<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 DECEMBER 31, 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 FEBRUARY 2,
1999: 25,950,368
<PAGE> 2
- ---------------------------------------------------------------------------
FORM 10-Q
AUSPEX SYSTEMS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
PART I. FINANCIAL INFORMATION NUMBER
<S> <C>
ITEM 1. Financial Statements 1
Condensed Consolidated Balance Sheets as of December 31, 1998 1
and June 30, 1998
Condensed Consolidated Statements of Operations for the Three and Six 2
Months Ended December 31, 1998 and December 31, 1997
Consolidated Statements of Cash Flows for the Six 3
Months Ended December 31, 1998 and December 31, 1997
Notes to Condensed Consolidated Financial Statements 4-6
ITEM 2. Management's Discussion and Analysis of Financial 7-14
Condition and Results of Operations
PART II. OTHER INFORMATION
ITEM 4. Submission of Matters to a Vote of Security Holders 14-15
ITEM 5. Other Information 15
ITEM 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 16
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. Financial statements
Auspex Systems, Inc.
Condensed Consolidated Balance Sheets
ASSETS
<TABLE>
<CAPTION>
December 31, 1998 June 30, 1998
- --------------------------------------------------------------------------------------
(In thousands)
(Unaudited)
Current Assets
<S> <C> <C>
Cash and cash equivalents $ 31,277 $ 23,312
Short-term investments 18,323 27,449
Accounts receivable, net 24,308 25,642
Inventories 10,121 12,208
Income tax receivable -- 9,010
Deferred tax assets and other 12,564 13,819
-------- --------
Total current assets 96,593 111,440
-------- --------
Property and equipment, net 33,103 33,617
Other assets 2,083 2,136
-------- --------
Total assets $131,779 $147,193
======== ========
</TABLE>
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
December 31, 1998 June 30, 1998
- --------------------------------------------------------------------------------------
<S> <C> <C>
Current Liabilities
Accounts payable $ 9,866 $ 10,066
Accrued liabilities 11,567 12,434
Deferred revenue 8,691 9,450
Current portion of capital lease obligations 46 54
-------- --------
Total current liabilities 30,170 32,004
-------- --------
Stockholders' equity 101,609 115,189
-------- --------
Total liabilities and stockholders' equity $131,779 $147,193
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
Page 1
<PAGE> 4
AUSPEX SYSTEMS, INC.
Condensed Consolidated Statements of Operations
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31, December 31, December 31,
1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------
(In thousands, except per share amounts) (unaudited) (unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues
Product revenue $ 22,353 $ 36,726 $ 44,383 $ 79,446
Service revenue 8,211 6,716 16,238 12,584
-------- -------- -------- --------
Total revenues 30,564 43,442 60,621 92,030
-------- -------- -------- --------
Cost of Revenues
Cost of product revenue 12,025 26,676 22,478 45,953
Cost of service revenue 5,785 4,936 11,469 9,639
-------- -------- -------- --------
Total cost of revenues 17,810 31,612 33,947 55,592
-------- -------- -------- --------
Gross margin 12,754 11,830 26,674 36,438
-------- -------- -------- --------
Operating Expenses
Selling, general and administrative 12,476 15,817 25,029 30,823
Research and development 8,391 8,160 17,099 15,414
-------- -------- -------- --------
Total operating expenses 20,867 23,977 42,128 46,237
-------- -------- -------- --------
Loss from operations (8,113) (12,147) (15,454) (9,799)
Other income, net 321 479 917 887
-------- -------- -------- --------
Loss before provision
for income taxes (7,792) (11,668) (14,537) (8,912)
Provision for (benefit from) income taxes 23 (4,084) 67 (3,119)
-------- -------- -------- --------
Net income (loss) $ (7,815) $ (7,584) $(14,604) $ (5,793)
======== ======== ======== ========
Earnings (loss) per share
Basic $ (0.30) $ (0.30) $ (0.57) $ (0.23)
======== ======== ======== ========
Diluted $ (0.30) $ (0.30) $ (0.57) $ (0.23)
======== ======== ======== ========
Shares used for earnings (loss) per share
Basic 25,728 25,283 25,714 25,163
======== ======== ======== ========
Diluted 25,728 25,283 25,714 25,163
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
Page 2
<PAGE> 5
AUSPEX SYSTEMS, INC.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
December 31, December 31,
Six Months Ended 1998 1997
- -----------------------------------------------------------------------------------------------------
(In thousands) (unaudited) (unaudited)
<S> <C> <C>
Cash flows from operating activities
Net income (loss) $(14,604) $ (5,793)
Adjustments to reconcile net income
to net cash provided by operating activities
Depreciation and amortization 7,551 6,895
Changes in assets and liabilities
Decrease in trade receivables 1,334 4,270
(Increase) decrease in inventories (2,147) 3,389
(Increase) decrease in income tax receivable,
deferred tax assets and other 10,265 (4,479)
Increase (decrease) in accounts payable (200) 9,140
Increase (decrease) in accrued liabilities (868) 1,690
Increase (decrease) in deferred revenue (759) 565
-------- --------
Net cash provided by operating activities 572 15,677
-------- --------
Cash flows from investing activities
Purchases of available-for-sale short-term investments (20,249) (15,587)
Proceeds from sales/maturities of available-for-sale
short-term investments 29,334 21,938
Purchases of property and equipment (4,905) (13,163)
Decrease in other assets 8 79
-------- --------
Net cash from (used in) investing activities 4,188 (6,733)
-------- --------
Cash flows from financing activities
Principal payments on capital lease obligations (8) (34)
Proceeds from sale and lease back of equipment 2,147 --
Proceeds from sale of common stock 754 1,932
-------- --------
Net cash provided by financing activities 2,893 1,898
-------- --------
Effect of exchange rate changes on cash 312 (220)
-------- --------
Net increase in cash and cash equivalents 7,965 10,622
Cash and cash equivalents, beginning of period 23,312 25,056
-------- --------
Cash and cash equivalents, end of period $ 31,277 $ 35,678
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
Page 3
<PAGE> 6
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 these estimates.
The results of operations for the three months ended December 31, 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 12 months.
3. 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.
Page 4
<PAGE> 7
4. 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 Six Months Ended
December 31, December 31, December 31, December 31,
1998 1997 1998 1997
-------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income (loss) ...................................... $ (7,815) $ (7,584) $(14,604) $ (5,793)
======== ======== ======== ========
Basic Earnings Per Share
Income (loss) available to common stockholders ....... $ (7,815) $ (7,584) $(14,604) $ (5,793)
Weighted average common shares outstanding ........... 25,728 25,283 25,714 25,163
-------- -------- -------- --------
Basic earnings (loss) per share ........................ $ (0.30) $ (0.30) $ (0.57) $ (0.23)
======== ======== ======== ========
Diluted Earnings Per Share
Income (loss) available to common stockholders ....... $ (7,815) $ (7,584) $(14,604) $ (5,793)
======== ======== ======== ========
Weighted average common shares outstanding ........... 25,728 25,283 25,714 25,163
Dilutive potential common shares from stock options .. -- -- -- --
-------- -------- -------- --------
Weighted average common shares and dilutive
potential common shares ............................. 25,728 25,283 25,714 25,163
-------- -------- -------- --------
Diluted earnings (loss) per share ...................... $ (0.30) $ (0.30) $ (0.57) $ (0.23)
======== ======== ======== ========
</TABLE>
Weighted average options outstanding to purchase 344,872 and 766,429
shares during the three months ended December 31, 1998 and 1997, respectively,
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
4,867,309 and 571,780 shares during the six months ended December 31, 1998 and
1997 respectively, 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.
5. 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)
December 31, 1998 June 30, 1998
----------------- -------------
<S> <C> <C>
Purchased materials $ 3,830 $ 5,615
Systems in process 4,186 4,041
Finished goods 2,105 2,552
------- -------
Total inventories $10,121 $12,208
======= =======
</TABLE>
Page 5
<PAGE> 8
Inventories contained components and assemblies in excess of the Company's
current estimated requirements and were fully reserved at December 31, 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.")
6. 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, Six Months Ended,
December 31, December 31, December 31, December 31,
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net Income (Loss) $ (7,815) $ (7,584) $(14,604) $ (5,793)
Other comprehensive income(loss):
Unrealized holding gains (losses)
on available-for-sale securities (63) (17) (42) 25
Foreign currency translation adjustments 157 (62) 313 (220)
-------- -------- -------- --------
Comprehensive income (loss) $ (7,721) $ (7,663) $(14,333) $ (5,988)
======== ======== ======== ========
</TABLE>
7. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS 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 market 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 and six months ended December
31, 1997 was $685,000 and $1,339,000, respectively.
Page 6
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Total revenues for the second quarter of fiscal 1999, ended December 31,
1998, were $30.6 million, a decrease of 30% compared to total revenues of $43.4
million in the second quarter of fiscal 1998. Total revenues for the six months
ended December 31, 1998 were $60.6 million, a decrease of 34% compared to total
revenues of $92 million for the six months ended December 31, 1997. The decrease
in total revenues primarily relates to the timing of new product introductions
and increased competitive pressures.
Product revenues for the second quarter of fiscal 1999 were $22.4
million or 73% of total revenues compared to $36.7 million or 85% of total
revenues in the second quarter of fiscal 1998. Revenues from system sales
accounted for 34% of total revenues during the second quarter of fiscal 1999 and
42% for the second quarter of fiscal 1998, while revenues from upgrades, add-on
options and software license agreements comprised 39% of total revenues during
the second quarter of fiscal 1999 and 42% for the second quarter of fiscal 1998.
Service revenues for the second quarter of fiscal 1999 were $8.2 million or 27%
of total revenues compared to 16% in the second quarter of fiscal 1998.
Geographically, North America accounted for 74% and 66% of total revenues in the
second quarters of fiscal 1999 and 1998, respectively; the Pacific Rim accounted
for 13% in the second quarters of fiscal 1999 and 1998; and Europe accounted for
13% and 21% in the second quarters of fiscal 1999 and 1998, respectively. The
decrease in revenues in the Company's main geographic markets primarily related
to the timing of new product introductions and increased competitive pressures.
Gross margin was 42% of net revenues in the second quarter of fiscal
1999 compared with 27% in the second quarter of fiscal 1998. For the six months
ended December 31, 1998 and 1997, gross margins were 44% and 40%, respectively.
Product gross margin increased to 46% in the second quarter of fiscal year 1999
from 27% in the second quarter of fiscal year 1998. The reduced gross margin in
the second quarter of fiscal 1998 was primarily due to a $9.4 million charge
incurred for the write-down of disk drive inventory to its net realizable value
as a result of rapid price declines of 4 gigabyte drives, coupled with an
accelerated transition to 9 gigabyte drive technology and product obsolescence.
Selling, general and administrative expenses during the second quarter
of fiscal 1999 totaled $12.5 million, a decrease of 21% from $15.8 million in
the corresponding period of the prior fiscal year, and comprised 41% and 36% of
total revenues, respectively. For the six months ended December 31, 1998,
selling, general and administrative expenses totaled $25 million, a decrease of
19% from $30.8 million for the six months ended December 31, 1997 and were 41%
and 33% of total revenues for the first six months of fiscal years 1999 and
1998, respectively. The decrease in absolute dollars for the comparison periods
reflects steps the Company has taken to streamline operations and reduce overall
costs. The increase in selling, general and administrative expenses as a
percentage of revenues for the comparison periods is a result of lower revenues
in second quarter and first six months of fiscal 1999.
Research and development expenses incurred during the second quarter of
fiscal 1999 were $8.4 million, an increase of 3% from $8.2 million in the
corresponding period of the prior fiscal year, and comprised 28% and 19% of
total revenues, respectively. For the six months ended December 31, 1998,
research and development expenses were $17.1 million, an increase of 11% from
$15.4 million for the six months ended December 31, 1997, and were 28% and 17%
of total revenues for the first six months of fiscal years 1999 and 1998,
respectively. This increase in absolute dollars and as a percentage of revenues
was primarily due to the continued development of the Auspex 4Front(TM) series
of products and lower revenue in second quarter and first six months of fiscal
1999.
Loss from operations for the second quarter of fiscal 1999 was $8.1
million, compared with loss from operations of $12.1 million in the second
quarter of fiscal year 1998. These operating losses were primarily due to
Page 7
<PAGE> 10
lower revenues and increased research and development, reflecting the Company's
investment across the organization in support of new network attached storage
products and technologies for UNIX and Windows NT markets.
The Company's income tax rate for the first six months of fiscal 1999
was 0% compared with income tax benefit rate for the first six months of fiscal
1998 of 35%. The income tax benefit in fiscal 1998 primarily relates to the
carry back of the Company's net operating loss.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and short-term investments
decreased by $1.2 million to $49.6 million for the six months ended December 31,
1998. The Company generated approximately $0.6 million in cash from operating
activities in the first six months of fiscal 1999, which included the collection
of $9.3 million of a income tax refund. The Company generated approximately $4.2
million in cash from investing activities in the first six months of fiscal
1999. The Company also generated approximately $2.9 million in cash from
financing activities, which included proceeds of $2.1 million from the sale and
leaseback of equipment. The Company's working capital decreased during the first
six months of fiscal 1999 by $13.0 million to $66.4 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 seventh paragraph, the fifth and sixth
sentences of the eight paragraph, the last sentence of the ninth paragraph, the
last sentence of the tenth paragraph, the entire eleventh paragraph, the last
sentence of the twelfth paragraph and the first sentence of the thirteenth
paragraph of the section entitled "Year 2000 Compliance" in "Factors That May
Affect Future Performance" contain forward looking statements as defined in the
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.
Page 8
<PAGE> 11
COMPETITIVE MARKET
The market for the Company's products is highly competitive. The Company
experiences substantial competition, principally from Sun Microsystems, Network
Appliance, EMC Corporation, 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 drives. Increased competition for the Company's products that
results in lower product sales could also adversely impact the Company's sales
of upgrades. In addition, decisions by customers not to increase capacity of
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.
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 software
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 and first six months of
fiscal 1999. 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 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.
Page 9
<PAGE> 12
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 first six months ended December 31, 1998 and 1997, direct sales
of products and services to Intel Corporation ("Intel") represented
approximately 20% and 17%, respectively, of the Company's revenues. Intel is not
obligated to purchase any minimum level of products from the Company.
Significant reductions in product sales to Intel would materially and adversely
affect the Company's business, financial condition and results of operations.
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 six months ended December 31, 1998, and 1997,
approximately 33% 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 six months ended
December 31, 1998 due to continued 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
Page 10
<PAGE> 13
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 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, 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
Page 11
<PAGE> 14
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.
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/
Questionnaire to its suppliers. However, as a result of a low response rate, the
Company has undertaken or is undertaking the following: (1) a new Readiness
Letter/Questionnaire 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/Questionnaire 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/Questionnaire or certify Year 2000 compliance. Based on their
responses and results of the Readiness Letter/Questionnaire, 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 the date of
this filing. The Company believes that its English and French facilities are
Year 2000 compliant; however, the lessors of 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. 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, which the
Company believes to be Year 2000 compliant, of the network were installed
within the past nine months. The Company's wide-area network requirements are
provided by a major national carrier and an international carrier. The Company
believes there is some uncertainty between these carriers due to the fact
testing between carriers cannot commence until each carrier is Year 2000
compliant.
Page 12
<PAGE> 15
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 was
completed during the fourth calendar quarter of 1998 which incorporated 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 the Company
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. Vendors have affirmed that the standard personal computers and
laptop computers installed during 1998 are Year 2000 compliant. Testing has
confirmed that commonly used functions operate satisfactorily.
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 completed the
assessment of Year 2000 issues of its engineering infrastructure during the
fourth calendar quarter of 1998, and all significant issues will be resolved by
the end of fiscal 1999.
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 completed the assessment of Year 2000 issues of its
manufacturing operations during the fourth calendar quarter of 1998, and all
significant issue will be resolved by the end of fiscal 1999.
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 these 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 relies 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 on or about the beginning of
2000. The Company expects an increase in calls on or about the beginning of
2000, which will likely impact Customer Service responsiveness.
Page 13
<PAGE> 16
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 second 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 second quarter of fiscal 1999
to the Company's foreign currency hedging programs.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a. The 1998 Annual Meeting of the Stockholders of Auspex Systems, Inc. was held
at the Company's headquarters, 2300 Central Expressway, Santa Clara,
California 95050 on November 19, 1998 at 9:00 a.m. (the "Annual Meeting").
a. At the Annual Meeting two (2) directors were re-elected to the Company's
Board of Directors as Class II directors to serve for a two-year term.
NUMBER OF VOTES
<TABLE>
<CAPTION>
Nominee Cast for Withheld or Against
------- -------- -------------------
<S> <C> <C>
W. Frank King 22,624,663 771,370
Bruce N. Moore 22,595,850 800,183
</TABLE>
a. The following additional proposals were considered at the Annual Meeting and
were approved by the stockholders.
(1) Ratification and approval to the Company's 1993 Director's Stock
Option Plan to (i) increase the number of shares of Common Stock
reserved for issuance thereunder by 150,000 to a total of 325,000 and
(ii) increase the number of shares of Common Stock subject to the
initial and annual option grants automatically awarded to the
Company's directors thereunder from 16,000 and 4,000 to 25,000 and
8,000, respectively.
<TABLE>
<CAPTION>
Cast for Against Abstentions Broker Non-Votes
-------- ------- ----------- ----------------
<S> <C> <C> <C>
18,155,818 5,102,243 134,972 0
</TABLE>
Page 14
<PAGE> 17
(2) Ratification and approval of the appointment of Arthur Anderson
LLP as the independent auditors of the Company for the year
ending June 30, 1999
<TABLE>
<CAPTION>
Cast for Against Abstentions Broker Non-Votes
-------- ------- ----------- ----------------
<S> <C> <C> <C>
23,197,752 136,737 61,544 0
</TABLE>
ITEM 5. OTHER INFORMATION:
a. Effective February 5, 1999, Russell M. Lait, Vice President of
Operations, resigned from the Company
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.
Date February 11, 1999 /s/ R. Marshall Case
--------------------------- ----------------------------------
R. Marshall Case,
Vice President of Finance and
Chief Financial Officer
Page 15
<PAGE> 18
AUSPEX SYSTEMS, INC.
EXHIBITS TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
Sequentially
Exhibit Description Numbered Page
- ------- ----------- -------------
<S> <C> <C>
27 Financial Data Schedule 15
</TABLE>
Page 16
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 31,277
<SECURITIES> 18,323
<RECEIVABLES> 25,906
<ALLOWANCES> 1,598
<INVENTORY> 10,121
<CURRENT-ASSETS> 96,593
<PP&E> 80,470
<DEPRECIATION> 47,367
<TOTAL-ASSETS> 131,779
<CURRENT-LIABILITIES> 30,170
<BONDS> 0
0
0
<COMMON> 26
<OTHER-SE> 101,583
<TOTAL-LIABILITY-AND-EQUITY> 131,779
<SALES> 22,353
<TOTAL-REVENUES> 30,564
<CGS> 12,025
<TOTAL-COSTS> 17,810
<OTHER-EXPENSES> 20,856
<LOSS-PROVISION> 11
<INTEREST-EXPENSE> 2
<INCOME-PRETAX> (7,792)
<INCOME-TAX> 23
<INCOME-CONTINUING> (7,815)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,815)
<EPS-PRIMARY> (.30)
<EPS-DILUTED> (.30)
</TABLE>
