largest
customers for the nine months ended September 30, 1998. Even though the
Company's customer mix will likely change from period to period in the future.
HMT Technology, Western Digital and Seagate Technology, Inc. accounted for
19.6%, 17.3% and 14.3%, respectively, of net sales. If net sales to these or any
other significant customer of the Company were to decrease in any material
amount in the future, the Company's business, results of operations and
financial condition would be materially adversely affected.
In general, the Company's customers do not enter into long-term purchase
agreements with the Company. If completed orders are not replaced on a timely
basis by new orders from the same or other customers, the Company's net sales
would be materially adversely affected. In addition, the loss of a key customer;
any reduction in orders from any key customer or the rescheduling or
cancellation of a significant order from a key customer, including reductions,
delays or cancellations due to customer departures from recent buying patterns;
or economic or competitive conditions in the disk drive industry could have a
material adverse effect on the Company's business, financial condition and
results of operations. Any failure to collect or delay in collecting receivables
could have a material adverse effect on the Company's business, operating
results and financial condition.
There has been a trend toward consolidation in the disk drive industry and the
Company expects this trend to continue. Certain of the Company's customers have
in the past and may in the future acquire competitors or be acquired by
competitors, causing further consolidation in the disk drive industry. Previous
acquisitions in the disk drive industry have often caused the purchasing
departments of the combined companies to reevaluate their purchasing decisions.
There can be no assurance that such acquisitions will not 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 the Company's customer revenues to
increase thereby increasing the Company's dependence on fewer customers.
INVENTORY RISKS
Due to the cyclical nature of and rapid technological change in the disk drive
industry, the Company's inventory is subject to substantial risk. To address
these risks, the Company monitors its inventories on a periodic basis and
provides inventory write-downs intended to cover inventory risks. However, given
the Company's dependence on a few customers and a limited number of product
programs for each customer, the magnitude of the commitments the Company must
make to support its customers' programs and the Company's limited remedies in
the event a customer cancels or materially reduces one or more product orders,
or should a customer experience financial difficulties, the Company may be
required to take significant inventory charges which, in turn, could materially
and adversely affect the Company's business, operating results and financial
condition. In connection with the negative impact on the Company's operations of
the significant data storage industry downturn, for the nine months ended
September 30, 1998, the Company recorded a $13.5 million charge to cost of sales
to write down excess and obsolete inventory. There can be no assurance that the
Company will not be required to take additional inventory write-downs in the
future, due to the Company's inability to obtain necessary product acceptance,
or due to further cancellations by customers.
COMPETITION
The disk drive process and production-test equipment industry is highly
competitive. In each of the Company's product lines, the Company faces
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 than the
Company. For example, the Company faces competition from General Disk for
servowriters; Hitachi DECO and Sony Techtronics for disk certifiers; Swan
Instruments for MR head testers; Zygo Corporation for flying height testers,
Technastar for automation technology and Guzik Technical for spin-stands.
Historically, there has also been competition from entrepreneurs with focused
market knowledge and new technology. The Company also experiences intense
competition world-wide from Hitachi DECO, a large, full-line manufacturer of
process and production-test equipment. Hitachi DECO, a subsidiary of Hitachi
Limited Japan, has substantially greater financial, technical, marketing,
manufacturing, research and development and other resources than the Company.
The Company also experiences competition from other full-line and partial-line
18
<PAGE> 19
manufacturers of process and production-test equipment. There can be no
assurance that the Company's competitors will not develop enhancements to, or
future generations of, competitive products that will offer price or performance
features superior to the Company's products, or that new competitors will not
enter the Company's markets. Finally, as many of the Company's competitors are
based in foreign countries, they have cost structures and equipment prices based
on foreign currencies. Accordingly, currency fluctuations could cause the
Company's dollar-priced products to be less competitive than its competitors'
products priced in other currencies.
Many of the Company's competitors are investing heavily in the development of
new and enhanced products aimed at applications currently addressed by the
Company's products. The Company expects its 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. The
Company will be required to make a continued high level of investment in product
development and research, sales and marketing and ongoing customer service and
support to remain competitive. There can be no assurance that the Company will
have sufficient resources to continue to make such investments or that the
Company will be able to achieve the technological advances necessary to maintain
its competitive position.
The Company believes that its future success will be dependent, in part, upon
its ability to compete successfully in the Japanese, South Korean and Southeast
Asian markets. The Company's largest competitor, Hitachi DECO, is headquartered
in Japan which gives it a competitive advantage over the Company in that market
to the extent buying decisions are influenced by Hitachi DECO's local presence.
In addition, the Company's 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, the continuing ability of the Company to
develop in a timely manner products that meet the technical requirements of its
foreign customers, and the continuing ability of the Company to develop and
maintain satisfactory relationships with leading companies in the data storage
industry in these areas. Moreover, the Company's 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 the Company's customers or
potential customers in affected regions, then such economic troubles have also
negatively impacted the Company's operations. With respect to existing
customers, the Company does not believe that such Asian economic troubles have
had a significant impact on the Company's operations. With respect to potential
customers, the Company is unable to quantify the impact that such Asian economic
troubles have had on its operations.
In addition to the competition the Company faces from other merchant
manufacturers of process and production-test equipment, most of the Company's
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, the Company 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, it is
possible that with the rapid changes in data storage technology, the development
of new process and production-test equipment will be so closely linked to the
Company's 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 the Company at a
competitive disadvantage.
Because of the foregoing competitive factors, there can be no assurance that the
Company will be able to compete successfully in the future. Increased
competitive pressure could cause the Company to lower prices for its products,
thereby adversely affecting the Company's business, financial condition and
results of operations.
PRODUCT CONCENTRATION
The Company derives its revenues primarily from sales of its process and
production-test systems and parts for such systems. The Company's products can
generally be categorized into four principal areas: (i) disk (media) testing and
processing, (ii) read/write head testing, (iii) disk drive testing and
processing and (iv) automation. The Company derives a significant portion of its
net sales from a relatively small number of products. For the nine months ended
September 30, 1998, the Company derived approximately 56.3% of its net sales,
respectively, from sales of its media certifier products (excluding parts and
service). In June 1997, the Company introduced its MC950 series media certifier
products. The Company expects that net sales from its media certifier products,
including its MG series and its MC series, will continue to account for a
substantial portion of the Company's total net sales in the foreseeable future.
Any material reduction in demand for its media certifier products would have a
material adverse effect on the Company's business, results of operations and
financial condition.
19
<PAGE> 20
DEPENDENCE ON PROPRIETARY TECHNOLOGY
The Company's success is heavily dependent upon the establishment and
maintenance of proprietary technologies. Although the Company attempts to
protect its intellectual property rights through patents, copyrights, trade
secrets and other measures, there can be no assurance that the steps taken by
the Company to protect its proprietary technologies will be adequate to prevent
misappropriation by third parties or will be adequate under the laws of some
foreign countries, which may not protect the Company's proprietary rights to the
same extent as do laws of the United States. In addition, others could "reverse
engineer" the Company's products in order to determine their method of operation
and introduce competing products or develop competing technology independently.
Any such adverse circumstances could have a material adverse effect on the
Company's business, financial condition and results of operations.
Although the Company does not believe any of its products or proprietary rights
infringe the rights of third parties, there can be no assurance that
infringement claims will not be asserted against the Company 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 the
Company to enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the
Company, or at all. If infringement were established, the Company could be
required to pay damages or be enjoined from making, using or selling the
infringing product. Likewise, there can be no assurance that a third party's
product, if infringing on the Company's proprietary rights, may be prevented
from doing so without litigation. Any of the foregoing could have a material
adverse effect on the Company's business, financial condition and results of
operations.
No assurance can be given that the claims allowed on any patents held by the
Company will be sufficiently broad to protect the Company's technology.
Moreover, there can be no assurance that any patent owned by the Company will
not be invalidated, deemed unenforceable, circumvented or challenged, that the
rights granted thereunder will provide competitive advantages to the Company or
that any of the Company's pending or future patent applications will be issued
with claims of the scope sought by the Company, if at all. Furthermore, there
can be no assurance that others will not develop similar products, duplicate the
Company's products or design around the patents owned by the Company. In
addition, there can be no assurance that foreign intellectual property laws or
the Company's agreements will protect the Company's intellectual property rights
in any foreign country. Any failure to protect the Company's intellectual
property rights could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company requires each of its employees to enter into a proprietary rights
and non-disclosure agreement in which the employee agrees to maintain the
confidentiality of all proprietary information of the Company and, subject to
certain exceptions, to assign to the Company all rights in any proprietary
information or technology made or contributed by the employee during his or her
employment. In addition, the Company regularly enters into non-disclosure
agreements with third parties, such as consultants, potential joint venture
partners and customers. In spite of these precautions, it may be possible for
third parties to copy, develop or otherwise obtain and use the Company's
proprietary technology without authorization or to develop similar technology
independently.
MANUFACTURING RISKS
The Company's products have a large number of components and are highly complex.
The Company has experienced and may in the future experience manufacturing
delays due to technical difficulties. In addition, many of the Company's
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 the Company's
products. As a result, the Company may be unable to complete the customized
development or technical specifications of its customers in a timely manner. Any
significant failure in this regard would have a material adverse effect on the
Company's business, financial condition and results of operations as well as its
customer relationships. In addition, due to the semi-customized nature of many
of the Company's products, the Company has in the past and may in the future
incur substantial unanticipated costs in a product's development and production,
such as 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
which cannot be passed on to the customer. The occurrence of any of such events
in the future could materially adversely affect the Company's business,
financial condition and results of operations.
In certain instances the Company relies on a single source or a limited group of
suppliers for certain components and subassemblies used in its products.
Although the Company seeks to reduce its dependence on sole and limited source
suppliers, the partial or complete loss of these sources could have at least a
temporary material adverse effect on the Company's 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 ofthe Company's products from these and other
suppliers which could impede the Company's ability to quickly respond to changes
in demand and product specifications.
20
<PAGE> 21
Shortages of critical components and subassemblies to manufacture the Company's
products have occurred in the past and there can be no assurance that shortages
will not occur in the future, or that materials will be available without longer
lead times. In addition, the manufacture and timely delivery of products by the
Company 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 the delivery
of products by the Company until alternative sourcing could be developed. There
can be no assurance that an alternative source could be located in time to avoid
penalties or cancellation of the Company's product orders. If a significant
order or orders were cancelled for this reason it could have a material adverse
effect on the Company's business, financial condition and results of operations.
Further, a significant increase in the price of one or more components used to
produce the Company's products would increase the cost of producing the
Company's products."
The Company conducts its manufacturing activities at its facilities in San
Diego, Fremont and Hayward, California. The Company's manufacturing facilities
are located in seismically active areas. A major catastrophe (such as an
earthquake or other natural disaster) or other long-term disruption in the
Company's manufacturing activities could result in a prolonged interruption of
the Company's business.
RISKS ASSOCIATED WITH ACQUISITIONS
While the Company currently has no commitments, agreements or understandings
with respect to any future acquisitions, its business strategy includes the
expansion of its business, products lines and technology through acquisitions.
The Company regularly reviews various acquisition prospects, including
companies, technologies or products complementary to the Company's business and
periodically engages 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; risks of entering markets in which the Company has limited or no
direct experience and the potential loss of key employees of the acquired
companies. In addition, acquisitions may result in dilutive issuances of equity
securities; the incurrence of additional debt; reduction of existing cash
balances; amortization expenses related to goodwill and other intangible assets
and other charges to operations that may materially adversely affect the
Company's results of operations. Moreover, there can be no assurance that any
equity or debt financings proposed in connection with any acquisition would be
available to the Company on acceptable terms or at all, when, and if, suitable
strategic acquisition opportunities arise. Although management expects to
carefully analyze any opportunity before committing the Company's resources,
there can be no assurance that any acquisition that is completed will result in
long-term benefits to the Company or its stockholders or that Phase Metrics'
management will be able to manage effectively the resulting business.
The Company recorded write-downs totaling approximately $2.0 million for the
nine months ended September 30, 1997 related to impairment losses on certain
purchased technology recorded primarily in connection with the Company's
acquisitions of ART and certain assets of Cambrian and ABI. Such impairment
losses were generally the result of post-acquisition technological changes that
were developed independent of purchased technologies, causing a decline in the
carrying values of such purchased technologies. There can be no assurance that
such impairments will not occur in the future or that future acquisitions will
not result in similar write-downs of acquired assets.
CAPITAL NEEDS
The Company believes that, in order to achieve its long-term strategic
objectives and maintain and enhance its competitive position, it may 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. The Company has added significant manufacturing
capacity and increased its fixed costs over the past two years while expanding
its facilities in Fremont and San Diego, California, and continues to invest in
new technologies and its international infrastructure. The Company's fixed costs
may also increase if the Company elects to expand its infrastructure in South
Korea, Japan, other parts of Asia, or other locations. Any liquidity deficiency
in the future could delay or change management's plans for the Company including
curtailing its acquisition strategy, capital expenditures, facilities expansion
and research and development expenditures, which could materially adversely
affect the ability of the Company to service its debt (including indebtedness
under the Notes) and its business, financial condition and results of
operations.
The Company will continue to have limited cash resources and significant future
obligations. The precise amount and timing of the Company's funding needs cannot
be determined at this time and will depend upon a number of factors, including
the market demand for the Company's products, the availability of strategic
opportunities, the progress of the Company's product development efforts,
technological challenges that must be overcome in connection with existing and
future products, the Company's inventory management and the Company's management
of its cash and accounts payable. The Company may not be able to obtain
additional financing as needed on acceptable terms or at all. If the Company is
unable to obtain sufficient capital, it could be required to curtail its
acquisition strategy, capital expenditures, facilities expansion and research
and development expenditures, which could materially adversely affect the
Company's business, financial condition and results of operations.
21
<PAGE> 22
ENVIRONMENTAL REGULATIONS
The Company is 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. The Company believes that it is 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 on the Company,
or its officers, directors or employees, suspension of production, alteration of
its manufacturing process or cessation of operations. Such regulations could
require the Company to acquire expensive remediation or abatement equipment or
to incur expenses to comply with environmental regulations. Any failure by the
Company to properly manage the use, disposal or storage of, or adequately
restrict the release of, hazardous or toxic substances could subject the Company
to significant liabilities.
YEAR 2000
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 as a result of this issue.
The Company is in the process of assessing the readiness of its internal
computer systems, its products and its vendors for handling the Year 2000 issue.
The Company believes that all of its critical internal business applications are
Year 2000 compliant, and that all Company products shipped after June 30, 1999
will be year 2000 Compliant. The Company does not believe that the costs of any
actions required as a result of such assessment will have a material adverse
effect on the Company's business, financial condition or results of operations.
There can be no assurance, however, that the Company will successfully implement
the correct solutions or that there will be no delay in or increased costs
associated with the Company's Year 2000 readiness programs. The Company's
inability to successfully implement such changes could have a material adverse
effect on the Company's business, financial condition or results of operations.
In addition, there can be no assurance that the Company's critical product and
service providers, and their critical providers and so on, are or will become
year 2000 compliant on a timely basis both individually and as a group,
including information systems integrated among businesses, financial
institutions, government agencies, utilities, etc. The failure of such critical
product and service providers and integrated information systems to be or become
year 2000 compliant could have a material adverse effect on the Company's
business, financial condition or results of operations. In addition, it is
possible that the Company's revenue may be adversely affected if current and
prospective customers direct their spending resources away from purchasing the
Company's products over the next two years in order to correct or replace
information systems which are not year 2000 compliant.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risks.
Not applicable.
22
<PAGE> 23
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
On May 4, 1998, Phase Metrics filed suit against Vlad Pogrebinsky, Igor
Iosilevsky, Jonathan Nguyen and Magnetic Recording Solutions, Inc. alleging
misappropriation of trade secrets, breach of contract, copyright infringement,
interference with prospective advantage and unfair competition. (Phase Metrics,
Inc. v. Magnetic Recording Solutions, et. al.) The case was filed in the U.S.
District Court in the Northern District of California. The individual defendants
are former employees of Phase Metrics. Among other things, Phase Metrics seeks
damages and injunctive relief for the misappropriation and use of its trade
secrets and confidential information and for unauthorized copying and use of its
copyrighted computer software. On July 29, 1998, the defendants in the case
filed counterclaims against Phase Metrics and its President and Chief Executive
Officer alleging intentional and negligent interference with contractual
relations, intentional and negligent interference with prospective business
advantage, trade libel, slander per se, intentional and negligent infliction of
emotional distress, unfair competition, attempted monopolization,
monopolization, and unfair practices in violation of California Business and
Professions Code Section 17000, et. seq. The counterclaim seeks injunctive
relief and damages in an unspecified amount. The court has stayed the claims in
the counterclaim which allege antitrust violations, in response to a motion to
bifurcate and stay brought by Phase Metrics. Although discovery has only
recently commenced, Phase Metrics believes it has valid defenses to the
counterclaims brought by the defendants in this case and intends to vigorously
defend such counterclaims.
The Company is also subject to various other legal matters in the normal course
of its business. While the results of litigation and claims cannot be predicted
with certainty, the Company believes that the final outcome of these other
matters will not have a material adverse effect on its business, results of
operations or financial condition.
ITEM 2 CHANGES IN SECURITIES
In August and September 1998, the Company issued and sold an aggregate of
7,610,000 shares of its Series C Preferred Stock for $4.00 per share to a group
of investors, which included a number of its current stockholders and two
members of the Company's Board of Directors. The Company received aggregate
proceeds of approximately $30.4 million in connection with the Series C
Financing. Immediately following the consummation of the Series C Financing, the
Company used $7.1 million of the net proceeds therefrom to repay the
indebtedness and accrued interest outstanding under the Credit Facility.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
The Company's second quarter operating results resulted in a technical default
under certain financial covenants contained in the Credit Facility. The Company
was not in payment default under the Credit Facility. Immediately following the
consummation of the Series C Financing, the Company used $7.1 million of the net
proceeds therefrom to repay the indebtedness and accrued interest outstanding
under the Credit Facility.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
As of July 29, 1998, in a Written Consent of Stockholders of the Company, a
majority of the holders of the then outstanding shares of Common Stock of the
Company (which majority included all of the holders of the Preferred Stock of
the Company, voting on an as converted basis) approved the Amended and Restated
Certificate of Incorporation which set forth the rights, preferences and
privileges of the Series C Preferred Stock, amended the rights, preferences and
privileges of the Series A and B Preferred Stock, and authorized a
twenty-for-one stock split with respect to the Series A Preferred Stock and
Series B Preferred Stock.
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
23
<PAGE> 24
PHASE METRICS, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHASE METRICS, INC.
(Registrant)
By /s/ BRAD LALUZERNE
----------------------------------
Brad LaLuzerne,
Vice President, Finance,
Chief Financial Officer and
Assistant Secretary (Chief
Accounting Officer)
Date: November 20, 1998
24
<PAGE> 25
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
27 Financial Data Schedule
<PAGE> 26
[ARTICLE] 5
[MULTIPLIER] 1,000
<TABLE>
<S> <C>
[PERIOD-TYPE] 9-MOS
[FISCAL-YEAR-END] DEC-31-1998
[PERIOD-START] JAN-01-1998
[PERIOD-END] SEP-30-1998
[CASH] 17,257
[SECURITIES] 0
[RECEIVABLES] 23,487
[ALLOWANCES] (2,504)
[INVENTORY] 32,664
[CURRENT-ASSETS] 78,631
[PP&E] 49,722
[DEPRECIATION] (18,277)
[TOTAL-ASSETS] 114,375
[CURRENT-LIABILITIES] 27,613
[BONDS] 115,462
[PREFERRED-MANDATORY] 41,492
[PREFERRED] 3
[COMMON] 6,381
[OTHER-SE] (85,799)
[TOTAL-LIABILITY-AND-EQUITY] 114,375
[SALES] 86,334
[TOTAL-REVENUES] 86,334
[CGS] 72,556
[TOTAL-COSTS] 72,556
[OTHER-EXPENSES] 52,813
[LOSS-PROVISION] 0
[INTEREST-EXPENSE] 10,822
[INCOME-PRETAX] (49,628)
[INCOME-TAX] 8,701
[INCOME-CONTINUING] (58,329)
[DISCONTINUED] 0
[EXTRAORDINARY] (1,345)
[CHANGES] 0
[NET-INCOME] (59,674)
[EPS-PRIMARY] 0
[EPS-DILUTED] 0
</TABLE>
