<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 0-21432
AUSPEX SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 93-0963760
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NO.)
2300 CENTRAL EXPRESSWAY
SANTA CLARA, CA 95050
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER: (408) 566-2000
WEB SITE: WWW.AUSPEX.COM
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 [ ]
NUMBER OF SHARES OF COMMON STOCK, $.001 PAR VALUE, OUTSTANDING AS OF NOVEMBER 2,
1998: 25,704,079
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<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
FORM 10-Q
AUSPEX SYSTEMS, INC.
INDEX
PAGE
NUMBER
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements 1
Condensed Consolidated Balance Sheets as of September 30, 1998
and June 30, 1998 1
Condensed Consolidated Statements of Operations for the Three
Months Ended September 30, 1998 and September 30, 1997 2
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended September 30, 1998 and September 30, 1997 3
Notes to Unaudited Condensed Consolidated Financial Statements 4-6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7-13
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K 14
SIGNATURES 14
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
AUSPEX SYSTEMS, INC.
Condensed Consolidated Balance Sheets
<TABLE>
<CAPTION>
ASSETS
September 30, 1998 June 30, 1998
-------------------- ---------------
(In thousands) (Unaudited)
Current Assets
<S> <C> <C>
Cash and cash equivalents $ 40,372 $ 23,312
Short-term investments 11,436 27,449
Accounts receivable, net 25,369 25,642
Inventories 12,322 12,208
Income tax receivable -- 9,010
Deferred tax assets and other 12,394 13,819
-------- --------
Total current assets 101,893 111,440
-------- --------
Property and equipment, net 37,426 33,617
Other Assets 2,106 2,136
-------- --------
Total assets $141,425 $147,193
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, 1998 June 30, 1998
-------------------- ---------------
Current Liabilities
Accounts payable $ 10,274 $ 10,066
Accrued liabilities 13,941 12,434
Deferred revenue 8,562 9,450
Current portion of capital lease obligations 51 54
-------- --------
Total current liabilities 32,828 32,004
-------- --------
Stockholders' equity 108,597 115,189
-------- --------
Total liabilities and stockholders' equity $141,425 $147,193
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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AUSPEX SYSTEMS, INC.
Condensed Consolidated Statements of Operations
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------
September 30, 1998 September 30, 1997
------------------ ------------------
(In thousands, except per share amounts) (Unaudited) (Unaudited)
<S> <C> <C>
Revenues
Product revenue $ 22,030 $ 42,720
Service revenue 8,027 5,868
-------- --------
Total revenues 30,057 48,588
-------- --------
Cost of Revenues
Cost of product revenue 10,453 19,277
Cost of service revenue 5,684 4,703
-------- --------
Total cost of revenues 16,137 23,980
-------- --------
Gross margin 13,920 24,608
-------- --------
Operating Expenses
Selling, general and administrative 12,553 15,006
Research and development 8,708 7,254
-------- --------
Total operating expenses 21,261 22,260
-------- --------
Income / (loss) from operations (7,341) 2,348
Other income, net 596 408
-------- --------
Income / (loss) before provision
for income taxes (6,745) 2,756
Provision for income taxes 44 965
-------- --------
Net income / (loss) $ (6,789) $ 1,791
======== ========
Net income / (loss) per share
Basic $ (0.26) $ 0.07
======== ========
Diluted $ (0.26) $ 0.07
======== ========
Weighted average common shares and equivalents
Basic 25,700 25,044
======== ========
Diluted 25,700 25,642
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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AUSPEX SYSTEMS, INC.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------
September 30, 1998 September 30, 1997
------------------ ------------------
(In thousands) (Unaudited) (Unaudited)
<S> <C> <C>
Cash flows from operating activities
Net income $(6,789) $ 1,791
Adjustments to reconcile net income
to net cash provided by operating activities
Depreciation and amortization 3,779 3,389
Changes in assets and liabilities
Decrease in trade receivables 273 6,356
Increase in inventories (4,348) (6,773)
Decrease in income tax receivable, deferred tax assets and other 10,435 884
Increase in accounts payable 208 1,859
Increase in accrued liabilities 1,507 210
Decrease in deferred revenue (888) (939)
-------- --------
Net cash provided by operating activities 4,177 6,777
-------- --------
Cash flows from investing activities
Purchases of available-for-sale short-term investments (8,799) (8,767)
Proceeds from sales/maturities of available-for-sale short-term investments 24,834 12,829
Purchases of property and equipment (3,328) (3,937)
Decrease in other assets 4 92
-------- --------
Net cash provided by investing activities 12,711 217
-------- --------
Cash Flows from financing activities
Principal payments on capital lease obligations (3) (15)
Proceeds from sale of common stock, net 19 527
-------- --------
Net cash provided by financing activities 16 512
-------- --------
Effect of exchange rate changes on cash 156 (158)
-------- --------
Net increase in cash and cash equivalents 17,060 7,348
Cash and cash equivalents, beginning of period 23,312 25,056
-------- --------
Cash and cash equivalents, end of period $40,372 $32,404
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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AUSPEX SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The accompanying interim consolidated financial statements and
related notes should be read in conjunction with the financial statements and
related notes included in the Company's fiscal 1998 Annual Report to
Stockholders.
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial
statements reflect, in the opinion of management, all adjustments (which include
only normal recurring adjustments) necessary to present fairly the financial
position as of the dates and results of operations for the periods indicated.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the Securities and
Exchange Commission rules and regulations. Additionally, the preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period. While
management makes its best effort to achieve its estimates, actual results could
differ from estimates.
The results of operations for the three months ended September 30,
1998, are not necessarily indicative of results for the entire fiscal year
ending June 30, 1999. (See "Factors That May Affect Future Operating
Performance" in Management's Discussion and Analysis of Financial Condition and
Results of Operations.)
2. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Substantially all cash equivalents consist of investments in
certificates of deposits, money market deposits, and municipal bonds with
original maturities of three months or less. Substantially all short-term
investments consist of municipal bonds, commercial paper and U.S. agency bonds,
which the Company intends to hold between three and twelve months.
3. NON-CASH INVESTING ACTIVITIES
Net inventory capitalized into property and equipment was $4,234,000
for the three months ended September 30, 1998. No inventory was capitalized into
property and equipment for the three months end September 30, 1997.
4. REVENUE RECOGNITION
Product revenue includes hardware sales and software license fees.
The Company generally recognizes system sales to end-users upon shipment. The
installation of the Company's systems is not considered a significant obligation
and acceptance by the customer is not considered a significant uncertainty.
Revenues from upgrade sales are generally recognized at the time the equipment
is shipped. Provisions for product sales returns and allowances are recorded in
the same period as the related revenue. Revenues earned under software license
agreements with end users are generally recognized when the software has been
shipped and there are no significant obligations remaining.
Service revenue includes installation, maintenance and training, and
is recognized ratably over the contractual period or as the services are
provided.
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5. NET INCOME PER SHARE
Basic net income per share is computed based only on the weighted
average number of common shares outstanding during the period and does not give
effect to the dilutive effect of common equivalent shares, such as stock
options. Diluted net income per share is computed based on the weighted average
number of common shares plus dilutive potential common shares calculated in
accordance with the treasury stock method.
<TABLE>
<CAPTION>
Three Months Ended September 30,
--------------------------------
1998 1997
-------- --------
<S> <C> <C>
Net income (loss) ......................................................... $ (6,789) $ 1,791
======== ========
Basic Earnings Per Share
Income (loss) available to common stockholders ........................ $ (6,789) $ 1,791
Weighted average common shares outstanding ............................ 25,700 25,044
-------- --------
Basic earnings (loss) per share ....................................... $ (0.26) $ 0.07
======== ========
Diluted Earnings Per Share
Income (loss) available to common stockholders ........................ $ (6,789) $ 1,791
-------- --------
Weighted average common shares outstanding ............................ 25,700 25,044
Dilutive potential common shares from stock options ................... -- 598
-------- --------
Weighted average common shares and dilutive
potential common shares ......................................... 25,700 25,642
-------- --------
Diluted earnings (loss) per share ......................................... $ (0.26) $ 0.07
======== ========
</TABLE>
All weighted average options outstanding during the three months
ended September 30, 1998, 4,574,919 shares were excluded from the computation
of diluted earnings per share because the effect of including them would have
been antidilutive due to the loss available to common stockholders. Weighted
average options outstanding to purchase 766,429 shares during the three months
ended September 30, 1997 were excluded from the computation of diluted earnings
per share because the exercise price for these options were greater than the
average market price of the Company's common stock during this period.
6. INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or
market, and include material, labor, and manufacturing overhead costs.
Inventories consist of the following:
<TABLE>
<CAPTION>
(In Thousands)
September 30, 1998 June 30, 1998
------------------ -------------
<S> <C> <C>
Purchased materials ... $ 6,002 $ 5,615
Systems in process .... 3,381 4,041
Finished goods ........ 2,939 2,552
------- -------
Total inventories $12,322 $12,208
======= =======
</TABLE>
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Inventories contained components and assemblies in excess of the
Company's current estimated requirements and were fully reserved at September
30, 1998 and June 30, 1998.
Certain of the Company's products contain critical components
supplied by a single or limited number of third parties. The Company has an
inventory of these critical components so as to ensure an available supply of
products for its customers. Any significant shortage of these components or the
failure of the third party suppliers to maintain or enhance these components
could materially adversely affect the Company's results of operations. (See
"Factors That May Affect Future Operating Performance--Dependence on Certain
Suppliers.")
7. COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standard No.
130 "Reporting Comprehensive Income" ("SFAS 130") effective for fiscal years
beginning after December 15, 1997 and has restated information for all prior
periods reported below to conform to this standard. The following table sets
forth the components of other comprehensive income (loss) as follows (in
thousands):
<TABLE>
<CAPTION>
Three Months Ended September 30,
--------------------------------
1998 1997
------- -------
<S> <C> <C>
Net income (loss) $(6,789) $ 1,791
Other comprehensive income (loss):
Unrealized holding gains
on available-for-sale securities, net of
tax expense of $0 and $15, respectively 22 28
Foreign currency translation adjustments,
net of tax benefit of $0 and $55,
respectively 156 (103)
------- -------
Comprehensive income (loss) $(6,611) $ 1,716
======= =======
</TABLE>
8. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFA
No. 131, "Disclosures about Segments of an Enterprise and Related Information,"
which establishes annual and interim reporting standards for an enterprise's
business segments and related disclosures about its products, services,
geographic areas and major customers. The Company is required to adopt SFAS No.
131 in fiscal 1999 and does not expect such adoption to have a material effect
on the consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. It requires that a reporting entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The Company is required to
adopt SFAS No. 133 in the first quarter of fiscal 2000. The impact of adopting
SFAS No. 133 to the Company has not been determined.
8. RECLASSIFICATION
The Company has reclassified certain prior year balances from
selling, general and administrative expenses to cost of service revenues to
reflect costs associated with service revenue to conform to the current year
presentation. The amount of reclassification for the three months ended
September 30, 1997 was $725,000.
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AUSPEX SYSTEMS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Total revenues for the first quarter of fiscal 1999, ended September
30, 1998, were $30.1 million, a decrease of 38% over total revenues of $48.6
million in the first quarter of fiscal 1998.
Product revenues for the first quarter of fiscal 1999 were $22.0
million or 73% of total revenues compared to $42.7 million or 88% of total
revenues in the first quarter of fiscal 1998. Revenues from system sales
accounted for 31% of total revenues during the first quarter of fiscal 1999 and
43% for the first quarter of fiscal 1998, while revenues from upgrades, add-on
options and software license agreements comprised 43% of total revenues during
the first quarter of fiscal 1999 and 45% for the first quarter of fiscal 1998.
Service revenues for the first quarter of fiscal 1999 were $8.0 million or 27%
of total revenues compared to 12% in the first quarter of fiscal 1998.
Geographically, North America accounted for 60% and 66% of total revenues in the
first quarters of fiscal 1999 and 1998, respectively; the Pacific Rim accounted
for 10% and 18% in the first quarters of fiscal 1999 and 1998, respectively; and
Europe accounted for 30% and 16% in the first quarters of fiscal 1999 and 1998,
respectively. The decrease in revenues in North America primarily related to the
timing of new product introductions and increased competitive pressures. The
increase in revenue in Europe as a percentage of total revenues in the first
quarter of fiscal 1999 was primarily due to orders from new customers in key
market areas. The decrease in Pacific Rim revenue as a percentage of total
revenues and in absolute dollars in the first quarter of fiscal 1999 was
primarily due to the reorganization of a major OEM partner and weakness in the
Japanese economy.
Gross margin was 46% of net revenues in the first quarter of fiscal
1999 compared with 51% in the first quarter of fiscal 1998. Product gross margin
decreased to 53% in the first quarter of fiscal 1999 from 55% in the first
quarter of fiscal 1998. The decline in margin was due to lower pricing on
systems sales and lower margins on product upgrade sales as a result of lower
average selling prices on disk drives.
Selling, general and administrative expenses during the first
quarter of fiscal 1999 totaled $12.6 million, a decrease of 16% from $15.0
million in the corresponding period of the prior fiscal year, and comprised 42%
and 31% of total revenues, respectively. This decrease in absolute dollars
reflects steps the Company has taken in streamlining operations and reducing
overall costs. The increase in selling, general and administrative expenses as a
percentage of revenues is a result of lower revenues in first quarter of fiscal
1999.
Research and development expenses incurred during the first quarter
of fiscal 1999 were $8.7 million, an increase of 20% from $7.3 million in the
corresponding period of the prior fiscal year, and comprised 29% and 15% of
total revenues, respectively. This increase in absolute dollars and as a
percentage of revenues was primarily due to new product development efforts, the
funding of the Company's new research and development facility acquired in the
Alphatronix, Inc. acquisition (See the Company's 1998 Form 10-K for a discussion
on the Alphatronix acquisition) and the lower revenue in first quarter of fiscal
1999.
Loss from operations for the first quarter of fiscal 1999 was $7.3
million, compared with income from operations of $2.3 million in the first
quarter of fiscal year 1998. The decline in operating results was primarily due
to lower revenues and an increase in research and development efforts,
reflecting the Company's investment across the organization in support of new
products and technologies for UNIX markets.
The Company's tax rate for the first quarter of fiscal 1999 was 0%
as compared with 35% in the first quarter of fiscal 1998.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and short-term investments
increased by $1.0 million to $51.8 million for the three months ended September
30, 1998. The Company generated approximately $4.2 million in cash from
operating activities in the first quarter of fiscal 1999, which included the
collection of $9.3 million of income tax receivable. The Company also generated
approximately $12.7 million in cash from investing activities in the first
quarter of fiscal 1999. The Company's working capital decreased during the first
quarter of fiscal 1999 by $10.4 million to $69.1 million.
Based on its current operating plans, the Company believes that its
existing cash, cash equivalents and short-term investments and cash flow from
operations will be sufficient to meet its working capital and capital
expenditure requirements at least through the next 12 months.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The entire second paragraph under the section entitled "Liquidity
and Capital Resources"; the third sentence of the risk factor entitled "Software
Product Risks" in "Factors That May Affect Future Performance"; the third
sentence of the risk factor entitled "New Products" in "Factors That May Affect
Future Performance"; the second sentence of the risk factor entitled "Risks of
International Sales" in "Factors That May Affect Future Performance"; and the
fifth, sixth and seventh sentence of the first paragraph, the second sentence of
the fourth paragraph, the entire eighth paragraph, the last sentence of the
ninth paragraph, the last sentence of the tenth paragraph and the entire
eleventh paragraph of the section entitled "Year 2000 Compliance" in "Factors
That May Affect Future Performance" contain forward looking statements as
defined in Private Securities Litigation Reform Act of 1995. The Company may
also make oral and written forward-looking statements from time to time. Actual
results may differ materially from those projected in any such forward-looking
statements due to a number of factors, including those set forth below. The
Company undertakes no obligation to update such information.
POTENTIAL SIGNIFICANT FLUCTUATIONS IN QUARTERLY RESULTS
The Company's operating results may fluctuate significantly from
quarter to quarter due to a combination of factors. These factors include the
timing of orders, the timing of new product introductions by the Company or its
competitors, and the mix of distribution channels through which the Company's
products are sold. The Company generally realizes higher gross margins on sales
of systems to end users and on single-system sales than on systems sold through
distributors and OEMs and on multiple-system sales. In addition, given the
Company's focus on highly configured enterprise class systems, the loss or delay
in a given quarter of a relatively limited number of system sales could
adversely affect the Company's revenues. Historically, the Company often has
recognized a substantial portion of its revenues in the last month of any given
quarter. Because the Company's operating expenses are based on anticipated
revenue levels and because a high percentage of the Company's expenses are
relatively fixed, a small variation in the timing of the recognition of revenues
could cause significant variations in operating results from quarter to quarter.
COMPETITIVE MARKET
The market for the Company's products is highly competitive. The
Company experiences substantial competition, principally from Sun Microsystems,
Hewlett-Packard Company and Silicon Graphics, Inc., among others. Some companies
have introduced proprietary products to provide network attached storage. Most
of the Company's competitors are better known and have substantially greater
financial, technological, production and marketing resources than the Company.
While the Company believes that the price/performance characteristics of its
products are competitive, price competition in the markets for the Company's
products is intense. Any material reduction in the price of the Company's
products without corresponding decreases in manufacturing costs and increases in
unit volume would negatively affect gross margins, which could in turn have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company also derives a significant portion of its
revenues from sales of product upgrades to its installed base of customers,
including additional processors, memory and disk. Increased competition for the
Company's products that results in lower product sales
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could also adversely impact the Company's upgrades sales. In addition, decisions
by customers not to increase capacity to their current systems could adversely
impact the Company's revenues and results of operations. The Company's ability
to maintain its competitive position will depend upon, among other factors, its
success in anticipating industry trends, investing in product research and
development, developing new products with improved price/performance
characteristics and effectively managing the introduction of new products into
targeted markets.
DEPENDENCE ON KEY PERSONNEL
Competition for employees with highly technical, management and other
skills is intense in the computer industry and is particularly intense in the
San Francisco Bay Area. The Company has in the recent past encountered some
difficulties in fulfilling its hiring needs and retaining key employees in this
employment market, and there can be no assurance that the Company will be
successful in hiring and retaining qualified employees in the future. The
Company's failure to retain the services of key personnel or to attract
additional qualified employees could have a material adverse effect on the
Company's business, financial condition and results of operations.
SOFTWARE PRODUCT RISKS
The Company markets software products in addition to its line of
network file servers. These software products include: NeTservices(TM),
DriveGuard(TM), FastBackup(TM), ServerGuard(TM), ServerGuard Global(TM) and
DataGuard(TM). The Company also expects to release enhancements and new features
for these products from time to time. Although the Company performs extensive
testing prior to releasing software products, such products may contain
undetected errors or bugs when first released. These may not be discovered until
the product has been used by customers in different application environments.
Failure to discover product deficiencies or bugs could delay product
introductions, require design modifications to previously shipped products,
cause unfavorable publicity or negatively impact system shipments; any of which
could result in a materially adverse effect on the Company's business, financial
condition and results of operations.
NEW PRODUCTS
New product introductions by the Company or its competitors carry the
risk that customers could delay or cancel orders for existing products pending
shipment of the new products. For instance, product transition issues had an
adverse impact on North America revenue in fiscal 1998. The Company's strategy
is to continue to introduce new products and upgrades to existing products on an
ongoing basis. There can be no assurance that the Company will not experience
difficulties that delay or prevent the successful development, introduction or
marketing of these products and enhancements or that these new products and
enhancements will adequately address market requirements, achieve market
acceptance or generate substantial sales. Additionally, delays in the launch or
lack of availability of new products could have a material adverse effect on the
Company's business, financial condition and results of operations.
DEPENDENCE ON ESTABLISHED STANDARDS
The rapid emergence of new or alternate standards such as Windows NT
which replace or diminish the market acceptance of UNIX operating systems or
NFS, on which the Company's products are currently based, could materially and
adversely affect the Company's results of operations unless the Company is able
to incorporate any such standards in the Company's products in a timely manner.
DEPENDENCE ON CERTAIN CUSTOMERS/DISTRIBUTORS
For the three months ended September 30, 1998 and 1997, direct sales
of products and services to Intel Corporation ("Intel") represented
approximately 15% and 19%, respectively, of the Company's revenues. Intel is not
obligated to purchase any minimum level of products from the Company. Additional
significant reductions in product sales to Intel would materially and adversely
affect the Company's business, financial condition and results of operations.
Page 9
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DEPENDENCE ON CERTAIN SUPPLIERS
Certain of the Company's products contain critical components
supplied by a single or limited number of third parties. While the Company has
an inventory of these critical components, any significant or prolonged shortage
of these components or the failure of the third-party suppliers to maintain or
enhance these components could materially and adversely affect the Company's
results of operations.
EXCESS OR OBSOLETE INVENTORY
Managing the Company's inventory of components and finished products
is a complex task. A number of factors, including but not limited to, the need
to maintain a significant inventory of certain components which are in short
supply or which must be purchased in bulk to obtain favorable pricing, the
general unpredictability of demand for specific products and customer requests
for quick delivery schedules, may result in the Company maintaining large
amounts of inventory. Other factors, including changes in market demand and
technology, may cause inventory to become obsolete. Any excess or obsolete
inventory could result in price reductions and/or inventory write-downs, which
in turn could adversely affect the Company and its results of operations. For
example, the Company wrote-down $9.4 million of certain disk drive inventories
in the second quarter of fiscal 1998, and this write-down had an adverse effect
on gross margins.
RISKS OF INTERNATIONAL SALES; EUROPEAN AND JAPANESE MARKET RISKS
During the first three months ended September 30, 1998 and 1997,
approximately 40% and 34%, respectively, of the Company's total revenues were
derived from markets outside of North America. The Company expects that sales to
the Pacific Rim and Europe will continue to represent a significant portion of
its business. However, there can be no assurance that the Company's Pacific Rim
or European operations will continue to be successful. The Company's
international business may be affected by changes in demand resulting from
localized economic and market conditions. For example, the Company experienced a
decrease in revenues from the Pacific Rim during the first three months ended
September 30, 1998 due to further weakness in the Japanese economy and effects
from continuing organizational change at one of the Company's major Japanese
distributors. In addition, the Company's international business may be affected
by fluctuations in currency exchange rates and currency restrictions. The
Company purchases the majority of its materials and services in U.S. dollars,
and most of its foreign sales are transacted in U.S. dollars. Continued
increases in the value of the U.S. dollar relative to foreign currencies will
make the Company's products sold internationally less price competitive. The
Company has offices in a number of foreign countries, the operating expenses of
which are also subject to the effects of fluctuations in foreign exchange rates.
Financial exposure may result due to the timing of transactions and movement of
exchange rates. The Company's international business may further be affected by
risks such as trade restrictions, increase in tariff and freight rates and
difficulties in obtaining necessary export licenses and meeting appropriate
local regulatory standards. For example, the Company has had to modify its
products in minor respects in Japan to comply with local electromagnetic
emissions standards, and must also comply with corresponding European Economic
Community standards. In marketing its products to the European Economic
Community, the Company also must face the challenges posed by a fragmented
market complicated by local distribution channels and local cultural
considerations. For international sales, the Company has largely relied on
distributors or OEMs, most of whom are entitled to carry products of the
Company's competitors. There can be no assurance that any of the foregoing risks
or issues will not have a material adverse effect on the Company's business,
financial condition and results of operations.
STOCK MARKET FLUCTUATIONS
In recent years, the stock market in general and the market for
technology stocks in particular, including the Company's Common Stock, have
experienced extreme price fluctuations. The market price of the Company's Common
Stock may be significantly affected by various factors such as quarterly
variations in the Company's operating results, changes in revenue growth rates
for the Company as a whole or for specific geographic areas or products, changes
in earning estimates by market analysts, the announcements of new products or
product enhancements by the Company or its competitors, speculation in the press
or analyst community, and general
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market conditions or market conditions specific to particular industries. There
can be no assurance that the market price of the Company's Common Stock will not
experience significant fluctuations in the future.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS; PENDING LITIGATION
The Company currently relies on a combination of patent, copyright,
trademark and trade secret laws and contractual provisions to protect its
proprietary rights in its hardware and software products. The Company currently
holds seven United States patents and has filed applications for additional
patents. The Company also has filed applications for counterpart patents in
foreign countries, including Japan. There can be no assurance that the Company's
present or future competitors will not independently develop technologies that
are substantially equivalent or superior to the Company's technology. Further,
there can be no assurance that the Company's patent applications will result in
issued patents, or that the Company's issued patents will be upheld if
challenged. Additionally, there can be no assurance that third parties will not
assert intellectual property infringement claims against the Company in the
future with respect to current or future projects or that any such assertions
may not require the Company to refrain from the sale of its products, enter into
royalty arrangements or undertake costly litigation.
The Company's adherence to industry standards with respect to its
products limits the Company's opportunities to provide proprietary features,
which may be protected. In addition, the laws of various countries in which the
Company's products may be sold may not protect the Company's products and
intellectual property rights to the same extent as the laws of the United
States.
The Company is subject to various claims which arise in the normal
course of business. The Company believes that the litigation, individually or in
the aggregate, to which it is currently a party, is not likely to have a
material adverse effect on the Company's results of operation or financial
condition.
YEAR 2000 COMPLIANCE
The Company is aware of the issues associated with the programming
code in existing computer systems, both customers and internal, as the Year
2000 approaches. The Year 2000 problem is pervasive and complex, as virtually
every computer operation will be affected in some way by the rollover of the
two-digit year value to 00. Systems that do not properly recognize
date-sensitive information when the year changes to 2000 could generate
erroneous data or cause a system to fail. Significant uncertainty exists in the
software industry concerning the potential effects associated with the Year 2000
problem. The Company's new products, as of fiscal 1998, are being designed to be
Year 2000 compliant (as the Company has defined that term in its published
statements). However, some of the Company's older products will not be Year 2000
compliant and, as a result, the Company's customers will be required to upgrade
these products. Although products have undergone, or will undergo, the Company's
normal quality testing procedures, there can be no assurance that the Company's
products will contain all necessary date code changes. Any failure of the
Company's products to perform, including system malfunctions due to the onset of
Year 2000, could result in claims against the Company, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. Moreover, the Company's customers could choose to convert
to other Year 2000 compliant products or to develop their own products in order
to avoid such malfunctions, either of which could have a material adverse effect
on the Company's business, financial condition and results of operations.
The Company currently is in the process of auditing its own
information technology infrastructure for Year 2000 compliance, including
reviewing what actions are required to make all software systems Year 2000
compliant as well as actions needed to mitigate the risks of Year 2000. Such
actions include a review of vendors' contracts, attention to Year 2000 issues in
future contracts with vendors and formal communications with suppliers
requesting that they certify that their products are Year 2000 compliant.
Page 11
<PAGE> 14
STATE OF READINESS
The Company has been actively addressing the Year 2000 issues since
fiscal 1997. The following sections broadly address Year 2000 matters with
respect to the Company's (a) suppliers, (b) facilities and infrastructure, (c)
information technology systems, (d) engineering infrastructure, and (e)
manufacturing operation Year 2000 compliance assessment.
Suppliers
During fiscal 1998, the Company sent a Year 2000 Readiness
Letter/Questionaire to its suppliers. Very few responses to this letter were
received and, as a result, the Company is undertaking the following: (1) a new
Readiness Letter/Questionaire was generated and mailed to all suppliers during
October 1998; (2) the Company is in the process of identifying and devoting
resources to ensure the Year 2000 compliance of significant and/or critical
suppliers; (3) supplier response to the new Year 2000 Readiness
Letter/Questionaire will be closely monitored; and (4) follow-up communication
will be initiated with significant and/or critical suppliers who do not respond
to the Year 2000 Readiness Letter/Questionaire or certify Year 2000 compliance.
Based on their responses and results of the Readiness Letter/Questionaire,
alternate suppliers may need to be identified by the Company. There can be no
assurance that the Company will be able to find suitable alternate suppliers and
contract with them on reasonable terms, or at all, and such inability could have
a material and adverse impact on the Company's business and results of
operations.
Facilities and Infrastructure
The Company's new headquarters facility in Santa Clara and domestic
remote sites are believed to be Year 2000 compliant with respect to building
automation systems, electronic security systems and utilities. The Company has
presented formal queries to local fire departments with regard to Year 2000
compliance/readiness. Formal responses have not been received as of this filing.
The Company believes that its English and French facilities are Year 2000
compliant; however, the German and Japanese facilities have not responded
formally to the Company's inquiries as of this filing.
Information Technology Systems
Over the past several years, the Company has invested in a number of
Year 2000 compliant PBXs and voice-mail systems. The one current non-compliant
Year 2000 PBX system resides at a subsidiary of the Company. Plans are in place
to migrate this system to a Year 2000 compliant PBX system by the end of
calendar year 1998. No effort has yet been spent on verifying Year 2000
compliance of local telephone systems of most sales offices, and the Company
expects to have verified such compliance by the end of fiscal 1999.
The Company believes that its internal production data communication
network is Year 2000 compliant. A majority of the key components of the network,
which the Company believes to be Year 2000 compliant, were installed within the
past nine months. The Company's wide-area network requirements are provided by a
major national and international carrier, and the Company believes inoperability
between these carriers is in question partly due to the fact testing between
carriers cannot commence until each carrier is Year 2000 compliant. For local
services that are provided by local carriers, the Company has not yet invested a
significant amount of time to verify their Year 2000 readiness, but intends to
verify compliance by the end of fiscal 1999.
The Company has replaced or upgraded, or is in the process of
replacing/upgrading, many of its core applications systems. A new Year 2000
compliant enterprise resource planning package was installed in the first
calendar quarter of 1998. An upgrade to a newer version of this package is
planned for the fourth calendar quarter of 1998 which incorporates several Year
2000 compliance--related bug fixes. The upgrade to a newer version of the
Company's payroll and human resources systems to Year 2000 compliant systems was
completed during September 1998. The Company's customer call tracking system is
being upgraded to provide additional functionality and stability and will
complete such upgrade by the end of fiscal 1999. Part of the project plan for
this upgrade will be to confirm the vendor's assertion that the product is Year
2000 compliant. During fiscal 1998, the Company invested in a desktop upgrade
program. The standard personal computers and laptop computers installed during
this period are Year 2000 compliant to the extent the vendors have affirmed.
Testing has confirmed at commonly used functions operate satisfactorily.
Page 12
<PAGE> 15
Engineering Infrastructure
The Company's engineering infrastructure is in a continual state of
change due to the dynamic nature of the Company's business and focus on new
products. As older products are retired and new products developed, the tools,
equipment and laboratory environments change. The Company is in the process of
assessing the Year 2000 issues of its engineering infrastructure and will
complete such assessment by the end of December 1998.
Manufacturing Operations
The Company is primarily an assemble-to-order manufacturing
operation. There is no significant automated assembly equipment on its
manufacturing shop floor. The Company is in the process of reviewing its
manufacturing operations for potential Year 2000 issues and will complete such
assessment by the end of December 1998.
COSTS TO ADDRESS YEAR 2000 ISSUES
The Company expects to incur total software-, hardware- and
systems-related costs of approximately $1.9 million and solutions providers
costs of approximately $500,000 in connection with the remediation of Year 2000
compliance issues. There can be no assurance that the cost estimates associated
with the Company's Year 2000 issues will prove to be accurate or that the actual
costs will not have a material adverse effect on the Company's results of
operations and financial condition.
YEAR 2000 ISSUES
The Company's Technical Support representatives work closely with
customers to resolve problems, issues and questions. The Company's Customer
Service organization uses several toll free phone numbers to address customer
problems, issues and questions. These calls are logged and tracked using a call
management system. Customer Service has a significant reliance on
communications, voice-mail, email, paging, Web and file transfer program
services and data communications. Given the number and variety of suppliers and
their inter-dependencies, the number and location of worldwide customers and the
number and locations of the various Technical Support offices, it is not
feasible to fully test whether the Company will be able to guarantee that each
customer will be able to contact and/or do business with Customer Service
without disruption. The Company expects an increase in calls during the period
of the Year 2000 transition, which will likely impact Customer Service
responsiveness.
CONTINGENCY PLANS
The Company currently is in the process of preparing general
contingency plans for the Year 2000 compliance issues areas noted above and the
Company anticipates completing those plans by September 1999. There can be no
assurance that such measures will prevent the occurrence of Year 2000 problems,
which could have a material adverse effect upon the Company's business,
operating results and financial condition.
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKS
INTEREST RATE RISK
There were no material changes during the first quarter of fiscal
1999 to the Company's exposure to market risk for changes in interest rates.
FOREIGN CURRENCY EXCHANGE RISK
There were no material changes during the first quarter of fiscal
1999 to the Company's foreign currency hedging programs.
Page 13
<PAGE> 16
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a. Exhibits
Not applicable
b. Reports on Form 8-K
No report on Form 8-K was filed during the current period
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.
Auspex Systems, Inc.
----------------------------------
Date November 12, 1998
----------------- ----------------------------------
R. Marshall Case
Vice President of Finance and
Chief Financial Officer
Page 14
<PAGE> 17
AUSPEX SYSTEMS, INC.
EXHIBITS TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
Sequentially
Exhibit Description Numbered Page
- ------- ----------- -------------
<S> <C> <C>
27 Financial Data Schedule 15
</TABLE>
Page 15
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 40,372
<SECURITIES> 11,436
<RECEIVABLES> 29,076
<ALLOWANCES> 3,707
<INVENTORY> 12,322
<CURRENT-ASSETS> 101,893
<PP&E> 82,277
<DEPRECIATION> 44,851
<TOTAL-ASSETS> 141,425
<CURRENT-LIABILITIES> 32,828
<BONDS> 0
0
0
<COMMON> 26
<OTHER-SE> 108,571
<TOTAL-LIABILITY-AND-EQUITY> 141,425
<SALES> 22,030
<TOTAL-REVENUES> 30,057
<CGS> 10,453
<TOTAL-COSTS> 16,137
<OTHER-EXPENSES> 21,321
<LOSS-PROVISION> (60)
<INTEREST-EXPENSE> 2
<INCOME-PRETAX> (6,745)
<INCOME-TAX> 44
<INCOME-CONTINUING> (6,789)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,789)
<EPS-PRIMARY> (.26)
<EPS-DILUTED> (.26)
</TABLE>
