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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549-1004
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FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 25, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER 0 - 20666
MICROTEST, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 86-0485884
- ------------------------------- ------------------------------------
(State or other jurisdiction of (IRS employer identification number)
incorporation)
4747 NORTH 22ND STREET
PHOENIX, ARIZONA 85016
(602) 952-6400
---------------------------------------------------
(Address, including zip code, and telephone number,
including area code, of registrant's
principal executive offices)
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 the
filing requirements for at least the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date (November 5, 1999).
Common stock, $.001 par value: 8,311,895 shares
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<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets-
September 25, 1999 and December 31, 1998 3
Consolidated Statements of Operations-
Three Months and Nine Months Ended
September 25, 1999 and September 26, 1998
(as restated) 4
Consolidated Statements of Cash Flows-
Nine Months Ended September 25, 1999 and
September 26, 1998 (as restated) 5
Notes to Consolidated Financial Statements 6-9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10-14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 16
2
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
September 25, December 31,
1999 1998
-------- --------
ASSETS (unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 6,468 $ 9,618
Restricted investments 603 1,124
Receivables:
Trade accounts, net of allowances of $1,137
and $2,029 8,660 8,171
Income taxes 2,969 2,897
Inventories 4,113 6,572
Prepaid expenses 693 1,148
Deferred income taxes 1,580 1,556
-------- --------
Total current assets 25,086 31,086
-------- --------
PROPERTY AND EQUIPMENT: 10,736 10,476
Less accumulated depreciation (8,329) (7,375)
-------- --------
Net property and equipment 2,407 3,101
-------- --------
OTHER ASSETS:
Capitalized software, net 1,457 1,894
Deferred income taxes 1,519 1,519
Other 1,332 1,750
-------- --------
Total other assets 4,308 5,163
-------- --------
$ 31,801 $ 39,350
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,939 $ 4,152
Accrued liabilities 2,606 2,922
Accrued payroll and employee benefits 1,159 860
Accrued deferred compensation 603 1,124
-------- --------
Total current liablilities 6,307 9,058
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, $.001 par value. Authorized
15,000,000 shares; issued 8,311,895 shares
as of September 25, 1999 and 8,253,585 as
of December 31, 1998 8 8
Additional paid-in capital 33,042 32,916
Accumulated deficit (6,338) (1,414)
Less treasury stock, at cost, 232,520 shares (1,218) (1,218)
-------- --------
Total stockholders' equity 25,494 30,292
-------- --------
$ 31,801 $ 39,350
======== ========
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
(as restated) (as restated)
September 25, September 26, September 25, September 26,
1999 1998 1999 1998
-------- -------- -------- --------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
NET REVENUE $ 11,297 $ 10,111 $ 29,893 $ 30,572
COST OF REVENUE 5,146 4,156 13,736 12,395
Special charge for write-down of
discontinued product inventories -- -- 803 --
-------- -------- -------- --------
Gross profit 6,151 5,955 15,354 18,177
-------- -------- -------- --------
OPERATING EXPENSES:
Sales and marketing 2,985 2,571 9,233 8,928
Research and development 1,726 1,800 5,506 5,467
General and administrative 1,220 1,404 4,282 3,970
Special charge (credit) (230) -- 1,276 --
-------- -------- -------- --------
Total operating expenses 5,701 5,775 20,297 18,365
-------- -------- -------- --------
INCOME (LOSS) FROM OPERATIONS 450 180 (4,943) (188)
Other income, net 73 81 136 258
-------- -------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES 523 261 (4,807) 70
INCOME TAXES (BENEFIT) -- (72) -- (111)
-------- -------- -------- --------
Income (loss) before cumulative effect of a change
in an accounting principle 523 333 (4,807) 181
CUMULATIVE EFFECT OF A CHANGE IN AN
ACCOUNTING PRINCIPLE, NET OF RELATED TAXES -- -- (117) --
-------- -------- -------- --------
NET INCOME (LOSS) $ 523 $ 333 $ (4,924) $ 181
======== ======== ======== ========
BASIC AND DILUTED INCOME (LOSS) PER SHARE:
Income (loss) before change in an accounting principle $ .06 $ .04 $ (.60) $ .02
Cumulative effect of a change in an accounting principle -- -- (.01) --
-------- -------- -------- --------
Net income (loss) $ .06 $ .04 $ (.61) $ .02
======== ======== ======== ========
Weighted average common and common
equivalent shares outstanding 8,123 8,068 8,062 8,132
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
----------------------------
September 25, September 26,
1999 1998
------- --------
CASH FLOW FROM OPERATING ACTIVITIES: (unaudited)
<S> <C> <C>
Net income (loss) (4,924) 181
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 1,834 897
Loss on disposition of equipment 142 --
Change in accounts receivable allowances (892) (428)
Decrease in accounts receivable 403 3,365
Increase in income tax receivable (72) (106)
(Increase) decrease in inventories 2,459 (206)
(Increase) decrease in prepaid expenses and other assets 873 (134)
Increase in deferred income taxes (24) --
Decrease in accounts payable (2,213) (589)
Decrease in accrued liabilities (316) (1,354)
Increase in accrued payroll and employee benefits 299 147
------- --------
Net cash provided by (used in) operating activities (2,431) 1,773
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (651) (678)
Capitalized software (194) (771)
------- --------
Net cash used in investing activities (845) (1,449)
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (purchase of) common and treasury stock 126 (897)
------- --------
Net cash provided by (used in) financing activities 126 (897)
------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (3,150) (573)
CASH AND CASH EQUIVALENTS, beginning of period 9,618 11,547
------- --------
CASH AND CASH EQUIVALENTS, end of period $ 6,468 $ 10,974
======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) BASIS OF PRESENTATION:
The accompanying consolidated financial statements include the accounts of
Microtest, Inc. (the "Company") and its wholly owned subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation.
The accompanying unaudited consolidated financial statements have been
prepared by the Company. The financial statements have been prepared in
accordance with generally accepted accounting principles, pursuant to the rules
and regulations of the Securities and Exchange Commission. In the opinion of
management, the accompanying financial statements include all adjustments (of a
normal recurring nature) which are necessary for a fair presentation of the
results for the interim periods presented. Certain information and footnote
disclosures normally included in financial statements have been condensed or
omitted pursuant to such rules and regulations. Although the Company believes
that the disclosures are adequate to make the information presented not
misleading, it is suggested that these financial statements be read in
conjunction with the consolidated financial statements and the notes thereto
included in the Company's 1998 Annual Report to Shareholders and report on Form
10-K. The results of operations for the three months and nine months ended
September 25, 1999 are not necessarily indicative of the results to be expected
for the full year.
(2) INVENTORIES:
Inventories consist of the following (in thousands):
September 25, December 31,
1999 1998
------------- ------------
(unaudited)
Raw materials $ 1,035 $ 1,946
Work-in-process 81 100
Finished goods 3,575 5,200
------- -------
4,691 7,246
Less allowance for inventory valuation (578) (674)
------- -------
$ 4,113 $ 6,572
======= =======
6
<PAGE>
(3) BASIC AND DILUTED INCOME (LOSS) PER SHARE:
The following table sets forth the computation of basic and diluted net
income (loss) per share:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------------- ----------------------------
(as restated) (as restated)
September 25, September 26, September 25, September 26,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net income (loss) $ 523 $ 333 $(4,924) $ 181
====== ====== ======= ======
Weighted average common shares
outstanding 8,078 8,068 8,062 8,132
Dilutive effect of stock options 45 -- -- --
------ ------ ------- ------
Weighted average common and common
equivalent shares outstanding 8,123 8,068 8,062 8,132
====== ====== ======= ======
Basic and diluted net income (loss)
per share $ .06 $ .04 $ (.61) $ .02
====== ====== ======= ======
</TABLE>
(4) SPECIAL CHARGE (CREDIT):
During the quarter ended September 25, 1999, the Company recorded a
$230,000 special credit as part of its exit from the integrated high-end
enterprise systems business. The credit relates to the sale of the Company's
active enterprise maintenance contracts and its enterprise customer database.
For the nine months ended September 25, 1999, the Company recorded net special
charges of $2.1 million relating to its exit from the enterprise systems
business and to restructure its management organization. The pre-tax special
charge primarily consists of $1.5 million in employee severance and benefits,
future lease payments, the write-off of fixed assets and capitalized software,
and an increase in the allowance for evaluation units. The charge also includes
$803,000 for the write-down of discontinued product inventories that is included
as a component of cost of revenue.
(5) SEGMENTS:
For organizational, marketing and financial reporting purposes, the Company
has organized into two reportable business segments: (1) Network Test and
Measurement ("NTM" formerly referred to as NMP), and (2) Network Attached
Storage ("NAS" formerly referred to as NCP).
The NTM business segment consists of products that are used by service
providers and system integrators to perform critical cabling certification and
network diagnostics. The NTM line consists of cable certification tools such as
OMNIScanner, PentaScanner, CertiFiber, and network trouble shooting tools such
as MICROSCANNER and COMPAS.
The NAS business segment consists of products that address challenges
associated with managing network devices and sharing large amounts of
information within workgroups. Network administrators, librarians and
information resource professionals in organizations such as law firms,
educational institutions, libraries and research facilities are some of the
target markets for the Company's NAS product line. The NAS line consists
primarily of thin server products marketed under the name Zerver.
7
<PAGE>
In the second quarter the Company announced the discontinuation of its
operations in the high-end CD-ROM enterprise system business. Exiting the
enterprise business, included as a part of the NAS business segment, allows the
Company to focus the Network Attached Storage Division exclusively on entry
level NAS thin server appliances for the workgroup and remote office market.
The Company currently does not measure assets or operating expenses
separately for the NTM and NAS business segments. Information related to the
operations of the Company in different business segments for the third quarter
and nine months ended September 25, 1999 and September 26, 1998 is set forth
below:
Quarter Ended Nine Months Ended
-------------------------- -----------------------------
NAS NTM Total NAS NTM Total
--- --- ----- --- --- -----
Net revenue: 1999 $ 2,790 $ 8,507 $ 11,297 $ 9,908 $ 19,985 $ 29,893
1998 3,063 7,048 10,111 10,295 20,277 30,572
Gross profit: 1999 1,472 4,679 6,151 4,188 11,166 15,354
1998 2,060 3,895 5,955 6,350 11,827 18,177
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
---------------------------- ----------------------------
(as restated) (as restated)
September 25, September 26, September 25, September 26,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Gross profit for reportable segments $ 6,151 $ 5,955 $ 15,354 $ 18,177
Unallocated amounts:
Operating expenses (5,701) (5,775) (20,297) (18,365)
Interest income, net 73 81 136 258
------- ------- -------- --------
Income (loss) before taxes $ 523 $ 261 $ (4,807) $ 70
======= ======= ======== ========
</TABLE>
(6) MAJOR CUSTOMERS:
Major customers accounting for more than 10% of total revenues for the
quarter and nine months ended September 25, 1999 and September 26, 1998, are
summarized below. Percentage of revenue amount is not presented if less than
10%.
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
---------------------------- ----------------------------
September 25, September 26, September 25, September 26,
Customer 1999 1998 1999 1998
- -------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Tech Data Corporation -- -- -- 11%
Anixter 10% 12% -- 10%
Ingram Micro, Inc. -- 13% -- 12%
Graybar Electric Company, Inc. 16% -- 13% --
</TABLE>
8
<PAGE>
(7) DOMESTIC AND INTERNATIONAL OPERATIONS:
The Company markets its products domestically and internationally through
its own direct sales organization and through a multiple channel, worldwide
distribution network. A summary of domestic and international net revenues to
unaffiliated customers for the quarter and nine months ended September 25, 1999
and September 26, 1998, follows:
Quarter Ended Nine Months Ended
--------------------- ---------------------
(as restated) (as restated)
Sept. 25, Sept. 26, Sept. 25, Sept. 26,
1999 1998 1999 1998
------- ------- ------- -------
Domestic $ 7,518 $ 7,182 $18,394 $21,094
International 3,779 2,929 11,499 9,478
------- ------- ------- -------
Net revenues $11,297 $10,111 $29,893 $30,572
======= ======= ======= =======
(8) RESTATEMENT:
The following table presents the Company's selected unaudited quarterly
operating results for the third quarter and nine months ended September 26, 1998
as originally reported, and as restated. The Company restated its quarterly
results for the first three quarters of 1998 to correct errors identified during
the 1998 year-end audit. The errors were primarily attributable to system
changes and turnover in the finance department that occurred during the first
half of 1998. The corrections related primarily to various adjustments
correcting the provision for sales returns, correcting software capitalization
and amortization, and intercompany account transactions.
Quarter Ended Nine Months Ended
------------------------- --------------------------
As Originally As Originally
Reported As Restated Reported As Restated
------------- ----------- ------------- -----------
Net revenue $10,111 $10,111 $30,952 $30,572
Cost of revenue 4,090 4,156 12,316 12,395
Gross profit 6,021 5,955 18,636 18,177
Total operating expenses 5,756 5,775 17,583 18,365
Net income 393 333 1,107 181
Net income per common
share - basic and
diluted $ .05 $ .04 $ .14 $ .02
(9) COMMITMENTS AND CONTINGENCIES:
The Company is involved in certain legal matters incidental to its
business, the outcome of which is currently unknown. Management believes that
the Company's liability, if any, with respect to such matters, will not have a
material adverse affect on the Company's financial condition and results of
operations.
On March 8, 1999, a purported class action lawsuit was filed against
Microtest, Inc. and certain former officers in the United States District Court
for the District of Arizona. The suit claims that Microtest violated Section
10(b) of the Securities Exchange Act of 1934 by making public misrepresentations
or failing to disclose material facts regarding its financial results. The suit
was filed as a class action on behalf of all purchasers of Microtest stock
between April 14, 1998 and March 2, 1999. A similar suit was filed April 7,
1999. Microtest intends to vigorously defend these lawsuits. The eventual
outcome of these claims cannot be predicted with any degree of legal certainty.
The Securities and Exchange Commission ("SEC") is engaged in an
investigation relating primarily to accounting matters of the Company. The SEC
has not, to date, asserted any specific claims or remedy with respect to the
Company.
9
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company develops and markets Network Test and Measurement ("NTM") and
Network Attached Storage ("NAS") products. The NTM products perform critical
cabling certification and network diagnostics. The NAS line consists primarily
of thin server products that allow the sharing of information among local area
network users.
The Company restated its quarterly results for the first three quarters of
1998 to correct errors identified during the 1998 year-end audit. The errors
were primarily attributable to system changes and turnover in the finance
department that occurred during the first half of 1998. The corrections related
primarily to various adjustments correcting the provision for sales returns,
correcting software capitalization and amortization and intercompany account
transactions.
The Company has made significant changes to address the issues that led to
the need for the restatement of earnings. The Company revised its strategic
direction and exited the integrated high-end CD-ROM enterprise systems business.
These efforts resulted in increased revenue and a return to profitability in the
third quarter of 1999, despite the Company's exit from the enterprise systems
business.
RESULTS OF OPERATIONS
REVENUE. Net revenue for the Company's third quarter ended September 25,
1999 was $11.3 million, an increase of 12% from revenue of $10.1 million for the
corresponding quarter last year. Net revenue for the nine months ended September
25, 1999 was $29.9 million, a decrease of 2% from revenue of $30.6 million for
the corresponding period last year. The increase in net revenue for the third
quarter of 1999 over 1998 was attributed to the increase in sales across the
Company's NTM and NAS product lines worldwide. Third quarter NAS revenue
increased significantly over the 1998 quarter, but the increase was not
sufficient to make up for the loss of revenue resulting from the Company's exit
from the integrated high-end CD-ROM enterprise systems and DiscPort/CD tower
business. The decrease in net revenue for the nine month period ended September
25, 1999 when compared to the corresponding period in 1998 was primarily a
result of the Company's efforts to reduce distribution channel inventories. NAS
DiscZerver revenue increased significantly since its introduction in the second
quarter of 1998, but was not able to offset the decline in revenue caused by
decreased distribution sales and the Company's exit from the enterprise systems
business.
The Company distributes its products in both the U.S. and international
markets. U.S. net revenue increased 4% to $7.5 million, or 67% of net revenues,
in the third quarter of 1999 from $7.2 million, or 71% of net revenues, for the
same quarter last year. U.S. net revenue decreased 12% to $18.4 million, or 62%
of net revenues, for the first nine months of 1999 from $21.0 million, or 69% of
net revenues, for the same period in 1998.
The increase in U.S. revenue for the third quarter of 1999 was primarily
attributable to increased NTM and NAS product demand for the OMNIScanner, the
new OMNIFiber, and DiscZerver offset in part by the decline in revenue caused by
decreased distribution sales. The overall decrease in U.S. revenue in both the
aggregate and as a percentage of total net revenues for the nine month ended
10
<PAGE>
September 25, 1999 resulted from the decline in revenue caused by decreased
distribution sales and the Company's exit from the enterprise systems business.
International sales were $3.8 million, or 34% of net revenue, and $2.9
million, or 29% of net revenue, for the third quarters of 1999 and 1998,
respectively. International sales were $11.5 million, or 38% of net revenue, and
$9.5 million, or 31% of net revenue, for the first nine months of 1999 and 1998,
respectively. The increase in international sales as a percentage of net
revenue, as well as in aggregate dollars, in the third quarter of 1999 and the
nine months ended September 25, 1999 over the same period in 1998, resulted
primarily from increased sales of the OMNIScanner and DiscZerver products
worldwide.
GROSS PROFIT. The Company's gross profit was $6.2 million, or 55% of net
revenue, and $6.0 million, or 59% of net revenue, for the third quarters ended
September 25, 1999 and September 26, 1998, respectively. Gross profit was $15.4
million, or 52% of net revenue, and $18.2 million, or 60% of net revenue, for
the nine months ended September 25, 1999 and September 26, 1998, respectively.
The decrease in the third quarter and first nine months gross margins as a
percentage of net revenue from 1998 to 1999 was primarily attributable to a
decrease in high margin DiscPort software revenue, and increases in the
amortization of capitalized software, volume rebates, and changes in product
mix. In addition, gross margin for the nine month period in 1999 was adversely
affected by a special charge of $803,000. The special charge represents the
write-down of discontinued product inventories as a result of the Company's exit
from the high-end CD-ROM enterprise business.
SALES AND MARKETING. Sales and marketing expenses were $3.0 million, or 26%
of net revenue, and $2.6 million, or 26% of net revenue, for the third quarters
of 1999 and 1998, respectively. For the first nine months of 1999 and 1998,
sales and marketing expenses were $9.2 million, or 31% of net revenue, and $8.9
million, or 29% of net revenue, respectively. The increase in sales and
marketing expenses in absolute dollars for the third quarter of 1999 and the
first nine months of 1999 over the corresponding periods in 1998 is primarily
due to increases in commissions, marketing expenses and expenses relating to
demo and evaluation units.
RESEARCH AND DEVELOPMENT. Research and development expenses were $1.7
million, or 16% of net revenue, and $1.8 million, or 18% of net revenue, for the
third quarters of 1999 and 1998, respectively. For the first nine months of 1999
and 1998, research and development expenses were $5.5 million, or 18% of net
revenue. Research and development expenses in absolute dollars for the third
quarter and the first nine months of 1999 and 1998 remained constant, although
the capitalization of software development costs decreased by $577,000. This
decrease was a result of the Company's completion of products under development
early in the third quarter of 1999. The Company capitalized these product
development costs in accordance with Statement of Financial Accounting Standard
No. 86. In the third quarter of 1999 the Company changed its development
process, and believes that new product development is essentially completed
concurrently with the establishment of technological feasibility. Accordingly,
no costs have been capitalized in the third quarter of 1999.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $1.2
million, or 11% of net revenue, and $1.4 million, or 14% of net revenue, for the
third quarters of 1999 and 1998, respectively. For the nine months ended
September 25, 1999 general and administrative expenses were $4.3 million, or 14%
of net revenue, compared with $4.0 million, or 13% of net revenue, for the
corresponding period in the prior year. The decrease in general and
administrative expenses as a percentage of net revenue, as well as in aggregate
dollars, for the third quarter of 1999 over the corresponding period in 1998 is
due primarily to the reduction in the allowance for doubtful accounts. The
increase in general and administrative expenses for the nine months ended
September 25, 1999 compared with the same period in the prior year is
11
<PAGE>
attributable to the resolution of certain sales tax related issues and
additional expenses for professional fees.
SPECIAL CHARGE (CREDIT). During the quarter ended September 25, 1999, the
Company recorded a $230,000 special credit as part of its exit from the
integrated high-end enterprise systems business. The credit relates to the sale
of the Company's active enterprise maintenance contracts and its enterprise
customer database. For the nine months ended September 25, 1999, the Company
recorded net special charges of $2.1 million relating to its exit from the
enterprise systems business and to restructure its management organization. The
pre-tax special charge primarily consists of $1.5 million in employee severance
and benefits, future lease payments, the write-off of fixed assets and
capitalized software, and an increase in the allowance for evaluation units. The
charge also includes $803,000 for the write-down of discontinued product
inventories that is included as a component of cost of revenue.
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE. The cumulative
effect of a change in accounting principle, recorded in the first quarter of
1999, reflects the write-off of international product translation costs that had
previously been capitalized. The write-off is in accordance with AICPA Statement
of Position 98-5, "REPORTING ON THE COSTS OF START-UP ACTIVITIES."
LIQUIDITY AND CAPITAL RESOURCES
The Company had cash and cash equivalents of $6.5 million at September 25,
1999 compared to $9.6 million at December 31, 1998. Working capital was $18.8
million at September 25, 1999 compared to $22.0 million at December 31, 1998.
The decrease in cash and cash equivalents and working capital was primarily a
result of purchases of equipment and funding of the net loss for the nine month
period.
The Company funds its working capital requirements on a short-term basis
primarily through existing cash balances and operating cash flows. The Company
has no long-term obligations and anticipates that existing cash balances and
cash flows from operations will be adequate to meet the Company's cash
requirements for at least the next year.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
In passing the Private Securities Litigation Reform Act of 1995 (the
"PSLRA"), Congress encouraged public companies to make "forward-looking
statements"(1) by creating a safe-harbor to protect companies from securities
law liability in connection with forward-looking statements. The Company intends
to qualify both its written and oral forward-looking statements for protection
under the PSLRA.
To qualify oral forward-looking statements for protection under the PSLRA,
a readily available written document must identify important factors that could
cause actual results to differ materially from those in the forward-looking
statements. The Company provides the following information in connection with
its continuing effort to qualify forward-looking statements for the safe harbor
protection of the PSLRA.
Forward-looking statements express expectations of future events. All
forward-looking statements are inherently uncertain as they are based on various
expectations and assumptions concerning future events and they are subject to
numerous known and unknown risks and uncertainties which could cause actual
events or results to differ materially from those projected. Due to these
- --------
1 "Forward-looking statements" can be identified by use of words such as
"expect," "believe," "estimate," "project," "forecast," "anticipate," "plan,"
and similar expressions.
12
<PAGE>
inherent uncertainties, the investment community is urged not to place undue
reliance on forward-looking statements. In addition, the Company undertakes no
obligation to update or revise forward-looking statements to reflect changed
assumptions, the occurrence of unanticipated events or changes to projections
over time.
Important factors currently known to management that could cause actual
results to differ materially from those in forward-looking statements include,
but are not limited to, the following: (1) changes in the Company's product and
customer mix; (2) introduction of new products by the Company or its
competitors; (3) pricing pressures and economic conditions in the United States,
Europe and the Pacific Rim; (4) the economic condition of the computer industry;
(5) failure of the Company 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 advances, satisfy diverse
and evolving customer requirements, or otherwise achieve market acceptance; (6)
loss of or reduction in purchases by certain of the Company's distributors and
VARs; (7) any reduction in sales of the Company's OMNIScanner or Zerver products
from which the Company derives substantially all of its revenue; (8) the
inability of the Company to accurately monitor end user demand for its products;
(9) unanticipated product returns to the extent such returns exceed the
Company's reserves; (10) the cost, quality and availability of third-party
components used in the Company's systems; (11) the loss of any of the Company's
third-party manufacturers or key suppliers; (12) any disruption or reduction in
the future supply of key components currently obtained from limited sources;
(13) defects in the Company's products that could 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; (14) inventory writedowns, product returns or price protection
credits that exceed the Company's estimates; (15) the inability of the Company
to expand its international operations in a timely and cost effective manner, as
well as other risks in conducting business internationally; (16) recruiting,
hiring and retaining the services of key engineering, sales and marketing,
management and manufacturing personnel; (17) failure of the Company to protect
its proprietary information and technology; and (18) the inability of the
Company or failure of the Company's vendors to become year 2000 complaint. Any
of the foregoing events could have a material adverse affect on the Company's
business, financial condition, and results of operations.
YEAR 2000 ISSUES
Like many other organizations, the year 2000 computer issue creates risks
for the Company. Many computer systems were originally designed to recognize
calendar years by their last two digits. Calculations performed using these
truncated fields would not work properly with dates during or after the year
2000. To address these year 2000 issues, the Company has initiated a
comprehensive assessment and remediation program to resolve any year 2000 issues
with respect to its information technology ("IT") systems, its non-IT systems,
products and the systems of third parties with which it has a material
relationship.
The IT systems section of its year 2000 program focuses on the Company's
computer hardware and software. The Company has completed the assessment phase
of its program. The Company's current IT systems which were determined not to be
compliant have been replaced or otherwise corrected for compliance. The
remediation phase for IT systems has been completed.
The non-IT systems section includes the hardware, software and associated
embedded computer technologies that are used to operate Company facilities,
equipment and other activities that are not related to IT systems. The Company's
building management has provided the Company with a complete list of vendors
13
<PAGE>
indicating compliance. The current telephone system is compliant and long
distance and local telephone service are compliant.
The Company's current products and all planned future releases, with minor
exceptions, are year 2000 compliant. Registered customers have been notified of
non-compliant products and any available upgrade. This information has also been
made available on the Company's Website since June 1998.
The Company is continuing the process of identifying, prioritizing and
communicating with critical suppliers, distributors and customers to determine
the extent to which the Company may be vulnerable in the event those parties
fail to properly identify and remedy their own year 2000 issues. The Company
believes that non-compliant systems related to the Company's top suppliers would
present the greatest risk to the Company. Questionnaires have been sent to those
suppliers and they have stated that they are compliant or expect compliance by
the end of 1999. The Company intends to monitor the progress made by these
critical third parties and formulate appropriate contingency and business
continuation plans as needed.
The Company currently believes that the worst case scenario with respect to
the year 2000 issue is the failure of a supplier, including utility suppliers,
to become year 2000 compliant, which could result in the temporary interruption
of the supply of necessary products or services. This could result in
interruptions in production for a period of time, which in turn could result in
potential lost sales and profits. In addition, marketing and administrative
expense could increase if automated functions would need to be performed
manually.
The total cost of the Company's year 2000 Plan is not expected to be
material to the Company's financial condition. The total cost of the Plan is
being funded through existing cash balances and operating cash flows. The
Company anticipates that the remaining expenditures to complete the Company's
year 2000 Plan are less than $20,000. None of the Company's other information
technology projects have been delayed or deferred as a result of the
implementation of the year 2000 Compliance Plan. The Company does not expect
that the incremental costs of this project will have a material adverse affect
on the Company's consolidated financial statements or results of operations in
any future periods.
The costs of the year 2000 project and the dates on which the Company
believes it will complete the year 2000 modifications and testing are based on
management's best estimates. These were derived utilizing numerous assumptions
regarding future events, including the continued availability of certain
resources, third-party modification plans and other factors. However, there can
be no guarantee that these estimates will be achieved and actual results could
differ materially from those currently anticipated. Examples of factors that
might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes and embedded technology and similar
uncertainties. In addition, there can be no guarantee that the systems or
products of other entities will be converted on a timely basis, or that failure
to convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse affect on the Company.
The Company presently believes it has an effective Compliance Plan in place
to anticipate and resolve potential year 2000 issues in a timely manner.
Concurrent with the remediation of the Company's systems and evaluation of
third-party systems, the Company continues to develop contingency plans to
mitigate the risks that could occur in the event of disruption due to
non-compliant systems. Contingency plans may include looking for alternative
suppliers, increasing inventory levels or other actions deemed prudent. It is
expected that assessment, remediation and contingency planning activities will
be on going throughout 1999 with the goal of appropriately resolving all
material internal systems and third-party issues. Estimated costs associated
with developing and implementing contingency measures are not currently
estimable.
14
<PAGE>
MICROTEST, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time the Company is involved in various legal proceedings
incidental to its business. Management does not believe that any current legal
proceedings will have a material adverse affect on the financial condition or
operating results of the Company, but there can be no assurances in this regard.
On March 8, 1999, a purported class action lawsuit was filed against Microtest,
Inc. and certain former officers in the United States District Court for the
District of Arizona. The suit claims that Microtest violated Section 10(b) of
the Securities Exchange Act of 1934 by making public misrepresentations or
failing to disclose material facts regarding its financial results. The suit was
filed as a class action on behalf of all purchasers of Microtest stock between
April 14, 1998 and March 2, 1999. A similar suit was filed April 7, 1999.
Microtest intends to vigorously defend these lawsuits. The eventual outcome of
these claims cannot be predicted with any degree of legal certainty.
The Securities and Exchange Commission ("SEC") is engaged in an
investigation relating primarily to accounting matters of the Company. The SEC
has not, to date, asserted any specific claims or remedy with respect to the
Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit Page or
Number Description Method of Filing
- ------ ----------- ----------------
3.1 Amended and Restated Certificate of Incorporated by reference
Incorporation of the Company dated to Exhibit 3.1 to Form S-1
May 19, 1992 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
27 Financial Data Schedule Filed herewith
(b) Reports on Form 8-K
None.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
MICROTEST, INC.
November 5, 1999 /s/ Vincent C. Hren
--------------------------------------------
Vincent C. Hren
President and Chief Executive Officer
November 5, 1999 /s/ Daniel J. Predovic
--------------------------------------------
Daniel J. Predovic
Vice President, Chief Financial Officer,
Secretary and Treasurer
(Principal Financial and Accounting Officer)
16
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