SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to __________________
Commission File Number 0-20666
MICROTEST, INC.
(Exact name of Registrant as specified in its charter)
Delaware 86-0485884
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4747 North 22nd Street, Phoenix, Arizona 85016
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (602) 952-6400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value Nasdaq National Market
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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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
At March 14, 1997, the aggregate market value of common stock held by
non-affiliates of the Registrant was approximately $54,955,471.
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
8,130,647 shares of Common Stock outstanding on March 14, 1997
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DOCUMENTS INCORPORATED BY REFERENCE
Materials from the Registrant's Proxy Statement relating to its 1997
Annual Meeting of Shareholders (the "Proxy Statement") to be held on July 23,
1997 have been incorporated by reference into Part III, Items 10, 11, 12 and 13.
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TABLE OF CONTENTS
Page
PART
I..............................................................................4
ITEM 1. BUSINESS..........................................................4
ITEM 2. PROPERTIES.......................................................19
ITEM 3. LEGAL PROCEEDINGS................................................19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS..........................................................20
PART
II............................................................................21
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY
SECURITIES AND RELATED SHAREHOLDER MATTERS.......................21
ITEM 6. SELECTED FINANCIAL DATA..........................................22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS....................24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................35
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.......................................................52
PART
III...........................................................................52
ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE
COMPANY..........................................................52
ITEM 11.EXECUTIVE COMPENSATION...........................................52
ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT............................................52
ITEM 13.CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS.....................................................53
PART
IV............................................................................53
ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K..............................................53
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PART I
ITEM 1. BUSINESS.
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Introduction
Microtest, Inc. ("Microtest" or the "Company") develops, markets and
supports products that make it easier to use, manage and service Local Area
Networks ("LANs"). The Company has developed and invested in two primary areas
of the LAN market: network management products and network connectivity
products. Historically, Microtest's primary product line has been a family of
easy-to-use, handheld network management tools ("Scanners") that quickly
pinpoint cable problems, certify whether LAN cabling will support a proposed
network system and monitor network activity at the physical layer level. These
devices operate across multiple cable types and network management systems and
cost-effectively increase LAN productivity and reliability by reducing network
downtime.
In 1996, the Company's newest introductions in the network management
product line included the PentaScanner(R)350 device, the only cable tester to
support the advanced capabilities of the new, wider dynamic range cable types
designed to operate at 350 MHz. Microtest also introduced the Internet
COMPAS(TM) product, an option that runs on Microtest's Netware(R) COMPAS product
and simplifies troubleshooting through the Internet and in local TCP/IP
environments. The Company also introduced the MICROSCANNER(TM) device, a
low-cost cable tester for verification and troubleshooting of new and installed
twisted-pair cabling, and the Multi-Pair Tester(TM) device, a tool that offers
quick continuity checks and pinpoints shorts, opens and crossed pairs on 25-pair
cabling in data communications and telecommunications environments.
In 1996, Microtest made a number of significant additions to its
network connectivity product line. Support for Microsoft Windows NT(TM) was
added across the product line, enabling Microtest to take full advantage of this
rapidly-expanding network operating system. The Company's workgroup line was
enhanced with the addition of the DiscPort(R) XL, the next generation,
high-performance CD-ROM networking solution that allows Novell(R) and Windows NT
workgroups to share up to seven CD-ROM devices simultaneously. The DiscPort(R)
Tower line saw the addition of 6X and 8X drive-speed models for both 7- and
14-bay units. A token ring Tower has been developed, which enables Microtest to
sell into the financial market with its large installed base of token ring
networks. Microtest's new DiscPort(R) Enterprise Server signaled a major
expansion of the product line. The Enterprise Server moves Microtest into the
burgeoning enterprise CD-ROM networking arena, by offering high-performance
CD-ROM servers bundled with the company's award-winning server software.
In December 1996, Microtest acquired Logicraft Information Systems,
Inc., ("Logicraft") a worldwide developer, integrator and manufacturer of
complete CD-ROM networking and optical storage
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management solutions for the Windows NT networking environment. The acquisition
brings together the expertise of both companies in their respective market
segments: Microtest in the Novell and workgroup environments, and Logicraft in
the enterprise and NT environments. The net result is that Microtest now has a
broader reach throughout the entire CD-ROM networking environment.
Microtest is a Delaware corporation, its principal executive offices
are located at 4747 N. 22nd Street, Phoenix, Arizona 85016, and its telephone
number is (602)952-6400.
This Annual Report on Form 10-K contains forward-looking statements.
Additional written or oral forward-looking statements may be made by the Company
from time to time in filings with the Securities and Exchange Commission or
otherwise. The words "believe," "expect," "anticipate," and "project," and
similar expressions identify forward-looking statements, which speak only as of
the date the statement was made. Such forward-looking statements are within the
meaning of that term in Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. Such
statements may include, but not be limited to, projections of revenues, income
or loss, capital expenditures, plans for future operations, financing needs or
plans, the impact of inflation and plans relating to products or services of the
Company, as well as assumptions relating to the foregoing. The Company
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events, or otherwise.
Forward-looking statements are inherently subject to risks and
uncertainties, some of which cannot be predicted or quantified. Future events
and actual results could differ materially from those set forth in, contemplated
by, or underlying the forward-looking statements. Statements in this Annual
Report, including the Notes to the Consolidated Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" describe factors, among others, that could contribute to or cause
such differences. Additional factors that could cause actual results to differ
materially from those expressed in such forward-looking statements are set forth
in "Business" and "Market for the Company's Equity Securities and Related
Shareholder Matters" in this Report.
Industry Background
As organizations have recognized the benefits of information and
equipment sharing, there has been a significant increase in the installed base
of LANs. In September 1996, Dataquest predicted a 5-year 20% compound annual
growth rate for network operating systems.
The growing dependence on LANs has created an increasing demand for
improved performance and reliability, as well as products and technologies to
maximize equipment and information sharing capabilities. Suppliers of LAN system
technologies and products have responded with new protocols (rules that govern
LAN operations), faster data transmission speeds, more sophisticated operating
systems, more peripheral hardware accessories and more advanced topologies
(wiring configurations) and cabling alternatives. The increase in
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functionality and devices available for LANs, and the increasing complexity of
LAN configurations have created a demand for products that help manage LAN
assets and allow users to share expensive network devices.
Leveraging the growing reliability, performance and integration of LAN
technologies, businesses are no longer satisfied with simply connecting PCs.
They now require faster access to a rapidly-growing amount of information and
solutions that facilitate this access and provide a management framework for the
organization of data. This information revolution is manifested in the following
three areas of technology development.
The first area relates to the incorporation and adoption of
CD-ROM-related technologies. The availability of low-cost CD-ROM drives and the
standardization of the file system for CD-ROM discs has enabled software title
producers and information suppliers to utilize this media for inexpensive, rapid
and efficient distribution of information. Decreasing costs of CD-ROM drives and
discs should continue to fuel the growth and adoption of these devices.
According to a 1995 Disk Trend analysis, shipments of CD-ROM drives are expected
to grow from 34 million units in 1995 to almost 70 million units in 1998, with
an average growth rate of 26%.
The second area relates to the rapid infrastructure growth and
deployment of wide area and Internet technologies. The Internet is positioned as
a truly synergistic channel for the distribution and access of information with
CD-ROMs.
The third area that affects the nature of information access is the
evolution and increasingly competitive environment of network operating systems
and services. With Novell maintaining a strong market share lead in network
servers installed, the value and appeal of the Windows NT application server
platform is gaining strength. The market is transforming into a heterogeneous
network environment, where businesses deploy servers using the technology most
appropriate for the service to be performed. Products must appropriately
leverage the various network operating system features such as protocols
(TCP/IP, IPX), services (file systems, device drivers), management (Windows,
SNMP, Network Management Systems, Security) and applications (Database,
Telephony, File and Print). This creates opportunities and requirements for
products to inter-operate in this environment.
Market for the Company's Products
Network Connectivity Products. As companies require faster access to
larger volumes of information, the demand for retrieving this information from
CD-ROM is increasing. Responding to this continuing market demand, the Company
has a line of network connectivity products that permit sharing of CD-ROM titles
in a workgroup environment or throughout the enterprise.
The Company's current focus on CD-ROM sharing products in the network
connectivity line reflects major market trends toward the need to access CD-ROMs
quickly and easily on networks. According to Frost & Sullivan, unit shipments of
CD-ROM networking products are being driven by continual growth in CD-ROM drive
shipments, increased number of CD-ROM
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titles available, continual growth in CD-R drive shipments and an increased
number of LANs and nodes on LANs. The Company's CD-ROM networking products are
designed to increase the ease of connecting network users to CD-ROM drives.
Expanding on the original DiscPort model, Microtest now features a full
range of CD-ROM networking products that encompasses the requirements of the
expanding marketplace. This changing market has driven the need to provide
products that are designed to meet the specific needs of two key segments of the
CD-ROM Networking market: workgroup products and enterprise solutions. In 1996,
the Company bolstered its workgroup offering by broadening the product line and
by adding support for Microsoft Windows NT. Its enterprise solutions offering
was significantly enhanced with the addition of complete CD-ROM servers which
include high availability storage arrays.
Network Management Products. The proliferation of and the growing
dependence on LANs has resulted in an increase in the market for products that
facilitate system installation and help manage the numerous hardware and
software network resources. As a result, the market for handheld test equipment
continues to grow. In March 1996, World Information Technologies, Inc.
forecasted that the worldwide revenue for Handheld Digital/Data Test Equipment
will grow from $140 million in 1995 to $327 million in 2000. Microtest develops
handheld test equipment for high-speed LAN applications.
Equipment and technologies are continuously being developed that enable
the high speed transmission of data over twisted-pair wiring systems. Category 5
unshielded twisted-pair cabling allows users to run applications at speeds up to
100MHz, which supports such sophisticated applications as intranets, multimedia,
and desktop video. To ensure that existing or proposed cabling will support a
particular high frequency LAN application, industry standards require that
cabling be certified for compliance. Microtest has been instrumental in the
development of these certification standards. The consequences of improperly
installed network cabling include costly network downtime, lost productivity,
and data transmission problems. The Company's scanners perform the critical
certification function for modern twisted-pair networking systems and legacy
cabling. Further, as new test requirements and certification standards are
created and evolve, the Company's Scanners are among the first to feature those
changes.
As LANs are increasingly relied upon to perform mission-critical
applications, organizations are requiring increasingly more accessibility. While
new equipment and topologies have been introduced in an effort to respond to
demands for greater reliability, LANs remain relatively failure-prone. In
addition, network devices and their related cabling are subject to frequent
moves, additions and changes to accommodate office changes, new technologies and
other factors that also increase the need for certification. As a result, there
is a demand for products that can quickly troubleshoot networks and identify
server and cable faults so that any problems can be readily resolved.
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The PentaScanner+ device is a portable Category 5 cable certification
and management system that provides complete 100 MHz certification reports and
exceeds the current standards for accuracy.
The Company's COMPAS(TM) troubleshooter runs diagnostic tests on Novell
NetWare networks and reports network, server and most cable faults.
Microtest broadened its market appeal as well in 1996 with mass market
solutions such as the low-cost MICROSCANNER(TM) and Multi-Pair Tester(TM) cable
testers. Each offers "first line of defense" diagnostic capabilities for cabling
networks. The MICROSCANNER confirms continuity, wiring configuration and cable
fault location in twisted-pair cabling. The Multi-Pair Tester tests
telecommunications, Category 3 or Category 5 25-pair cabling for continuity,
configuration, and wiring faults.
Company Strategy
Microtest strives to make computer and telecommunications networks
easier to use, and mission-critical information easier to share. The Company
provides easy-to-use devices and software to solve complex LAN management
problems. To effectively serve its customers, the Company relies on developing
fully integrated solutions, optimizing established distribution channels and
expanding software content across all types of products.
Developing Fully Integrated Solutions. Microtest develops integrated,
intuitive "plug and play" solutions which can be quickly and easily installed on
a network and brought into everyday use. The Company's Products are designed to
be marketed and sold as complete solutions to common network problems
experienced by users. For example, in 1996 the Company introduced a complete
line of network-ready DiscPort Towers, which included the CD-ROM drives, tower
enclosure and CD-ROM networking software. Towers are available in several
configurations, to accommodate the varying needs of different types of users.
Optimizing Established Distribution Channels. The Company's worldwide
indirect sales channels allow it to reach a broad base of customers efficiently.
Products are sold through a worldwide network of distributors and through
manufacturers' representative organizations and value-added resellers ("VARs")
that market PC-related hardware and software products. Microtest also employs
Major Account sales representatives who develop opportunities with enterprise
customers for fulfillment through channel partners.
Expanding Software Content. Increasing software content in integrated
products, while releasing new software products and software upgrades, continues
to be important to Microtest. In 1996, the Company experienced increases both in
server software revenue (primarily from sales of its CD-NOW! for NetWare
product) and software upgrade revenue.
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Products
The Company's products consist of a family of handheld Scanners and
network troubleshooting devices which pinpoint cable problems, certify cable
across multiple LAN configurations and troubleshoot network faults. Sales of
network management products account for 59%, 65% and 81% of the Company's total
revenues in 1996, 1995 and 1994, respectively. Additionally, the Company offers
a line of LAN connectivity products that allow users to easily share information
on a variety of peripheral devices, including CD-ROMs.
The Company currently derives substantially all of its revenues from
its PentaScanner and DiscPort products. Any decrease in sales of PentaScanner or
DiscPort products would have a material adverse effect on the Company's
business, financial condition and operating results.
Network Management Products. Microtest's network management products
are used by cable installers and LAN administrators to identify network and
physical cable problems. These handheld tools are designed for field use. The
Company's Cable Scanners address the various types of networks and cable types
and certify that cable installations will meet the link performance requirements
as well as major industry standards, such as those issued by the International
Standards Organization ("ISO") and TIA/EIA. Microtest's COMPAS device is a
product that combines the best features of protocol analyzers, cable testers and
network diagnostic utilities in an easy-to-use portable troubleshooting tool.
Microtest's cable testing products utilize a patented gate-array
circuitry (a proprietary cable radar technology) based upon Time Domain
Reflectometry ("TDR"). Using this technology for fault diagnosis, the Company's
Scanners transmit a high-speed pulse into the tested cable, receive the
reflected pulse and identify the location and nature of the cable fault. The
fault is reported to the customer in non-technical terms, such as "short at 270
feet." Generally, these functions can be performed without requiring the network
to be shut down
Microtest's PentaScanner+(R) with 2-Way Injector+(R) product is the
industry's premiere certification and cable troubleshooting device. The Category
5 tester tests 155 Mbps ATM and exceeds TIA/EIA TSB-67 Level II accuracy
requirements. The PentaScanner+ with 2-Way Injector+ device provides a 21-second
autotest, automatic increment of circuit ID, an extensive cabling library,
storage of 500 autotests and flash ROM for field updates. Designed specifically
for professional cable installers, service providers and LAN managers, the
PentaScanner+ with 2-Way Injector+ device facilitates the certification,
installation, management and troubleshooting of Category 5 cabling systems. The
PentaScanner+ device uses a one-button autotest function to simplify testing and
a graphical LCD display with on-line help to guide users through certifying and
trouble-shooting the network. Equipped with a large cable-type reference library
and Flash ROM for instant upgrades, the unit performs a wire map and measures
NEXT, attenuation, length, noise and active and passive ACR. The PentaScanner+
device certifies whether UTP (Categories 1-5), coax and SCP/ScTP cabling will
support various network types, including 10BASE-T, 4/16 Mbps Token Ring,
100Base-VG, Arcnet, ISDN, AppleTalk, T1/E1, TP-Pmd, CDDI, TPDDI, Fast Ethernet
(both proposals), Multimedia 802.9, ATM51 and/or ATM155 Mbps networks.
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Microtest released the PentaScanner(R) 350 device in 1996, the only
tester to support the advanced capabilities of the new, wider-dynamic-range
cable types that operate at 350 MHz. The PentaScanner 350 device includes all of
the TSB-67 Level II functionality and accuracy of PentaScanner+, and is the only
Category 5 tester with performance grading. The PentaScanner 350 device is the
result of an industry initiative that promotes the performance grading of
premium high-quality cabling on Category 5 networks. Link quality depends on a
complex combination of factors including cables, components, and installation
techniques. With networks relying on today's advanced communications
technologies to transmit data, it is even more important for LANs with Category
5 cabling to be certified for performance at higher speeds. Prior to the release
of the PentaScanner 350 product, performance could not be tested beyond a simple
pass/fail measurement -- testers could not distinguish between links that barely
met Category 5 requirements and those offering superior performance. With the
PentaScanner 350 device, users can verify that their installed links exceed
Category 5 performance standards, thereby ensuring support for future high-speed
applications. The PentaScanner 350 product is also available with Microtest's
2-Way Injector+ device.
The Company also sells software enhancements for its Scanners that
provide easy-to-use methods for storing, retrieving and managing network test
results and cabling information. These enhancements and upgrades include
additional test functionality, customized test suites, expanded native language
support and communication capabilities to external equipment and databases. The
company also sells accessories that complement the functions performed by its
Scanner.
The COMPAS product is a handheld LAN tester that provides network
troubleshooting functions, protocol functions, cable testing functions, and
serial functions on Novell NetWare networks, the Internet and in local TCP/IP
environments. The COMPAS product was designed in a modular fashion, permitting
users to purchase optional software modules, such as the NT module (introduced
in 1997) and the Internet module (introduced in 1996) to customize a product
which best suits their network. The unit attaches anywhere on a LAN (for
example, at the fileserver, workstation or hub), provides the user with a main
menu of common network problems, runs a series of automated troubleshooting
tests and identifies faults. If the connection changes during the test, the
COMPAS product re-adjusts and starts the test again. The unit provides detailed
information about NetWare fileservers and workstations and troubleshoots
problems inside NetWare fileservers via a NetWare Loadable Module ("NLM"). The
unit's on-line help provides explanations of test results and suggests possible
repair techniques. The COMPAS product's NetTap function enables monitoring of
errors between any network node and the hub. The COMPAS device tests cabling for
length, crosstalk, noise, signal level and proper connector wiring. The COMPAS
product can also monitor serial conversations, determine throughput and identify
a workstation's maximum receive rate. The Internet software module was released
in 1996 and permits users to perform tests such as duplicate IP address
detection, IP ping, Internet control message protocol ("ICMP") monitoring and
many others. The NT software module, released early in 1997, provides
information on Windows NT domains, servers, and hosts.
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Network Connectivity Products. The Company's connectivity product line
is designed to provide easy, cost-effective linking and sharing of network
peripheral devices. Over the past several years, the Company has developed a
variety of connectivity products, including its LANPORT(R) product, which the
Company sold to Intel in 1992, and LANMODEM, which the Company sold to Xylogics
in 1993. Responding to continuing market needs for network connectivity devices,
the Company has increased its emphasis on this product line, particularly in the
area of linking and sharing CD-ROM devices. Just as Microtest's first
connectivity product, LANPORT, brought "plug-n-play" capability to networking
printers, the Company's DiscPort with DiscView product provides a "plug-n-play"
solution to CD-ROM networking. Microtest's current CD-ROM product focus in the
network connectivity line reflects major market trends toward the need to access
CD-ROMs quickly and easily on networks.
The Company introduced its first CD-ROM networking product into the
network connectivity product family in 1993 with DiscPort. The DiscPort device
was built on the foundation that products that are easy to install, manage and
use will be successful in the marketplace. As companies require faster access to
larger volumes of information, the demand for retrieving this information from
CD-ROM is increasing. The Company's network connectivity product line provides
this functionality based with products that are easy to use and intuitive.
The DiscPort PRO with DiscView PRO software, the Company's flagship
network connectivity product, provides a means to install, manage and share
networked CD-ROMs from anywhere on the network. The DiscPort PRO device is
designed to meet the increasing needs of workgroups to conveniently share and
access CD-ROMs. The DiscPort PRO device is easy to install and configure. It
plugs into any Thin Ethernet or 10BASE-T network or attaches directly onto the
network and allows users to share up to 14 CD-ROM devices. The product works on
Novell NetWare operating systems and support for Microsoft's popular Windows NT
operating system was added in 1996. The DiscPort PRO device fully supports
CD-ROM drives on 10mbps networks and popular mini-changer devices such as the
recently introduced Nakamichi 4x8X changer.
The Company expanded the DiscPort line in 1996 with the introduction of
DiscPort XL, the next generation, high performance CD-ROM networking solution
for workgroups. This product allows users in a workgroup environment to share up
to 7 CD-ROM devices. The DiscPort XL features DiscView(R) PRO management
software and offers dynamic security, lets the user auto-mount CDs instantly and
share them using as little as 1.5K of RAM per disc. The DiscPort XL can be
attached anywhere on a NetWare(R), IntranetWare(TM) or Windows NT network for
local control and access of CD-ROM libraries. Also announced in 1996 was the
addition of CD Internetworking features for the DiscPort product line. DiscView
PRO's internetworking features include CDBrowser(TM) which lets
Internet/intranet users browse any CD, and WebLaunch(TM), which lets intranet
users launch CD-ROM applications from their web browser.
To support the growing demand for turnkey solutions, the Company
expanded its DiscPort Tower product line in 1996. With the DiscPort Tower line,
the Company has
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incorporated its powerful CD-ROM networking technology and embedded it into a 7
and 14 CD-ROM drive configuration. Each Tower comes with all of the features and
benefits of the DiscView PRO management software along with 7 or 14 high quality
4X or 8X CD-ROM drives. New speeds will be added to the line as they become
available to the market.
For enterprise continuing needs, Microtest offers CD-NOW! for NetWare.
CD-NOW! is software which turns any industry standard PC into a high
performance, high capacity, dedicated CD-ROM server. CD-NOW! includes native
NetWare 4.1 technology and supports NetWare 3.x and 4.1. CD-NOW! comes with
DiscView PRO management software which allows users to seamlessly extend CD-ROM
resources into workgroups by using the Company's DiscPort and DiscPort PRO
devices.
Also introduced in 1996, the CD-NOW! E/Server is the highest-capacity,
highest-performance CD-ROM server on the market and allows users to share CD-ROM
data enterprise-wide. This attach-and-access solution combines CD-NOW! software
and integrates it with high-availability CD-ROM storage modules and a
high-performance CPU module. CD-NOW! E/Server is built to customer
specifications or is available in standard configurations with 21, 42, or 63 8x
drives for 10/100 Ethernet and Token Ring networks. DiscView PRO management
software is included for easy CD resource management and access.
Product Integration and Rebranding
As a result of the acquisition of Logicraft Information Systems, Inc.,
and integration of complementary technologies, the Company will rename some of
its networking products as part of an ongoing effort to simplify the product
line and unify all products under the well-known DiscPort brand name. At the
workgroup level, DiscPort, DiscPort PRO, DiscPort XL and DiscPort Tower will
remain unchanged. At the enterprise level, Microtest will offer CD-ROM
networking solutions with two new products: DiscPort Enterprise Servers,
available in rack or tower configurations, and DiscPort Executive, available
with versions for IntranetWare or Windows NT.
The DiscPort Enterprise Server rack configuration integrates
Microtest's CD-NOW! E/Server with Logicraft's LS Server. It enables hundreds of
users enterprise-wide to share numerous titles with point-and-click simplicity.
It is a fully integrated solution that features robust, reliable,
industry-standard CPU and drive modules. Systems range from 21 to 63 high-speed
drives for 10/100 Ethernet and Token Ring networks and can be packaged for
IntranetWare or Windows NT operating systems.
The DiscPort Enterprise Server tower configuration is a fully modular
solution that works with nearly all network operating systems including
IntranetWare and Windows NT. It features a robust, reliable, industry-standard
CPU and high-speed hot-swappable drives configured as a tower with a locking
security door. Users can add or replace drives without any network downtime and
configure additional towers together for added expandability.
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DiscPort Executive integrates the Company's CD-NOW! server software
with Logicraft's CD Executive software. The IntranetWare version of DiscPort
Executive transforms any PC into a high-performance CD-ROM server. It includes
the DiscView PRO management interface and the internetworking features of
WebLaunch and CDBrowser. It features dynamic security, dynamic volume sets and
lets users mount CD-ROMs automatically.
DiscPort Executive for Windows NT provides all of the advanced CD-ROM
system management capabilities needed to turn a standard Windows NT server into
a complete network CD-ROM system. Users can access thousands of CD-ROM resources
from a single drive letter off an NT server. Its AutoShare(TM) utility runs in
the background and catalogs CD-ROM volumes, detects media changes and shares
CD-ROMs automatically according to predefined permissions and directory
structures.
Microtest also acquired Virtual CD-ROM from Logicraft. Virtual CD-ROM
is software that allows users to access CD-ROM resources with unprecedented
speed by enabling a user's hard drive to function as a CD-ROM drive. Disc
information is imaged, compressed and stored on the hard drive for instant
retrieval. Wait time is virtually eliminated and the CD-ROM drive is freed up
for other uses.
Sales, Distribution and Customers
Sales. The Company's sales, marketing and distribution strategy is to
use a multiple channel, worldwide distribution network. The network includes
distributors, VARs and dealers, as well as selected OEMs and licensees. The
Company's sales organization manages the activities of these distribution
channels, directs sales leads to these distribution channels and responds to
sales calls from distributors, resellers, dealers and end users. In addition,
the Company has a telesales department that assists the sales efforts of its
sales representatives.
Distribution Network. The Company sells its products through an
established worldwide network of distributors, VARs and dealers that market
PC-related, and networking hardware and software products. The Company focuses a
significant amount of its sales and marketing resources on its distribution
channel, providing ongoing communication and support to channel participants.
Distribution network support programs include regular mailings of product,
promotional and technical materials, participation in industry trade shows,
incentive programs for distributors, VAR and dealer sales personnel and
cooperative marketing programs. A dedicated sales force manages and supports the
company's distributors and VARs. The Company provides technical and sales
product training to all of its distributors and dealers, who in turn provide
technical and sales training to their customers who purchase Microtest products.
Microtest also provides a strong set of VAR professional service offerings that
includes installation services, installation planning and pre-sale site
planning.
North American sales accounted for approximately 71%, 64% and 66%, of
the Company's total revenues in 1996, 1995 and 1994, respectively. The Company's
United States distributors include national distributors, cable and wire
distributors and catalog merchandisers.
13
<PAGE>
To address international markets, the Company has developed
relationships with distributors throughout Europe. The Company supports its
European distributors through offices located in the United Kingdom and Germany.
In addition, the Company has developed relationships with distributors located
throughout Canada, Mexico, South America and the Pacific Rim. All international
sales are denominated in United States dollars. Sales outside of North America
accounted for 29%, 36% and 34% of the Company's total revenues in 1996, 1995 and
1994, respectively. The decrease in sales outside of North America is primarily
due to a weakening of the European economy in 1996.
Customers. The primary target market of the Company's products include
LAN management personnel, LAN installers, field service personnel, resellers,
and technical end users with departmental applications. The Company's customers
span the broad range of industries that utilize LANs, including technology,
industrial, transportation, retail, health care, financial services, government
and education. The Company maintains a customer support organization in both
North America and Europe to answer customer questions concerning the usage of
the Company's products.
Product Development
The Company believes that its continued success will depend upon its
ability to enhance its existing products, expand products into product lines,
introduce new products on a timely basis and continue to develop technology that
can be incorporated into commercially viable products addressing the demands of
the LAN industry. To facilitate new and continuing product development, Company
personnel work with customers, distribution channels and leaders in other LAN
industry segments to identify market needs and define appropriate product
specifications. Microtest employees participate in numerous user groups, working
groups and industry forums. In addition, Company employees are involved with a
number of technical committees including the IEEE 802.3 and the IEEE 802.12
committees, the ATM Forum, ISO/IEC, CNX Technical Advisory Board, and the
TIA/EIA organization. The Company believes that tracking developments in the
latest high-speed technologies, like ISDN, ADSL and ATM, will facilitate the
development of products supporting the networks of the future.
As one of the early entrants into the cable troubleshooting and
certification markets, the Company has developed a substantial level of
proprietary technology. The Company leverages its proprietary technology and
industry expertise into new product offerings to enhance the troubleshooting,
certification and connectivity capabilities of its product lines. The Company
also routinely evaluates the acquisition or licensing of complementary products
and technologies. There can be no assurance that any new products developed or
acquired by the Company will be successful or profitable.
Acquisitions
In recent years, the Company has strategically acquired network
connectivity product offerings. In December 1996, the Company completed the
acquisition of Logicraft Information
14
<PAGE>
Systems, Inc., a leading developer and manufacturer of enterprise CD-ROM
networking systems. The Company acquired all of the capital stock of Logicraft
for approximately $13 million and assumed certain Logicraft liabilities totaling
approximately $4 million, which were paid off immediately after the closing. As
a result of the allocation of the purchase price, the Company recorded an
expense of $15.7 million to record the value of software research it acquired
relating to products for which technological feasibility has not been
established and for which no alternative future use existed. Microtest acquired
Logicraft to give it broader reach throughout the entire CD-networking spectrum,
most notably at the enterprise and NT levels.
In June 1995, the Company completed the acquisition of Optical Media
International ("OMI"), a pioneer in the CD-ROM and the CD-R industry. The
Company acquired all of the outstanding capital stock of OMI for approximately
$4 million in cash and the assumption of OMI-related debt. As a result of the
allocation of the purchase price, the Company recorded an expense of $8.3
million and a related tax benefit of $3.2 million to record the value of
software research it acquired relating to products for which technological
feasibility has not been established and for which no alternative future use
existed . The Company acquired OMI to develop networkable CD-R technology. CD-R
technology is used in the areas of records archiving, information transfer,
computer data back-up and mass storage.
In August 1995, the Company acquired the technologies of Hotware, Inc.,
an independent software company for $450,000 in cash. Hotware has developed
technologies in the LAN information access market and has made significant
contributions over the past several years to existing Microtest product
technology.
The Company intends to continue to evaluate acquisition opportunities
as they are presented from time to time. The Company may face competition from
other suppliers or manufacturers of network hardware and software products or
other third parties for acquisition opportunities that become available. There
can be no assurance that the Company will identify acquisition candidates that
will result in successful combinations in the future. Any future acquisitions by
the Company may result in the incurrence of additional debt and amortization of
expenses related to goodwill and intangible assets, which could adversely affect
the Company's profitability, or could involve the potentially dilutive issuance
of additional equity securities. In addition, acquisitions involve numerous
risks, including difficulties in assimilation of the acquired company's
operations, particularly in the period immediately following the consummation of
such transactions, the diversion of the attention of the Company's management
from other business, and the potential loss of customers, key employees and
suppliers of the acquired company, all of which could have a material adverse
effect on the Company's business and operating results.
Manufacturing and Backlog
The Company contracts with domestic manufacturers to build its
products. These manufacturers comply with industry-accepted (IPC) standards and
are, whenever possible, ISO 9002 certified. The Company's internal operations
consist of supplier management, incoming test and inspection, final product
configuration and packaging, and order consolidation and
15
<PAGE>
shipment. The Company retains a skilled, permanent, core workforce, utilizing
temporary employees to accommodate workload fluctuations. The Company maintains
two authorized repair centers, one in Phoenix, Arizona and one in the United
Kingdom.
Certain components used in the Company's products are presently
available from or supplied by only one source and others are available from
limited sources. Although the Company does not have long-term supply contracts
with any of its component suppliers, it has been able to obtain sufficient
supplies of components and products in a timely manner. However, in the event
that certain of its suppliers or contract manufacturers were to experience
financial or other difficulties that resulted in a reduction or interruption in
supply to the Company, the Company's results of operations would be adversely
affected until the Company established alternate sources.
In 1995, the Company began the documentation process to become ISO 9001
certified. The Company was unable to complete this process in 1996 due to
personnel changes, but plans to complete it in 1997, which will position the
Company for a pre-certification audit. ISO 9001 requires that business processes
are under control and it provides for mechanisms to continually improve the
Company's general business practices and products. The Company is committed to a
fully functional quality management system.
Historically, the Company has not maintained significant backlog
because it fills substantially all orders for its products within 30 days after
receipt of a firm purchase order. The Company does not believe that backlog is a
reliable long-term indicator of future sales or earnings.
Competition
The market for LAN products is extremely fast-moving and competitive,
and competition in the Company's market segment is continually increasing. Rapid
technological advances and emerging industry standards can quickly change
competitive conditions in the LAN industry. These changes require frequent new
product introductions, added product features and rapid improvements in the
relative price or performance of networking products. Failure to keep pace with
technological advances or market changes would adversely affect the Company's
competitive position and operating results. The Company's products compete on
the basis of ease-of-use, product features, quality, reliability and price.
There can be no assurance that existing or future competitors of the Company
will not introduce comparable or superior products that incorporate more
advanced technology at lower prices.
The markets served by the Company's connectivity products continue to
grow at rates that naturally attract new entrants into those markets. This is
especially true for the CD-ROM networking market where the Company's DiscPort
and CD-NOW! products currently enjoy a strong market position. There can be no
assurance that this market position can be maintained or that existing or future
competitors will not introduce comparable or superior connectivity products.
16
<PAGE>
In the network management and certification market, the Company
competes with products manufactured by Wavetek Corporation, Scope
Communications, Inc., Fluke Corporation and Datacom Technologies, Inc. To a
lesser extent, the Company competes with manufacturers of time domain
reflectometers, ohm meters, volt meters and oscilloscopes. The Company's network
troubleshooting products compete with the products from Scope Communications,
Inc., and Fluke Corporation. To a lesser extent, the Company competes with
manufacturers of software-based protocol analyzers, such as Triticom and Intel.
The Company's network connectivity products compete with products from
Meridian Data, Micro Design International, CBIS, Reed Technology and Information
Services, Inc., Ornetix, SciNet, Inc., Compact Devices, Inc. and Axis
Communication, Inc. The Company also competes indirectly with suppliers of
personal computers and network operating systems, such as Microsoft and Novell,
to the extent that these companies include CD-ROM networking utilities as part
of their operating systems.
The Company's competitors include large domestic and international
companies, many of which have significantly greater financial, technical,
manufacturing, marketing, sales and distribution resources than the Company.
There can be no assurance that the Company's current or potential competitors
will not develop products comparable or superior to those developed by the
Company or adapt more quickly than the Company to new or emerging technologies,
evolving industry trends, or changing customer requirements. There also can be
no assurance that the Company will have the financial resources, technical
expertise, or marketing, sales, distribution, customer service, and technical
support capabilities to compete successfully.
Proprietary Rights
Microtest relies upon a combination of copyright, trademark, trade
secret and patent protection to establish and protect the Company's proprietary
rights in its products and technologies. In addition, the Company generally
enters into nondisclosure and confidentiality agreements with its employees,
distributors, customers and suppliers with access to sensitive information and
limits access to and distribution of its software documentation and other
proprietary information. The Company has several trademarks, including
Microtest(R), DiscPort(R), DiscView(R), PairScanner(R), PentaScanner(R),and
Fiber Eye(R), as well as Logicraft's disk-caching technology called FastCD(TM),
and disc management utility called AutoShare(TM).
The Company embodies a substantial portion of its TDR technology in a
custom gate array to deter reverse engineering. The Company has obtained a
United States patent on a portion of its technology related to TDR.
In 1996, the Company obtained two additional patents on a technique
that enables high-speed (100 Mbps) channel measurements to be made without being
impaired by high levels of crosstalk typically found in unshielded twisted-pair
connector systems.
17
<PAGE>
The Company has filed other United States patent applications which are
currently pending. The first patent application, filed in 1993, describes a
technique to expand the application of LAN Media Servers to control various
types of equipment. A second patent application, which was filed in January
1996, relates to the creation and installation of a foreign file system. The
Company continues to evaluate the desirability of additional patent applications
relating to its diagnostics and connectivity technologies.
There can be no assurance that any patents will issue from the
above-described applications. Further, there can be no assurance that the steps
taken by the Company to protect its proprietary rights will be adequate to deter
misappropriation of its technology or independent third-party development of its
technology, or that its patents or registered trademarks can be successfully
enforced. Because of the rapid pace of technological change in the LAN product
industry, the Company believes that patent protection for its products is less
significant to its success than the knowledge, ability and experience of its
employees and the frequent introduction and market acceptance of new products
and product enhancements.
Given the rapid pace of technological development in the LAN industry,
there can be no assurance that certain aspects of the Company's products do not
or will not infringe the existing or future proprietary rights of others. The
Company believes that if such infringement existed, it could obtain the
requisite licenses or rights to use such technology. However, there can be no
assurance that such licenses or rights could be obtained or obtained on terms
that would not have a material adverse effect on the Company.
Employees
As of March 14, 1997, the Company employed 267 persons on a full-time
basis: 102 in sales, marketing and customer support, 38 in manufacturing, 87 in
research and development and 40 in administration. Many of the Company's
employees are highly skilled in certain disciplines and the Company's continued
growth and success will depend in part on its ability to retain management and
key employees and, where appropriate, hire new employees. The Company has never
had a work stoppage, no employees are represented by a labor organization and
the Company considers its employee relations to be good.
18
<PAGE>
ITEM 2. PROPERTIES.
-----------
The Company's principal corporate offices and research and development
facilities are located in a 49,000 square foot facility in Phoenix, Arizona. The
lease for this facility commenced October 1, 1992, and continues for a period of
eight years, but may be canceled without penalty after five years. Current
monthly rental payments for this facility are approximately $55,000. The Company
may decide to terminate the lease effective October 1, 1997. Accordingly, the
Company is in the process of finding a new facility and plans on remaining in
the Phoenix metropolitan area. If there is a significant interruption in the
Company's business as a result of moving to a new facility, it could have a
material adverse effect on the Company's business and operating results in the
quarter in which such moves occurs. The Company also leases sales and support
offices in California, Illinois and the United Kingdom. Logicraft leases offices
for sales, support and research and development in New Hampshire and Germany
ITEM 3. LEGAL PROCEEDINGS.
------------------
In September and October 1996, the Company, Richard G. Meise, Richard
R. Douglas and David C. Bolles were named as defendants in two shareholder
lawsuits brought in the Maricopa County Superior Court for the State of Arizona,
entitled James T. Zelloe, et al. v. Microtest, Inc. et al., Cause No, CV96-16655
and Richard Fluegel et al. v. Microtest, Inc. et al., Cause No. CV96-19144.
These shareholder lawsuits have been consolidated. The plaintiffs in these
lawsuits purport to represent a class of plaintiffs who purchased the Company's
common stock between April 13, 1995 and January 17, 1996. The plaintiffs allege,
among other things, that certain statements made by the Company and its
representatives, as well as the financial statements contained in the Company's
Quarterly Reports on Form 10-Q filed during 1995, were false and misleading due
to the Company's purported improper recognition of revenue on certain sales of
products to distributors and resellers in violation of generally accepted
accounting principles. More specifically, the plaintiffs allege that certain
sales of products to distributors and resellers were contingent on resale and,
as a result, the Company should not have recognized revenue on such sales and
did not properly reserve for returns on such sales. Furthermore, according to
the plaintiffs, the Company should have disclosed that future demand for its
products would be constrained by the alleged excess levels of products held by
its distributors as a result of the Company's purported contingent sales in
1995. The lawsuits include causes of action for securities fraud and common law
fraud and seek unspecified damages and the recovery of attorneys' fees and
costs. The Company maintains that its statements and financial statements were
true and correct and that its recognition of revenue was proper and in
accordance with generally accepted accounting principles. The Company believes
that the shareholder class action lawsuits are without merit, and has to filed a
motion to dismiss the lawsuits and intends to vigorously defend against them.
The Company currently expects that the ultimate resolution of the lawsuits will
not have a material effect on the Company's financial condition or operating
results; however, if the shareholder lawsuits were ultimately determined
adversely to the Company, it would have a material adverse effect on the
Company's financial condition and operating results.
19
<PAGE>
The Company is involved in various other legal proceedings incidental
to its business. Management does not believe that any of these legal proceedings
will have a material adverse effect on the financial condition or operating
results of the Company.
ITEM 4. SUBMISSION OF MATTERS.
----------------------
The Company did not submit any matter to a vote of its shareholders
during the fourth quarter of 1996.
20
<PAGE>
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY SECURITIES AND RELATED
-----------------------------------------------------------------------
SHAREHOLDER MATTERS.
--------------------
General
The Company's common stock has been traded on the Nasdaq National
Market ("Nasdaq") since October 30, 1992, under the symbol "MTST." The following
table sets forth the quarterly high and low closing sales prices of the common
stock as reported on Nasdaq.
Period High Low
- ------ ---- ---
1995 First Quarter . . . . . . . . . . . . . . . . . .$24.25 $15.875
Second Quarter . . . . . . . . . . . . . . . . . 22.75 18.50
Third Quarter . . . . . . . . . . . . . . . . . . 25.25 19.75
Fourth Quarter . . . . . . . . . . . . . . . . . 19.735 9.75
1996 First Quarter . . . . . . . . . . . . . . . . . . 12.25 5.00
Second Quarter . . . . . . . . . . . . . . . . . 12.25 7.00
Third Quarter . . . . . . . . . . . . . . . . . . 11.50 7.00
Fourth Quarter . . . . . . . . . . . . . . . . . 10.875 6.875
The closing price of the Company's Common Stock on March 14, 1997 was
$7.25 per share.
As of March 14, 1997, there were 8,130,647 shares of common stock
outstanding, which were held of record by 200 holders. The Company estimates
that there are approximately 6,887 beneficial owners of the Company's common
stock.
The Company has not paid any cash dividends on its Common Stock. The
Company presently intends to retain earnings for use in its business and does
not anticipate paying cash dividends on its outstanding shares in the
foreseeable future.
Factors That May Affect Future Stock Performance
The performance of the Company's common stock is dependent upon several
factors, including those set forth below and in "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors That May
Affect Future Results and Financial Condition."
Possible Volatility of Stock Price - The Company believes that factors
such as announcements of developments related to the Company's business,
announcements by competitors, quarterly fluctuations in the Company's financial
results, conditions in the CD-ROM networking industry, conditions in the network
management and certification industry,
21
<PAGE>
changes in the general economy, and other factors could cause the price of the
Company's Common Stock to fluctuate substantially. In addition, in recent years
the stock market in general, and the market for shares of small capitalization
technology stocks in particular, have experienced extreme fluctuations, which
have often been unrelated to the operating performance of affected companies.
Such fluctuations could have a material adverse effect on the market price of
the Company's Common Stock.
Certain Charter and Bylaw Provisions - The Company's Certificate of
Incorporation and Bylaws empower the Board of Directors, without approval of the
shareholders, to fix the rights and preferences and to issue shares of preferred
stock and divide the Company's Board of Directors into three classes. These
provisions, as well as other provisions in such documents, could have the effect
of deterring unsolicited takeovers or delaying or preventing changes in control
or management of the Company, including transactions in which shareholders might
otherwise receive a premium for their shares over the current market prices.
ITEM 6. SELECTED FINANCIAL DATA.
------------------------
The following selected consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and related
Notes and with "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere herein. The consolidated balance
sheets as of December 31, 1995 and 1996, and the consolidated statements of
operations, stock holders' equity and cash flows for each of the three years in
the period ended December 31, 1996 and the independent auditors' report thereon,
are included in Item 8 of this Form 10-K.
22
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Statement of Income Data:
Revenues ...................................... $ 26,487 $ 22,142 $ 39,574 $ 52,537 $ 50,442
Cost of sales and services .................... 10,316 9,680 16,584 21,961 20,452
-------- -------- -------- -------- --------
Gross profit ............................. 16,171 12,462 22,990 30,576 29,990
Total operating expenses ...................... 11,087 15,045 16,212 22,192 24,939
Restructuring charges, purchased R & D
and other unusual items(1) ................. -- 3,358) -- (8,776) (15,697)
Income from sale of technology(1) ............. 6,245 959 -- -- --
-------- -------- -------- -------- --------
Income (loss) from operations ................. 11,329 (4,982) 6,778 (392) (10,646)
Interest income - net ......................... 243 729 743 1,232 762
-------- -------- -------- -------- --------
Income (loss) before income taxes ............. 11,572 (4,253) 7,521 840 (9,884)
Provision (benefit) for income taxes .......... 4,432 (1,730) 2,231 (305) 1,711
-------- -------- -------- -------- --------
Net income (loss) ............................. $ 7,140 $ (2,523) $ 5,290 $ 1,145 $(11,595)
======== ======== ======== ======== ========
Net income (loss) per common and
equivalent share (1) ....................... $ 1.05 $ (0.34) $ 0.64 $ 0.13 $ (1.43)
======== ======== ======== ======== ========
Net income (loss) excluding restructuring
charges, purchased R & D, other unusual
items and income from sale of technology (1) $ 3,287 $ (1,100) $ 5,290 $ 6,531 $ 4,102
======== ======== ======== ======== ========
Net income (loss) per common and
equivalent share excluding restructuring
charges, purchased R & D, other unusual
items and income from sale of technology (1) $ 0.49 $ (0.14) $ 0.64 $ 0.77 $ 0.50
======== ======== ======== ======== ========
Shares used in per share calculation .......... 6,769 7,503 8,269 8,534 8,104
Shares used in per share calculation excluding
restructuring charges, purchased R & D, other
unusual items and income from sale of
technology .................................... 6,769 7,739 8,269 8,534 8,251
Balance Sheet Data:
Working capital ............................... $ 32,613 $ 29,576 $ 36,635 $ 39,128 $ 26,583
Total assets .................................. 39,080 36,537 47,642 50,158 43,313
Shareholders' equity .......................... 35,389 33,433 40,579 43,027 31,672
</TABLE>
(1) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a discussion of the impact on net income of
restructuring charges, purchased R & D, other unusual items and income
from sale of technology.
23
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-----------------------------------------------------------------------
OF OPERATIONS.
--------------
Introduction
The Company develops and markets network management and connectivity
products. Its network management products certify whether cabling will support a
proposed LAN installation, as well as troubleshoot cable and other faults that
occur on established LANs. Its connectivity products facilitate both the storage
of information on CD-ROM devices, as well as the sharing of that information
among LAN users.
In 1996, the Company achieved net revenues of $50.4 million and
recorded a net loss of $11.6 million or $(1.43) per share in 1996. This differs
from the Company's previously announced unaudited results of net revenues of
$52.5 million and a net loss of $10.7 million or $(1.31) per share. The
difference is due to a recent determination by the Company that reserves
relating to end user direct sales were inadequate. As a result, net revenues
attributable to such sales decreased as a result of a $2.1 million increase in
the reserves for fourth quarter sales made through OMI's direct sales program.
The Company also recently determined that its interim unaudited results for the
second, third and fourth quarters of 1996 required adjustments as discussed in
Note 10 to the Company's Consolidated Financial Statements included elsewhere in
this Annual Report.
The Company is making changes in the structure of the end user direct
sales program, and the changes will impact operating results for the first
quarter of 1997. In addition to changes to this program, the Company has been
affected by an overall slowing in the growth of the network products industry,
which also will negatively impact first quarter operating results. Accordingly,
the Company will not meet internal operating expectations for the quarter.
Despite overall growth in 1995, during the fourth quarter of 1995 there
was a significant slowing in the market for the Company's products following
increased sales to certain distributors during the third quarter of 1995. In
addition, sales of the Company's relatively new diagnostic product, COMPAS, did
not ramp up as quickly as anticipated.
The Company's operating results have been volatile over the past
several years, particularly on a quarter to quarter basis. For a discussion of
factors that may affect the Company's business, financial condition and future
results, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Factors That May Affect Future Results and Financial
Condition" included in this Report.
24
<PAGE>
Results of Operations
<TABLE>
<CAPTION>
(in thousands) 1994 Change 1995 Change 1996
- ------------------------------------------------------- -------- -------- --------- ------ --------
<S> <C> <C> <C> <C> <C>
Revenues $ 39,574 33% $ 52,537 -4% $ 50,442
Gross profit 22,990 33% 30,576 -2% 29,990
As a percentage of revenues 58.1% 58.2% 59.5%
Sales & marketing 8,739 44% 12,585 14% 14,334
As a percentage of revenues 22.1% 24.0% 28.4%
Research & development 4,063 46% 5,913 8% 6,414
As a percentage of revenues 10.3% 11.3% 12.7%
General & administrative 3,410 8% 3,694 13% 4,191
As a percentage of revenues 8.6% 7.0% 8.3%
Interest income 743 66% 1,232 -38% 762
As a percentage of revenues 1.9% 2.3% 1.5%
Income taxes excluding tax benefit from purchased R & D 2,231 38% 3,085 -45% 1,711
Effective tax rate 29.7% 32.1% 29.4%
Net Income (Loss) 5,290 -78% 1,145 -1113% (11,595)
As a percentage of revenues 13.4% 2.2% -23.0%
Net Income (Loss) Excluding
restructuring charges, purchased 5,290 23% 6,531 -37% 4,102
R % D and other unusual items
As a percentage of revenues 13.4% 12.4% 8.1%
</TABLE>
Revenues - Product sales decreased 4% [GRAPHIC OMITTED]
from 1995 to 1996. This is mainly due to Bar Graph showing revenue
increased competition in the Category 5 as $26.5 million for
cable testing market and a softening of 1992, $22.1 million for
the European economy in 1996. Product sales 1993, $39.6 million for
increased from 1994 to 1995 primarily due 1994, $52.5 million for
to the increased demand in the domestic and 1995 and $50.4 million
international marketplaces for DiscPort products. for 1996.
International sales were $14.8 million, $19.1 million and $13.4 million
in 1996, 1995 and 1994, or 29%, 36% and 34% of total revenues, respectively.
International sales decreased in both absolute dollars and as a percentage of
total revenue during 1996 primarily due to the above mentioned weakening in the
European economy in 1996. International sales increased in both absolute dollars
and as a percentage of total revenue during 1995 due to an increased demand for
the Company's DiscPort products in its international markets.
25
<PAGE>
[GRAPH OMITTED] Gross Profit -Gross profit decreased 2%
Bar Graph showing Gross in 1996. This decrease is due to the
Profit for 1992 of $16.2 decrease in revenue during 1996
million, 1993 of $12.5 partially offset by the introduction of
million, 1994 of 23.0 a manufacturers' representative
million, 1995 of $30.6 program. Discounts to many of the
million, and 1996 of Company's distributors were lowered as
$30.0 million a result of this program. Gross profit
increased 33% in 1995 due to the
corresponding 33% increase in total
revenues during the same time period.
Gross profit as a percentage of total
revenues may fluctuate on a quarterly
basis due to a variety of factors, including changes in product and customer
mixes, the introduction of new products by the Company or its competitors and
other competitive factors, such as pricing pressures.
Sales & Marketing Expenses- Sales and
marketing expenses increased in both
absolute dollars and as a percentage
of total revenues from 1995 to 1996.
The increase is largely due to the [GRAPH OMITTED]
implementation of the above mentioned Bar Graph showing sales and marketing
manufacturers' representative expenses of $6.2 million in 1992, $7.7
compensation program, as well as the million in 1993, $8.7 million in 1994,
addition of personnel to bolster the $12.6 million in 1995, and $14.3
Company's sales force. Sales and million in 1996.
marketing expenses increased in both
absolute dollars and as a percentage
of revenue from 1994 to 1995.
Increased advertising and promotional
expenses, commissions and sales,
marketing and support personnel were
the main contributors to the increase
during this period.
26
<PAGE>
[GRAPHIC OMITTED] Research & Development Expenses - 1996
Bar Graph showing research and research and development expenses
development expenses of $3.4 million increased in absolute dollars and as a
in 1992, $4.7 million in 1993, $4.1 percentage of total revenues as
million in 1994, $5.9 million in compared to 1995 research and
1995, and $6.4 million in 1996. development expenses primarily due to
an increase in the number of prototypes
developed in 1996 as compared to 1995.
Research and development expenses
increased in both absolute dollars and
as a percentage of revenue from 1994 to
1995. This increase is due primarily to
an increase in personnel stemming from
the acquisition of OMI and use of
outside services.
General & Administrative Expenses- General and administrative expenses increased
during 1996 in both absolute dollars and as a percentage of revenues mainly
because of an increase in expenses related to the settlement of a lawsuit during
the first quarter of 1996, as well as the legal
costs associated with the defense of two
shareholder lawsuits filed during the
last half of 1996. General and [GRAPHIC OMMITED]
administrative expenses increased in Bar Graph showing general and
absolute dollars but decreased as a adminstrative expenses of $1.5 million
percentage of total revenues from in 1992, $2.7 million in 1993, $3.4
1994 to 1995. The increase in million in 1994, $3.7 million in 1995,
absolute dollars was due primarily to and $4.2 million in 1996
increased legal and consulting fees
as well as increased headcount and
administrative costs associated with
OMI. The decrease in general and
administrative expenses as a
percentage of total revenues was due
to the higher sales volumes in 1995
compared with 1994.
27
<PAGE>
[GRAPHIC OMITTED] Interest - The Company's interest
Bar Graph showing interest income of income decreased from 1995 to 1996
$243,000 in 1992, $729,000 in 1993, primarily due to a reallocation of
$743,000 in 1994, $1,232,000 in 1995, investments in anticipation of the
and $762,000 in 1996. Company's acquisition activities in
1996. The Company invests the majority
of its excess cash in municipal bond
funds with maturities ranging from 7
days to 3 months.
[GRAPHIC OMITTED] Effective Tax Rate - Excluding the
Bar Graph showing the effective tax effects of purchased research and
rate excluding tax benefit related to development, the Company experienced a
purchased R & D of 38% for 1992, 41% decrease in its effective income tax
for 1993, 30% for 1994, 32% for 1995, rate during 1996. The decrease was
and 29% for 1996. mainly due to the recognition of R & D
tax credits earned in 1996. The
Company's 1995 effective tax rate
includes a tax benefit of $3.4 million
related to purchased research and
development. Excluding the effects of
purchased research and development, the
Company's effective tax rate was 32% in
1995. This represents
an increase from 30% in 1994. The increase was primarily due to the realization
of net operating loss carryforwards during 1994 for which a valuation allowance
had previously been established.
Net Income - The Company's net income decreased in both absolute
dollars and as a percentage of total revenues from 1995 to 1996. During the
fourth quarter of 1996, the Company recorded an expense for research and
development costs associated with software products for which technological
feasibility has not been established and for which no alternative future use
existed arising from the purchase of Logicraft. The expense totaled $15.7
million. Excluding this expense, net income decreased 42% from $6.5 million in
1995 to $4.1 million in 1996. This decrease is mainly attributable to the
decrease in revenues, the overall increase in operating expenses and the
decrease in interest income during 1996. Net income decreased in both absolute
dollars and as a percentage of total revenues from 1994 to 1995. During the
second quarter of 1995, the Company recorded an expense for research and
development costs associated with software products for which technological
feasibility has not been established and for which no alternative future use
existed arising from the purchase of OMI. The expense totaled $8.3 million and a
tax benefit of $3.2 million was recognized. Additionally, during the third
quarter of 1995, the Company recorded an expense for research and development
costs associated with products for which technological feasibility has not been
established and for which no alternative future use existed arising from the
purchase of certain technologies from
28
<PAGE>
Hotware, Inc. The expense totaled $450,000 and a tax benefit of $180,000 was
recognized. Excluding these items, net income was $6.5 million, a 23% increase
from 1994. This increase was due to higher sales volumes and an increase in
interest income. See Note 5 to the Consolidated Financial Statements included
elsewhere in this Form 10-K.
[GRAPHIC OMITTED] [GRAPHIC OMITTED]
Bar Graph showing net income/(loss) Bar Graph showing net income/(loss)
of $7.1 million for 1992, $(2.1) excluding restructuring charges,
million for 1993, $5.3 million for purchased R & D, other unusual items
1994, $1.1 million for 1995 and and income from sale of technology of
$(11.6) million for 1996. $3.3 million for 1992, $(1.1) million
for 1993, $5.3 million for 1994, $6.5
million for 1995 and $4.1 for 1996.
Liquidity and Capital Resources
To date, the Company has financed its operations primarily through
operating cash flow and equity financings. At December 31, 1996, the Company had
cash and cash equivalents of $10.3 million. This represents a $9.6 million
decrease in cash and cash equivalents from December 31, 1995 to December 31,
1996. As a result of the decrease in cash and cash equivalent, the Company
intends to secure a $10 million unsecured revolving credit facility with a bank
which will be used for general corporate and working capital purposes. This
decrease in cash and cash equivalents is mainly attributable to the Logicraft
acquisition and an increase in accounts receivable. The increase in accounts
receivable is mainly due to a slowing in the collection process caused by a
mid-year systems conversion along with personnel turnover in the collections
area and the addition of Logicraft receivables due to the year-end acquisition.
Accrued liabilities also showed a significant increase due mainly to the
assumption of Logicraft liabilities and additional accruals for
acquisition-related expenses.
At December 31, 1995, the Company's cash and cash equivalents had
decreased $11.7 million to $19.9 million from December 31, 1994. This decrease
in cash and cash equivalents is mainly attributable to the OMI and Hotware
acquisitions, a stock repurchase program, an increase in receivables and an
increase in inventory at year end. The increase in accounts receivable is
primarily attributable to third quarter sales resulting from extensions of
payment terms to certain of the Company's distributors.
29
<PAGE>
Capital expenditures were $1.1 million in 1996, $1.4 million in 1995
and $1.3 million in 1994. The Company believes that capital investments of
property and equipment will approximate $1.0 million in 1997. The Company
expects expenditures related to the completion of in-process technology of
Logicraft Information Systems, Inc. acquired during 1996 to approximate $700,000
in 1997. The Company expects that existing cash balances, anticipated cash flow
from operations and the anticipated revolving credit line referenced below will
satisfy the Company's working capital and capital expenditure requirements for
the foreseeable future.
Inflation
The Company does not believe that it is significantly impacted by
inflation because of its rapid inventory turnover and relatively small
investment in capital assets.
Factors That May Affect Future Results and Financial Condition
The Company's future operating results and financial condition are
dependent on the Company's ability to successfully develop, manufacture, and
market technologically innovative products in order to meet dynamic customer
demand patterns. Inherent in this process are a number of factors that the
Company must successfully manage in order to achieve favorable future operating
results and financial condition. Potential risks and uncertainties that could
affect the Company's future operating results and financial condition include,
without limitation, the factors discussed below.
Fluctuations in Quarterly Operating Results - The Company's revenues
may vary significantly from quarter to quarter due to a variety of factors,
including changes in the Company's product and customer mix, the introduction of
new products by the Company or its competitors, and other factors, including
pricing pressures and economic conditions in the United States and Europe. The
Company operates with relatively little backlog and substantially all of its
revenues in each quarter result from orders received in that quarter. In
addition, the Company incurs significant operating start-up expenses in
anticipation of future revenues. If near-term demand for the Company's products
weakens or if orders are not shipped in any quarter as anticipated, the
Company's results of operations for that quarter could be adversely affected.
The Company's quarterly operating results may vary significantly depending on
various factors, including the introduction of new products by the Company's
competitors, market acceptance of new products, the mix of software and system
sales, , adoption of new technologies and standards, prices and other forms of
competition, the cost, quality and availability of third party components used
in the Company's systems, changes in the Company's distribution arrangements,
and the inability of the Company to accurately monitor end user demand for its
products due to the sales of products through distributors and VARs and
unanticipated product returns to the extent such returns exceed the Company's
reserves for future returns. The Company's operating results will also be
affected by the economic condition of the computer industry, which has from time
to time experienced cyclical, depressed business conditions, often in connection
with or in anticipation of a decline in general economic conditions. Due to all
of the foregoing factors, the Company's revenues or operating results may in one
or more future quarters be below the expectations of stock market analysts and
investors. In such event, the
30
<PAGE>
price of the Company's common stock would likely decline, and such decline could
be substantial.
Dependence on Third Party Distributors - The Company derives
substantially all of its product sales through distributors and VARs. Two of the
Company's distributors accounted for 28% of the Company's revenues in 1996. The
loss of certain distributors or VARs would have a material adverse effect on the
Company's business and operating results. The Company's contractual
relationships with its distributors and VARs are generally cancelable upon
notice to the Company. Certain of the Company's distributors and VARs also act
as distributors for competitors of the Company and could devote greater effort
and resources to marketing competitive products. In addition, effective
distributors and VARs must devote significant technical, marketing, and sales
resources to an often lengthy sales cycle. There can be no assurance that the
Company's current distributors and VARs will continue to market the Company's
products effectively or that economic or industry conditions will not adversely
affect such distributors and VARs. Because the Company sells a significant
portion of its products through distributors and VARs, it is difficult for the
Company to monitor end user demand for its products on a current basis. Initial
stocking orders may not be indicative of long-term end user demand. The
Company's customers typically are allowed by contract to return products,
subject to certain limitations, without charge or penalty. While the Company
provides for a reserve for future returns, there can be no assurance that the
reserve will adequately cover actual product returns. Excessive or unanticipated
returns could materially adversely affect the Company's business, operating
results, or financial condition. The Company's operating results could also be
materially adversely affected by changes in distributors' inventory strategies,
which could occur rapidly and, in many cases, may not be related to end user
demand. New products may require different marketing, sales, and distribution
strategies than those for the Company's current products. There can be no
assurance that the Company's distributors and VARs will choose or be able to
effectively market these new products or to continue to market the Company's
existing products. A failure of the Company's distributors and VARs to
successfully market the Company's product would have a material adverse effect
on the Company's business and results of operations.
Dependence on Third Party Suppliers - The Company is dependent on a
small number of third party vendors for the manufacturing of all of the
Company's products. The Company also is dependent on a small number of suppliers
for certain key components used in its product, including CD-ROM drives,
microprocessors, integrated circuits and power modules. The Company purchases
these components pursuant to purchase orders placed from time to time, does not
carry significant inventories of these components, and has no long-term supply
arrangements. The loss of any of the Company's third-party manufacturers or key
suppliers could have a material adverse effect upon the Company's business,
financial condition and operating results. Although the Company believes that
alternative sources of product manufacturing and components could be arranged,
the process of qualifying new suppliers could be lengthy. There can be no
assurance that any additional source would be available to the Company on a
timely basis or at a cost acceptable to the Company. Any disruption or reduction
in the future supply of any key components currently obtained from limited
sources could have a material adverse effect on the Company's business,
financial condition and operating results.
31
<PAGE>
Rapid Technological Change; Potential for Product Defects - The market
for the Company's products is characterized by rapid technological advances,
evolving industry standards in computer hardware and software technology,
changes in customer requirements, and frequent new product introductions and
enhancements. The Company's future success will depend on its ability to
continue to enhance its current product line and to continue to develop and
introduce new products that keep pace with competitive product introductions and
technological developments, satisfy diverse and evolving customer requirements,
or otherwise achieve market acceptance. There can be no assurances that the
Company will be successful in continuing to develop and market on a timely and
cost-effective basis new products or product enhancements that respond to
technological advances by others, or that these products will achieve market
acceptance. In addition, companies in the industry have in the past experienced
delays in the development, introduction, and marketing of new and enhanced
products, and there can be no assurance that the Company will not experience
delays in the future. Any failure by the Company to anticipate or respond
adequately to changes in technology and customer preferences, or any significant
delays in product development or introduction, would have a material adverse
effect on the Company's business, financial condition and results of operations.
Due to the complexity and sophistication, the Company's products from
time to time may contain defects or "bugs" which can be difficult to correct.
Moreover, as the Company continues to develop and enhance its products, there
can be no assurance that the Company will be able to identify and correct
defects in such a manner as will permit the timely introduction of such product.
Furthermore, despite extensive testing, the Company has from time to time
discovered defects only after its products have been commercially released.
There can be no assurance that product defects will not cause delays in product
introductions and shipments, cause loss of or delays in market acceptance,
result in increased costs, require design modifications, or impair customer
satisfaction. Any such event could materially adversely affect the Company's
business, financial condition and results of operations.
Over the past two years, CD-ROM drive technology has advanced
significantly. Additionally, the pace of new drive introductions has increased.
As a result, the Company may find itself holding an inventory of obsolete
drives. Additionally, the Company's contracts with its distributors allow for
product return, or price protection credits, based on current inventory levels
of current and obsolete products under certain limited circumstances. The
Company estimates and accrues an allowance for such occurrences, but there can
be no assurance that actual inventory writedowns, product returns, or price
protection credits will not exceed the Company's estimates. Any of the foregoing
events could materially adversely affect the Company's business, financial
condition and results of operations.
Competition - The markets for the Company's products are extremely
competitive. The Company expects that competition will increase as more
companies enter the market and as existing competitors continue to change and
expand product offerings. Pricing is very aggressive in the Company's industry,
and the Company expects pricing pressures to continue to intensify. The
Company's current competitors in the CD-ROM networking market include other
suppliers of CD-ROM networking software and hardware such as Meridian Data,
Inc., Micro Design
32
<PAGE>
International, CBS, Reed Technology and Information Services, Inc., Ornetix,
SciNet, Inc., Axis Communication, Inc. and Compact Devices, Inc. The Company
also competes indirectly with suppliers of personal computers and network
operating systems such as Microsoft and Novell, to the extent such companies
include CD-ROM networking utilities as part of their operating systems. The
Company's potential competitors in the hardware area include companies in the
personal computer market and certain CD-ROM manufacturers. The Company's current
competitors in the network management and certification market include other
suppliers of network management and certification software and hardware such as
Wavetek Corporation, Scope Communications, Inc., Fluke Corporation and Datacom
Technologies, Inc. The Company's competitors include large domestic and
international companies, many of which have significantly greater financial,
technical, manufacturing, marketing, sales and distribution resources than the
Company. There can be no assurance that the Company's current or potential
competitors will not develop products comparable or superior to those developed
by the Company or adapt more quickly than the Company to new or emerging
technologies, evolving industry trends, or changing customer requirements. There
also can be no assurance that the Company will have the financial resources,
technical expertise, or marketing, sales, distribution, customer service, and
technical support capabilities to compete successfully.
Product Concentration - The Company currently derives substantially all
of its revenue from its PentaScanner and DiscPort products. The market for these
products is characterized by rapid technological advances, evolving standards in
computer hardware and software technology, changes in customer requirements and
frequent new product introductions and enhancements. Any decrease in sales of
the Company's PentaScanner or DiscPort products as a result of the foregoing or
other factors would have a material adverse effect on the Company's business,
financial condition and operating results.
International Operations - Sales outside of North America account for
29%, 36% and 34% of the Company's revenues in 1996, 1995 and 1994, respectively.
An important element of the Company's strategy is to expand its international
operations. There can be no assurance that the Company will be able to continue
to successfully localize, market, sell and deliver products internationally. The
inability of the Company to successfully expand its international operations in
a timely and cost effective manner could materially adversely affect the
Company's business, financial condition and results of operations. The Company's
business and results of operations could be materially adversely affected by
risks inherent in conducting business internationally, such as changes in
currency exchange rates, longer payment cycles, difficulties in staffing and
managing international operations, problems in collecting accounts receivable,
seasonal reductions in business activity during the summer months in Europe and
certain other parts of the world, and tariffs, duties and other trade barriers.
The Company seeks to mitigate its direct exposure to exchange rate fluctuation
by selling only in United States currency.
Litigation - As described in this Annual Report under the caption
"Legal Proceedings," the Company is a defendant in class action shareholder
lawsuits and in other litigation incidental to the Company's business. The
Company may be required to incur substantial legal fees and costs in defending
against these legal proceedings, which could have a material adverse effect on
the Company's operating results. Although the Company believes that the claims
asserted against
33
<PAGE>
the Company in these proceedings are without merit, there can be no assurance
that the Company will be successful in defending against any of the legal
proceedings in which it is involved. Moreover, although the Company intends to
vigorously defend itself against such proceedings, the Company could make a
business decision to settle such claims instead of continuing to incur
substantial legal fees and costs. Further, there can be no assurance that the
Company will not be named as a defendant in additional legal proceedings,
especially if the Company's actual operating results do not meet or exceed
anticipated results. If the Company is unsuccessful in defending against any of
these proceedings, decides to pay a substantial sum to settle any of the
proceedings or is named as a defendant in additional legal proceedings, it could
have a material adverse effect on the Company's business, financial condition
and operating results.
Dependence on Key Personnel; Management of Growth - Due to the
specialized nature of the Company's business, the Company's future success is
highly dependent upon the continued services of its key engineering personnel
and executive officers and upon its ability to attract and retain qualified
engineering, sales and marketing, management and manufacturing personnel for its
operations. Competition for such personnel is intense. There can be no assurance
that the Company will be successful in attracting or retaining such personnel.
The loss of any key personnel or the Company's inability to attract and retain
qualified employees could have a material adverse effect on the Company's
business, financial condition and results of operations. To manage its growth,
the Company must continue to implement and improve its operational, financial,
and management information systems and expand, train, and manage its workforce.
The Company believes that success in its industry requires substantial capital
in order to maintain the flexibility to take advantage of opportunities as they
may arise. The Company may, from time to time, as market and business conditions
warrant, invest in or acquire complementary businesses, products, or
technologies. Such investment or acquisitions may be funded by internally
generated cash, marketable securities, debt or additional equity. The sale of
additional equity could result in dilution in the equity ownership of the
Company's shareholders. The Company's failure to manage growth effectively could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Dependence on Proprietary Rights - The Company's success depends in
part upon protecting its proprietary technology. The Company relies on a
combination of intellectual property laws, nondisclosure agreements and other
protective measures to protect its proprietary information. There can be no
assurance, however, that the steps taken by the Company will be adequate to
deter misappropriation or independent third party development of its technology
or that its intellectual property rights can be successfully defended if
challenged. In addition, the laws of certain foreign countries do not protect
the Company's intellectual property rights to the same extent as the laws of the
United States. Given the rapid development of technology, there can be no
assurance that certain aspects of the Company's products do not or will not
infringe upon the existing or future proprietary rights of others or that, if
licenses or rights are required to avoid infringement, such licenses or rights
could be obtained or obtained on terms that are acceptable to the Company.
34
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
--------------------------------------------
Consolidated balance sheets of the Company as of December 31, 1995 and
1996 and consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1996,
together with the related notes and the report of Deloitte & Touche LLP,
independent auditors, are set forth on the following pages. Other required
financial information is set forth herein, as more fully described in Item 14
hereof.
35
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
Consolidated Financial Statements
Years Ended December 31, 1994, 1995 and 1996, and
Independent Auditors' Report
36
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors of
Microtest, Inc.
Phoenix, Arizona
We have audited the accompanying consolidated balance sheets of Microtest, Inc.
and subsidiaries as of December 31, 1995 and 1996, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1996. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Microtest, Inc. and subsidiaries at
December 31, 1995 and 1996, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Phoenix, Arizona
March 27, 1997
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands, Except Share Data)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
--------------------
ASSETS 1995 1996
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 19,907 $ 10,282
Accounts receivable - less allowance for doubtful accounts of
$521 and $582 and less returns reserve of $919 and $3,030 14,938 17,544
Inventories - less reserve for obsolescence of $717 and $540 (Note 2) 6,814 6,163
Prepaid expenses 681 823
Income taxes receivable (Note 4) 2,100 291
Deferred income taxes (Note 4) 1,819 3,121
-------- --------
Total current assets 46,259 38,224
EQUIPMENT AND LEASEHOLD IMPROVEMENTS - Net (Note 3) 3,212 3,642
INTANGIBLES AND OTHER ASSETS - Net (Note 3) 448 832
DEFERRED INCOME TAXES (Note 4) 239 615
-------- --------
TOTAL $ 50,158 $ 43,313
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 4,757 $ 5,579
Accrued liabilities (Note 9) 1,492 4,983
Accrued payroll and employee benefits 882 1,079
-------- --------
Total liabilities 7,131 11,641
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY (Note 7):
Common stock, .001 par value - authorized, 15,000,000 shares;
issued, 8,159,058 and 8,159,058 shares 8 8
Additional paid-in capital 32,546 32,593
Retained income/(Deficit) 11,455 (485)
Common stock in treasury at cost - 63,824 and 27,970 shares (982) (444)
-------- --------
Total stockholders' equity 43,027 31,672
-------- --------
TOTAL $ 50,158 $ 43,313
======== ========
</TABLE>
See notes to consolidated financial statements.
-38-
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in Thousands, Except Per Share Data)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------
1994 1995 1996
<S> <C> <C> <C>
REVENUES (Notes 8 and 9) $ 39,574 $ 52,537 $ 50,442
COST OF SALES 16,584 21,961 20,452
-------- -------- --------
Gross profit 22,990 30,576 29,990
-------- -------- --------
OPERATING EXPENSES:
Sales and marketing (Note 9) 8,739 12,585 14,334
Research and development 4,063 5,913 6,414
General and administrative 3,410 3,694 4,191
-------- -------- --------
Total operating expenses 16,212 22,192 24,939
-------- -------- --------
UNUSUAL ITEM - Purchased R & D (Note 5) (8,776) (15,697)
-------- -------- --------
INCOME (LOSS) FROM OPERATIONS 6,778 (392) (10,646)
INTEREST INCOME - Net 743 1,232 762
-------- -------- --------
INCOME/(LOSS) BEFORE INCOME TAXES 7,521 840 (9,884)
INCOME TAX PROVISION/(BENEFIT) (Note 4) 2,231 (305) 1,711
-------- -------- --------
NET INCOME/(LOSS) $ 5,290 $ 1,145 $(11,595)
======== ======== ========
NET INCOME/(LOSS) PER COMMON
AND EQUIVALENT SHARE $ .64 $ .13 $ (1 .43)
======== ======== ========
COMMON AND EQUIVALENT SHARES OUTSTANDING 8,269 8,534 8,104
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
-39-
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Amounts in Thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Common Stock Treasury Stock Additional Retained Total
-------------------- --------------------- Paid-In Income/ Stockholders'
Shares Amount Shares Amount Capital (Deficit) Equity
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1994 7,632 $ 8 (78) $ (468) $ 27,693 $ 6,200 $ 33,433
Common stock issued upon:
Exercise of stock options 327 1,125 1,125
Employee Stock Purchase Plan 30 184 184
Exercise of stock warrants 44 264 (96) 168
Disqualifying dispositions of stock options 379 379
Net income 5,290 5,290
-------- -------- -------- -------- -------- -------- --------
BALANCE, DECEMBER 31, 1994 7,989 8 (34) (204) 29,381 11,394 40,579
Common stock issued upon:
Exercise of stock options 161 128 2,019 914 (1,084) 1,849
Employee Stock Purchase Plan 9 7 114 130 244
Disqualifying dispositions of stock options 2,121 2,121
Treasury stock purchase (165) (2,911) (2,911)
Net income 1,145 1,145
-------- -------- -------- -------- -------- -------- --------
BALANCE, DECEMBER 31, 1995 8,159 8 (64) (982) 32,546 11,455 43,027
Common stock issued upon:
Exercise of stock options 27 394 4 (279) 119
Employee Stock Purchase Plan 20 254 (66) 188
Disqualifying dispositions of stock options 43 43
Treasury stock purchase (11) (110) (110)
Net loss (11,595) (11,595)
-------- -------- -------- -------- -------- -------- --------
BALANCE, DECEMBER 31, 1996 8,159 $ 8 (28) $ (444) $ 32,593 $ (485) $ 31,672
======== ======== ======== ======== ======== ======== ========
</TABLE>
See notes to consolidated financial statements.
-40-
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------
1994 1995 1996
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income/(loss) $ 5,290 $ 1,145 $(11,595)
Adjustments to reconcile net income/(loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 1,751 1,512 1,460
Deferred provision for income taxes (1,132) 370 (833)
Allowance for doubtful accounts 90 311 61
Deferred rent (38) (27) (32)
Loss on sale of marketable securities 76
Compensation expense related to vested, non-qualified stock options 4
Purchased R & D - net of related tax benefit 5,386 15,697
Change in operating assets and liabilities:
Accounts receivable (734) (8,984) (321)
Inventories (2,315) (3,300) 1,107
Prepaid expenses and other assets 85 (217) (20)
Accounts payable 1,216 1,423 (1,610)
Accrued liabilities 1,660 (1,053) 1,089
Income taxes payable 1,496 (941)
Income taxes receivable 1,687 21 1,852
-------- -------- --------
Net cash provided by (used in) operating activities 9,136 (4,354) 6,855
-------- -------- --------
INVESTING ACTIVITIES:
Purchases of equipment and leasehold improvements (1,278) (1,383) (1,056)
Acquisitions - net of cash acquired (5,100) (15,621)
Proceeds from sale of marketable securities 7,895
-------- -------- --------
Net cash provided by (used in) investing activities 6,617 (6,483) (16,677)
-------- -------- --------
FINANCING ACTIVITIES:
Proceeds from sale of common and treasury stock 1,097 2,065 307
Purchase of treasury stock (2,911) (110)
-------- -------- --------
Net cash provided by (used in) financing activities 1,097 (846) 197
-------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 16,850 (11,683) (9,625)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 14,740 31,590 19,907
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 31,590 $ 19,907 $ 10,282
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
41
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
- --------------------------------------------------------------------------------
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Microtest,
Inc. and its wholly-owned subsidiaries, Microtest, Inc., International, a
foreign sales corporation, Optical Media International and Logicraft
Information Systems, Inc. (collectively, the "Company"). All intercompany
transactions are eliminated. The Company develops, markets and supports
products that make it easier to manage and service local area networks.
The following are the significant accounting policies of the Company:
a. Inventories are stated at the lower of cost (first-in, first-out
("FIFO") basis) or market.
b. Equipment and leasehold improvements are stated at cost. Depreciation
and amortization are computed utilizing the straight-line method based
on the estimated useful lives of the related assets or, for leasehold
improvements, the lease term, if shorter. Estimated useful lives are
as follows:
Useful Life
Equipment 3 - 5 years
Furniture and fixtures 7 years
Leasehold improvements 5 years
c. Income Taxes - Income taxes are provided based upon the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 109,
Accounting for Income Taxes, which among other things, requires that
recognition of deferred income taxes be measured by the provisions of
enacted tax laws in effect at the date of the financial statements.
d. Research and Development Expenses - Costs and expenses which can be
clearly identified as research and development are charged to research
and development expense as incurred. Costs which relate to prototype
and experimental models which are sold to customers are charged to
cost of sales.
e. Revenue Recognition - The Company recognizes revenue from product
sales to distributors upon shipment. Sales to distributors in the
United States, Canada and Europe account for the majority of the
Company's net sales. The Company recognizes revenue from product sales
to direct end users upon customer commitment. The Company has
established a program which, under specified conditions, enables
distributors and resellers to return products to the Company for
credit against additional purchases or in the event the Company
reduces its selling prices, to receive credits for the reduction in
selling price. The amount of potential product returns, including
returns under the Company's warranty program, and credits for selling
price reductions, is estimated and provided for in the period of sale.
42
<PAGE>
f. Consolidated Statements of Cash Flows - For purposes of the
consolidated statements of cash flows, the Company considers all
highly liquid investments with an initial maturity of three months or
less to be cash equivalents.
g. Net income (loss) per common and equivalent share has been computed
using the weighted average number of common shares and common share
equivalents outstanding during each period. Stock options and warrants
have been included as common equivalent shares utilizing the treasury
stock method only when their effect is dilutive.
h. Stock Based Compensation - The Company accounts for its stock based
compensation plan based on Accounting Principles Board ("APB") Opinion
No. 25. In October 1995, the Financial Accounting Standards Board
issued SFAS No. 123, Accounting for Stock Based Compensation. The
Company has determined that it will not change to the fair value
method and will continue to use APB Opinion No. 25 for measurement and
recognition of employee stock based transactions (Note 7).
i. Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles necessarily
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these
estimates.
j. Product Concentration - The market for the Company's products is
characterized by rapidly changing technology, short product life
cycles and evolving industry standards. The Company has derived
substantially all of its revenues from the development and sales of a
limited number of cable management and network connectivity devices
for the local area network ("LAN") industry.
k. Reclassifications - Certain reclassifications were made to the 1994
and 1995 financial statements to conform with the 1996 presentation.
2. INVENTORIES
Inventories consisted of the following at December 31:
1995 1996
(Amounts in Thousands)
Raw materials $ 1,647 $ 1,242
Work-in-progress 23 153
Finished goods 5,861 5,308
------- -------
Total 7,531 6,703
Less reserve for obsolescence (717) (540)
------- -------
Inventories - net $ 6,814 $ 6,163
======= =======
43
<PAGE>
3. EQUIPMENT AND LEASEHOLD IMPROVEMENTS AND INTANGIBLES
Equipment and leasehold improvements consisted of the following at
December 31:
1995 1996
(Amounts in Thousands)
Equipment $ 5,081 $ 6,522
Furniture and fixtures 1,469 1,530
Leasehold improvements 503 533
------- -------
Total 7,053 8,585
Less accumulated depreciation and amortization (3,841) (4,943)
------- -------
Equipment and leasehold improvements - net $ 3,212 $ 3,642
======= =======
Intangibles consisted of the following at December 31:
1995 1996
(Amounts in Thousands)
Purchased software $ 1,355 $ 594
Non-compete agreement and other intangibles 902 238
------- -------
Intangibles - gross 2,257 832
Less accumulated amortization (1,985)
------- -------
Intangibles - net $ 272 $ 832
======= =======
Purchased software and other intangibles are amortized over their
estimated useful life of 2 to 3 years. Amortization is accelerated when
there is deemed to be a reduction in the estimated revenues or other
benefits arising from such intangibles.
4. INCOME TAXES
The components of the provision for income taxes for the years ended
December 31 are as follows:
1994 1995 1996
(Amounts in Thousands)
Current:
Federal $ 2,982 $ (675) $ 2,326
State 381 149
Foreign 69
------- ------- -------
Total current provision 3,363 (675) 2,544
Deferred (1,132) 370 (833)
------- ------- -------
Total provision for income taxes $ 2,231 $ (305) $ 1,711
======= ======= =======
44
<PAGE>
The Company's current income tax liability was reduced and additional
paid-in capital increased approximately $379,000, $2,121,000 and $43,000
during 1994, 1995 and 1996, respectively, resulting from disqualifying
dispositions of incentive stock options. Cash payments for income taxes
were approximately $1,864,000, $3,329,000 and $750,000 in 1994, 1995 and
1996, respectively.
A reconciliation of the difference between the provision for income taxes
and income taxes at the statutory United States federal income tax rate is
as follows for the years ended December 31:
<TABLE>
<CAPTION>
1994 1995 1996
(Amounts in Thousands)
<S> <C> <C> <C>
Income taxes at statutory United States federal income tax rate $ 2,557 $ 286 $(3,361)
Increase (decrease) in taxes:
Acquired research and development 5,337
State taxes - net 451 50 90
Research and development credits (224) (350) (111)
Tax exempt interest income (104) (363) (261)
Reversal of valuation allowance (599)
Other - net 150 72 17
------- ------- -------
Total $ 2,231 $ (305) $ 1,711
======= ======= =======
</TABLE>
The components of deferred income taxes at December 31 are as follows:
1995 1996
(Amounts in Thousands)
Current:
Nondeductible accruals and reserves $ 1,549 $ 2,880
Inventory costs capitalized for income tax purposes 270 241
------- -------
Total current 1,819 3,121
------- -------
Noncurrent:
Excess of tax over book depreciation (153) (71)
Excess of book over tax amortization 293 466
Deferred rent 29 10
Deferred compensation 70 210
------- -------
Total noncurrent 239 615
------- -------
Total deferred income taxes $ 2,058 $ 3,736
======= =======
5. ACQUISITIONS
On December 17, 1996, the Company purchased all of the issued and
outstanding shares of capital stock (the "Logicraft Stock") of Logicraft
Information Systems, Inc., a Delaware corporation ("Logicraft"). The
consideration for the acquisition of all of the Logicraft stock was
$12,517,000 in
45
<PAGE>
cash. Additionally, Microtest assumed $4,483,000 in debt that Logicraft
owed to Information Handling Services, Inc. ("IHS"), the previous majority
owner of Logicraft. Immediately following the closing, this debt was
repaid. Logicraft develops and sells CD-ROM networking products and
technologies. The acquisition was accounted for using the purchase method
of accounting, and accordingly, the purchase price has been allocated to
the assets purchased and the liabilities assumed based upon their fair
values at the date of acquisition. As a result of the allocation of the
purchase price, the Company recorded an expense of $15,697,000 in the
fourth quarter of 1996 to record the value of software research it
acquired relating to products for which technological feasibility has not
been established and for which no alternative future use existed.
The Company is still in the process of evaluating the fair value of the
assets of Logicraft and may adjust the allocation of the purchase price in
1997.
On June 6, 1995, the Company acquired all of the outstanding capital stock
of Optical Media International ("OMI"), a California corporation, for cash
of $4,000,000 and assumption of OMI-related debt of $660,000. OMI
specializes in CD-ROM and CD-Recordable technology. The acquisition was
accounted for using the purchase method of accounting, and accordingly,
the purchase price has been allocated to the assets purchased and the
liabilities assumed based upon the fair values at the date of acquisition.
As a result of the allocation of the purchase price, the Company recorded
an expense of $8,326,000 and related tax benefit of $3,210,000 in the
second quarter of 1995 to record the value of software research it
acquired relating to products for which technological feasibility has not
been established and for which no alternative future use existed.
The accompanying consolidated statements of operations reflect the
operating results of Logicraft and OMI since the effective dates of the
acquisitions. Pro forma unaudited consolidated operating results of the
Company, OMI and Logicraft for the years ended December 31, 1995 and 1996,
assuming the acquisitions had been made as of January 1, 1995, are
summarized below:
Year Ended
December 31, 1995 December 31, 1996
(In Thousands, Except
Per Share Amounts)
Net revenues $ 67,796 $ 64,747
======== ========
Net (loss) $ (1,445) $ 171
======== ========
Net (loss) per common share $ (.$6) $ .02
======== ========
These pro forma results have been prepared for comparative purposes only
and include certain adjustments such as the decrease in interest income
imputed on the consideration for the acquisitions, the decrease in
amortization expense as a result of applying the purchase method of
accounting for the acquisitions and the increase in amortization expense
associated with the capitalization of certain acquisition costs. The pro
forma results exclude the expenses related to the purchase of in-process R
& D in 1995 and 1996. The pro forma financial information is not
necessarily indicative of the results of operations as they would have
been had the transactions been affected on the assumed dates.
46
<PAGE>
6. COMMITMENTS AND CONTINGENCIES
Future minimum rental payments due under the Company's office operating
leases are as follows:
(Amounts in
Thousands)
1997 $ 742
1998 241
1999 232
2000 206
2001 148
2002 12
------
Total minimum rental payments $1,581
======
Rent expense for 1994, 1995 and 1996 was approximately $673,000, $691,000
and $982,000, respectively.
In September and October 1996, two purported class action lawsuits were
filed against the Company in the Maricopa County Superior Court for the
State of Arizona. The suits allege, among other things, that certain
statements made by the Company and its representatives, as well as the
financial statements contained in the Company's Quarterly Reports on Form
10-Q filed during 1995, were false and misleading. The Company believes
that the shareholder lawsuits are without merit and it intends to
vigorously defend against them. The Company expects that the ultimate
resolution of the lawsuits will not have a material effect on the
Company's financial position and the results of operations taken as a
whole.
The Company is involved in certain legal matters, the outcome of which is
currently unknown. Management believes that the Company's liability, if
any, will not have a material adverse effect on the Company's financial
condition and results of operations.
The Company utilizes contract manufacturing for virtually all of its
product requirements. Under these agreements, the Company is obligated to
purchase in the ordinary course of business products manufactured under
these contracts at contract prices. Some contracts require the Company to
purchase all inventory and components in the event of contract
cancellation.
7. EMPLOYEE BENEFIT PLANS
Stock Plans - The Company currently has five fixed stock option plans: the
1989 Incentive Stock Option Plan ("1989 Incentive Plan"), the 1989
Non-Qualified Stock Option Plan ("1989 Non-Qualified Plan"), the 1995
Long-Term Incentive Plan ("LTIP"), the 1993 Non-Employee Directors Plan
("1993 Directors Plan"), and the 1993 Annual Non-Employee Directors Plan
("1993 Annual Plan"). The 1989 Incentive Plan permitted the granting of
options to employees and the 1989 Non-Qualified Plan permitted the
granting of options to employees, directors, and consultants to purchase
the Company's common stock at not less than the fair market value on the
date of grant. Both of these plans were canceled upon adoption of the LTIP
on May 10, 1995, although grants outstanding at the time of cancellation
were not affected. The LTIP permits the granting of
47
<PAGE>
incentive stock options, non-qualified stock options and other stock-based
awards to employees, officers, and consultants to purchase the Company's
common. The Company is authorized to grant options to acquire up to
600,000 shares under the LTIP. The period during which options granted
under the above plans are exercisable is fixed by the Board of Director at
the date of grant but is not to exceed ten years. The 1993 Directors Plan
permits the one-time grant of 10,000 options to purchase the Company's
common stock and the 1993 Annual Plan permits the annual grant of 5,000
options to purchase the Company's common stock to each non-employee
director at not less than the fair market value on the date of grant.
Under the two directors plans, the Company is authorized to grant options
to acquire up to 200,000 shares. Vesting of options granted under these
two plans is defined by the plan with a term not to exceed five years.
A summary of the status of the Company's five fixed stock options plans as
of December 31, 1994, 1995, 1996, and changes during the years ending on
those dates is presented below:
<TABLE>
<CAPTION>
1994 1995 1996
---------------------- ----------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 1,103,938 $4.79 1,135,821 $7.61 1,432,304 $12.43
Granted 462,850 $11.17 653,330 $18.23 589,148 $8.86
Exercised (327,128) $3.44 (288,862) $6.39 (26,567) $4.74
Cancelled (103,839) $5.26 (67,985) $11.60 (621,609) $17.06
----------------------- ------------------------ -----------------------
Outstanding at end
of year 1,135,821 $7.61 1,432,304 $12.43 1,373,276 $9.00
======================= ======================== =======================
Options exercisable at
end of year 313,547 415,939 622,289
============= ============= =============
Weighted average fair
value of options granted
during the year $ 9.74 $ 4.20
=========== ==========
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------ -----------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
Range of as of Contractual Exercise as of Exercise
Exercise Prices 12/31/96 Life (in yrs) Price 12/31/96 Price
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$3.80-$5.50 330,250 6.61 $5.13 281,421 $5.11
$6.25-$9.00 368,465 8.37 $7.82 165,751 $7.73
$9.50-$13.25 549,132 8.67 $9.93 117,154 $10.24
$14.63-$20.25 114,929 5.49 $18.21 52,863 $18.78
$23.50-$24.25 10,500 3.34 $23.54 5,100 $23.52
=========================================================================
$3.80-$24.25 1,373,276 7.78 $9.00 622,289 $8.09
=========================================================================
</TABLE>
48
<PAGE>
On May 18, 1992, the Company adopted an Employee Stock Purchase Plan (the
"Purchase Plan"). A total of 200,000 shares of common stock is reserved
for issuance under the Purchase Plan. The Purchase Plan permits eligible
employees to purchase common stock through payroll deductions, which may
not exceed 10% of an employee's compensation, at 85% of the lower of the
fair market value of the common stock at the beginning or at the end of
each offering period, as defined. The weighted-average fair value of those
purchase rights granted in 1995 and 1996 was $3.89 and $8.29. Transactions
related to the plan are summarized as follows:
Weighted Average
Shares Purchase Price
-------- --------------
Available at December 31, 1993 192,936
Purchases (29,978) $ 6.13
--------
Available at December 31, 1994 162,958
Purchases (16,080) $ 15.16
--------
Available at December 31, 1995 146,878
Purchases (20,499) $ 9.04
--------
Available at December 31, 1996 126,379
========
The Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its stock option and purchase plans.
Accordingly, no compensation cost has been recognized for its fixed stock
options plans and its stock purchase plan. Had compensation cost for the
Company's stock option plans and its stock purchase plan been determined
based on the fair value at the grant dates for awards under those plans
consistent with the method of SFAS No. 123, the Company's net income/(loss)
and earnings/(loss) per share for the years ended December 31, 1995 and
1996 would have been reduced to the pro forma amounts indicated below:
December 31, 1995 December 31, 1996
----------------- -----------------
Net income/(loss)
As reported (in '000s) $ 1,145 ($ 11,595)
Pro forma (in '000s) ($ 729) ($ 13,577)
Net income/(loss) per common and
equivalent share
As reported $ 0.13 ($ 1.43)
Pro forma ($ 0.09) ($ 1.69)
The fair value of options granted under the Company's fixed stock option
plans during 1995 and 1996 were estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-averaged
assumptions used:
49
<PAGE>
1995 1996
------- -------
Expected volatility 75.00% 75.00%
Expected term 4 years 4 years
Dividend yield 0.00% 0.00%
Risk-free interest rate 6.90% 5.45%
The fair value of purchase rights granted under the Employee Stock Purchase
Plan is measured using the Black-Scholes option-pricing model with the
following weighted-averaged assumptions used:
1995 1996
------- -------
Expected volatility 75.00% 75.00%
Expected term 1 year 1 year
Dividend yield 0.00% 0.00%
Risk-free interest rate 6.38% 5.12%
401(k) Plan - Under the Company's 401(k) Plan, full-time employees may
contribute to the Plan between 1% and 15% of their total covered
compensation, in lieu of receiving such amounts as taxable salary or
wages. The Company may, in its discretion, make matching contributions
equal to a percentage of an employee's covered compensation contributed to
the 401(k) Plan for the year, or in a fixed dollar amount, as determined
each year by the Board of Directors. The Company's contribution to the
Plan was approximately $78,000, $137,000 and $117,000 during 1994, 1995
and 1996, respectively.
8. EXPORT SALES
Export sales, primarily to customers in Europe, were approximately
$13,400,000, $19,080,000 and $14,783,000 in 1994, 1995 and 1996,
respectively.
9. OTHER
Major customers accounting for more than 10% of total revenues in any
given year are summarized below. Percentage of revenue amounts are not
presented if less than 10% in any year.
Customer 1994 1995 1996
A 19% 21%
B 15% 11%
C 14% 15% 18%
Sales and marketing expenses included advertising expense of approximately
$1,270,000, $1,909,000 and $2,056,000 in 1994, 1995 and 1996,
respectively.
Accrued liabilities include accrued acquisition expenses of $1,093,000 at
December 31, 1996.
50
<PAGE>
10. UNAUDITED QUARTERLY FINANCIAL INFORMATION
1995 Quarters
--------------------------------------------
First Second Third Fourth
(In Thousands, Except Per Share Amounts)
Total revenues $ 12,643 $ 14,014 $ 15,154 $ 10,726
Cost of sales and services 4,762 5,526 6,408 5,265
Gross profit 7,881 8,488 8,746 5,461
Net income/(loss) 1,876 (3,030) 1,840 459
Net income/(loss) per common and
equivalent share $ .22 $ (.37) $ .22 $ .06
1996 Quarters
--------------------------------------------
First Second Third Fourth
(In Thousands, Except Per Share Amounts)
Total revenues $ 11,960 $ 12,666 $ 12,136 $ 13,680
Cost of sales and services 5,001 5,501 4,853 5,097
Gross profit 6,959 7,165 7,283 8,583
Net income/ (loss) 707 982 991 (14,275)
Net income/(loss) per common and
equivalent share $ .09 $ .12 $ .12 $ (1.75)
Net charges relating to the acquisition of R&D were $5,116,000, $.63 per
common and equivalent share, in the second quarter of 1995 and $270,000,
$.03 per common and equivalent share, in the third quarter of 1995.
Charges relating to the acquisition of R & D were $15,697,000, $1.92 per
common and equivalent share, in the fourth quarter of 1996.
Quarterly results for 1996 vary from the previously published results due
to changes to recording sales under the Company's direct end user sales
program during the second, third and fourth quarters of 1996. Previously
published Quarterly Reports on Form 10-Q were changed by reducing second
quarter total revenues, cost of sales and services, gross profit, net
income and net income per common and equivalent share by $654,000,
$163,000, $491,000, $334,000 and $.04, respectively and third quarter
total revenues, costs of sales and services, gross profit, net income and
net income per common and equivalent share by $871,000, $218,000,
$653,000, $444,000 and $0.5, respectively. As a result of changes to
second and third quarter, fourth quarter total revenues, cost of sales and
services, gross profit, and net income were increased by $1,525,000,
$381,000, $1,144,000 and $778,000, respectively, which reduced the loss by
$.10 per share.
The sum of quarterly earnings per share information may not agree to the
annual amount due to the use of the treasury stock method.
For interim reporting purposes, the Company ends its quarters on the
Saturday closest to the calendar quarter end with the fourth quarter
ending on December 31.
* * * * * *
51
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
----------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
The Company has never filed a Current Report on Form 8-K to report a
change in accountants because of a disagreement over accounting principles or
procedures, financial statement disclosure or otherwise.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
------------------------------------------------
Information concerning continuing directors, nominees and executive
officers of the Company is set forth under the caption "Information Concerning
Directors, Nominees and Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Registrant's Proxy Statement relating to its 1997
Annual Meeting of Stockholders to be held on July 23, 1997, which is
incorporated by reference into this Form 10-K Report. With the exception of the
foregoing information and other information specifically incorporated by
reference into this Form 10-K Report, the Proxy Statement is not being filed as
a part hereof.
ITEM 11. EXECUTIVE COMPENSATION.
-----------------------
Information responsive to this Item 11 is incorporated by reference to
the caption "Executive Compensation", "Employment Agreements" and "Change of
Control Arrangements" in the Proxy Statement; provided, however, that the
"Compensation Committee Report on Executive Compensation" and the "Stock Price
Performance Graph" contained in the Proxy Statement are not incorporated by
reference herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
Information concerning the common stock beneficially owned by each
director of the Company, by all officers and directors of the Company as a group
and by each shareholder known by the Company to be the beneficial owner of more
than 5% of the outstanding common stock is incorporated herein by reference to
"Security Ownership of Certain Beneficial Owners and Management" from the Proxy
Statement.
52
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
-----------------------------------------------
Information responsive to this Item 13 is incorporated herein by
reference to "Certain Transactions and Relationships" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
-------------------------------------------------------------------
(a) Financial Statements and Schedules.
----------------------------------- Page or
Method of Filing
----------------
(i) Financial Statements.
(1) Independent Auditors' Report................................ Page 37
(2) Consolidated Financial Statements:
Balance Sheets - December 31, 1995 and 1996................ Page 38
Statements of Operations - For the Years Ended December 31,
1994, 1995 and 1996........................................ Page 39
Statements of Stockholders' Equity - For the Years Ended
December 31, 1994, 1995 and 1996........................... Page 40
Statements of Cash Flows - For the Years Ended December 31,
1994, 1995 and 1996........................................ Page 41
Notes to Consolidated Financial Statements - December 31,
1994, 1995 and 1996........................................ Page 42
(ii) Financial Statements Schedules.
Schedules have been omitted because of the absence of
conditions under which they are required or because the
required material information is included in the Consolidated
Financial Statements or Notes to the Consolidated Financial
Statements included herein.
(b) Reports on Form 8-K.
On December 30, 1996, the Company filed a Current Report on
Form 8-K dated December 17, 1996, disclosing its acquisition
of Logicraft Information Systems, Inc. The required financial
statements relating to the acquisition were filed on March 3,
1997.
53
<PAGE>
(c) Exhibits.
---------
<TABLE>
<CAPTION>
Exhibit
Number Description Method of Filing
<S> <C> <C>
3.1 Amended and Restated Certificate of Incorporation of the Company, Incorporated by reference
dated May 19, 1992 to Exhibit 3.1 to Form S-1
Registration Statement
#33-52264 ("Form S-1
#33-52264")
3.2 Bylaws of the Company Incorporated by reference
to Exhibit 3.2 to Form S-1
#33-52264
10.1 Lease Agreement between Camelback Associates II Limited Partnership Incorporated by reference
and the Company dated June 19, 1992, relating to Company's to Exhibit 10.5 to Form S-1
principal offices and facilities #33-52264
10.2 Incentive Stock Option Plan Incorporated by reference
to Exhibit 10.7 of
Amendment No. 1 to Form S-1
#33-52264
10.3 Non-Qualified Stock Option Plan Incorporated by reference
to Exhibit 10.8 of
Amendment No. 1 to Form S-1
#33-52264
10.4 Employee Stock Purchase Plan Incorporated by reference
to Exhibit 10.9 of
Amendment No. 1 to Form S-1
#33-52264
</TABLE>
54
<PAGE>
<TABLE>
<S> <C> <C>
10.5 401(k) Retirement Savings Plan Incorporated by reference
to Exhibit 10.12 to Form
S-1 #33-52264
10.6 Non-Employee Directors Stock Option Plan Incorporated by reference
to Exhibit 4 to Form
S-8 #33-67948
10.7 Annual Non-Employee Directors Stock Option Plan Incorporated by reference
to Exhibit 4 to Form
S-8 #33-79070
10.8 Form of Indemnity agreement between directors and certain officers Incorporated by reference
of the Company and the Company to Exhibit 10.18 to Form
S-1 #33-52264
10.9 Agreement of Purchase and Sale of Stock between Optical Media Incorporated by reference
International and the Company dated June 6, 1995 to Exhibit 2 of Form 8-K
Report dated June 6, 1995
10.10 1994 Profit Sharing Plan Incorporated by reference
to Exhibit 10.15 of Form
10-K Report dated December
31, 1993
10.11 Long-Term Incentive Plan Incorporated by reference
to Exhibit 10.16 of Form
10-K Report dated December
31, 1994
10.12 Deferred Compensation Plan Incorporated by reference
to Exhibit 10.17 of Form
10-K Report dated December
31, 1994
</TABLE>
55
<PAGE>
<TABLE>
<S> <C> <C>
10.13 Agreement of Purchase and Sale of Stock between Logicraft Incorporated by reference
Information Systems, Inc. and the Company dated December 17, 1996 to Exhibit 2 of Current
Report on Form 8-K dated
December 17, 1996
11 Statement Regarding Computation of Per Share Earnings Filed herewith
21 Subsidiaries of the Registrant Filed herewith
23 Consent of Deloitte & Touche LLP Filed herewith
24.1 Power of Attorney of Dianne C. Walker Filed herewith
24.2 Power of Attorney of Roger C. Ferguson Filed herewith
24.3 Power of Attorney of Steven G. Mihaylo Filed herewith
24.4 Power of Attorney of William C. Turner Filed herewith
</TABLE>
56
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized, this 31st
day of March, 1997.
MICROTEST, INC.
By:/s/Richard G. Meise
-------------------------------------
Richard G. Meise
President & Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report on Form 10-K has been signed below by the following persons on
behalf of the Company and in the capacities and on the date indicated.
<TABLE>
<CAPTION>
Name and Signature Title Date
- ------------------ ----- ----
<S> <C> <C>
/s/ Richard G. Meise Chief Executive Officer, President & Chairman of March 31, 1997
- ------------------------
Richard G. Meise the Board (Principal Executive Officer)
Roger C. Ferguson
/s/ Richard R. Douglas V.P. & Chief Financial Officer (Principal March 31, 1997
- ------------------------ Financial and Accounting Officer)
Richard R. Douglas
* Director March 31, 1997
- --------------------------
Roger C. Ferguson
* Director March 31, 1997
- --------------------------
Steven G. Mihaylo
* Director March 31, 1997
- --------------------------
William C. Turner
* Director March 31, 1997
- --------------------------
Dianne C. Walker
* By /s/ Richard G. Meise March 31, 1997
---------------------
Richard G. Meise
Attorney-in-Fact
</TABLE>
57
<PAGE>
MICROTEST, INC.
EXHIBIT 11
STATEMENT OF COMPUTATION OF COMMON
AND COMMON EQUIVALENT SHARES
(In Thousands, Except Per Share Amounts)
Year ended December 31,
---------------------------------
1994 1995 1996
---- ---- ----
Net income/(loss) $ 5,290 $ 1,145 $(11,595)
======== ======== ========
Common shares outstanding at end of period 7,955 8,095 8,131
Adjustment to reflect weighted average for
shares issued during period (229) (22) (27)
Adjustments for options and warrants calculated
under the treasury stock method:
Options 512 461 --
Warrants 31 -- --
-------- -------- --------
Common and equivalent shares outstanding 8,269 8,534 8,104
======== ======== ========
Net income/(loss) per share $ 0.64 $ 0.13 $ (1.43)
======== ======== ========
58
MICROTEST, INC.
SUBSIDIARIES OF THE REGISTRANT
Name of Subsidiary Jurisdiction of Incorporation
- ------------------ -----------------------------
Logicraft Information Systems, Inc. Delaware
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements Nos.
33-53922, 33-53924, 33-53926, 33-67946, 33-67948, 33-68120, 33-79070, and
33-81668 of Microtest, Inc. on Forms S-8 of our report dated March 27, 1997,
appearing in this Annual Report on Form 10-K of Microtest, Inc. for the year
ended December 31, 1996.
DELOITTE & TOUCHE LLP
Phoenix, Arizona
March 31, 1997
60
SPECIAL POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and
appoints Richard G. Meise and Richard R. Douglas, and each of them, her true and
lawful attorney-in-fact and agent with full power of substitution and
resubstitution, for her and in her name, place and stead, in any and all
capacities, to sign the Annual Report on Form 10-K for the fiscal year ended
December 31, 1996, for filing with the Securities and Exchange Commission by
Microtest, Inc., a Delaware corporation, together with any and all amendments to
such Form 10-K, and to file the same with all exhibits thereto, and all
documents in connection therewith, with the Securities and Exchange Commission,
granting to such attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully and to all intents and purposes
as he might or could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents, or each of them, may lawfully do or cause to be
done by virtue hereof.
DATED: March 27, 1997
/s/ Dianne C. Walker
---------------------
Dianne C. Walker
STATE OF ARIZONA )
) ss.
County of Maricopa )
On this 27th day of March, 1997, before me, the undersigned Notary
Public, personally appeared Dianne C. Walker, known to me to be the person whose
name is subscribed to the within instrument and acknowledged that she executed
the same for the purposes therein contained.
IN WITNESS WHEREOF, I hereunto set my hand and official seal.
/s/ Betty Peterson
-------------------
Notary Public
My commission expires 7-31-97
SPECIAL POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and
appoints Richard G. Meise and Richard R. Douglas, and each of them, his true and
lawful attorney-in-fact and agent with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign the Annual Report on Form 10-K for the fiscal year ended
December 31, 1996, for filing with the Securities and Exchange Commission by
Microtest, Inc., a Delaware corporation, together with any and all amendments to
such Form 10-K, and to file the same with all exhibits thereto, and all
documents in connection therewith, with the Securities and Exchange Commission,
granting to such attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully and to all intents and purposes
as he might or could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents, or each of them, may lawfully do or cause to be
done by virtue hereof.
DATED: March 3, 1997
/s/ Roger C. Ferguson
----------------------
Roger C. Ferguson
STATE OF ARIZONA )
) ss.
County of Maricopa )
On this 3rd day of March, 1997, before me, the undersigned Notary
Public, personally appeared Roger C. Ferguson, known to me to be the person
whose name is subscribed to the within instrument and acknowledged that he
executed the same for the purposes therein contained.
IN WITNESS WHEREOF, I hereunto set my hand and official seal.
/s/ Betty Peterson
-------------------
Notary Public
My commission expires 7-31-97
SPECIAL POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and
appoints Richard G. Meise and Richard R. Douglas, and each of them, his true and
lawful attorney-in-fact and agent with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign the Annual Report on Form 10-K for the fiscal year ended
December 31, 1996, for filing with the Securities and Exchange Commission by
Microtest, Inc., a Delaware corporation, together with any and all amendments to
such Form 10-K, and to file the same with all exhibits thereto, and all
documents in connection therewith, with the Securities and Exchange Commission,
granting to such attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully and to all intents and purposes
as he might or could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents, or each of them, may lawfully do or cause to be
done by virtue hereof.
DATED: February 25, 1997
/s/ Steven G. Mihaylo
----------------------
Steven G. Mihaylo
STATE OF ARIZONA )
) ss.
County of Maricopa )
On this 25th day of February, 1997, before me, the undersigned Notary
Public, personally appeared Steven G. Mihaylo, known to me to be the person
whose name is subscribed to the within instrument and acknowledged that he
executed the same for the purposes therein contained.
IN WITNESS WHEREOF, I hereunto set my hand and official seal.
/s/ Lonnie Barrett
-------------------
Notary Public
My commission expires 11-18-97
SPECIAL POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and
appoints Richard G. Meise and Richard R. Douglas, and each of them, his true and
lawful attorney-in-fact and agent with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign the Annual Report on Form 10-K for the fiscal year ended
December 31, 1996, for filing with the Securities and Exchange Commission by
Microtest, Inc., a Delaware corporation, together with any and all amendments to
such Form 10-K, and to file the same with all exhibits thereto, and all
documents in connection therewith, with the Securities and Exchange Commission,
granting to such attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully and to all intents and purposes
as he might or could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents, or each of them, may lawfully do or cause to be
done by virtue hereof.
DATED: February 22, 1997
/s/ William C. Turner
----------------------
William C. Turner
STATE OF ARIZONA )
) ss.
County of Maricopa )
On this 22nd day of February, 1997, before me, the undersigned Notary
Public, personally appeared William C. Turner, known to me to be the person
whose name is subscribed to the within instrument and acknowledged that he
executed the same for the purposes therein contained.
IN WITNESS WHEREOF, I hereunto set my hand and official seal.
/s/ LaVonne L. Lindall
-----------------------
Notary Public
My commission expires 6-5-98
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial
information extracted from the Consolidated
Balance Sheets as of December 31, 1996 and the
Consolidated Statements of Income for the year
ended December 31, 1996 contained in the Form 10-K
for the year ended December 31, 1996, and is
qualified in its entirety by reference to such
financial statements
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 10,282
<SECURITIES> 0
<RECEIVABLES> 21,156
<ALLOWANCES> (3,612)
<INVENTORY> 6,163
<CURRENT-ASSETS> 38,224
<PP&E> 8,585
<DEPRECIATION> (4,943)
<TOTAL-ASSETS> 43,313
<CURRENT-LIABILITIES> 11,641
<BONDS> 0
0
0
<COMMON> 8
<OTHER-SE> 31,664
<TOTAL-LIABILITY-AND-EQUITY> 43,313
<SALES> 50,442
<TOTAL-REVENUES> 50,442
<CGS> 20,452
<TOTAL-COSTS> 20,452
<OTHER-EXPENSES> 40,636
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 762
<INCOME-PRETAX> (9,884)
<INCOME-TAX> 1,711
<INCOME-CONTINUING> (11,595)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,595)
<EPS-PRIMARY> (1.43)
<EPS-DILUTED> (1.43)
</TABLE>
