10-Q 1 p64076e10-q.txt FORM 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549-1004 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 30, 2000 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 ___ AT NOVEMBER 11, 2000, THERE WERE 8,780,422 SHARES OF COMMON STOCK OUTSTANDING, EXCLUSIVE OF TREASURY SHARES HELD BY THE REGISTRANT. 2 MICROTEST, INC. AND SUBSIDIARIES INDEX Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets- September 30, 2000 and December 31, 1999 3 Consolidated Statements of Operations- Three Months and Nine Months Ended September 30, 2000 and September 25, 1999 4 Consolidated Statements of Cash Flows- Nine Months Ended September 30, 2000 and September 25, 1999 5 Notes to Consolidated Financial Statements 6-11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12-14 PART II. OTHER INFORMATION Item 1. Legal Proceedings 15 Item 6. Exhibits and Reports on Form 8-K 16 SIGNATURE 16 3 MICROTEST, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2000 AND DECEMBER 31, 1999 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)

3 4 MICROTEST, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND SEPTEMBER 25, 1999 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

4 5 MICROTEST, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND SEPTEMBER 25, 1999 (IN THOUSANDS)

5 6 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. and its wholly owned subsidiaries (the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair statement of the results of operations and consolidated financial position for the interim periods presented. Certain information and footnote disclosures normally included in full year financial statements have been condensed or omitted pursuant to interim reporting 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 1999 Annual Report to shareholders and report on Form 10-K. The results of operations for the three months and nine months ended September 30, 2000 are not necessarily indicative of the results to be expected for a full fiscal year. 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. (2) INVENTORIES: Inventories consist of the following (in thousands):

6 7 (3) EARNINGS (LOSS) PER SHARE: The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share amounts):

(4) SPECIAL CHARGE: During the three months ended September 25, 1999, the Company recorded a special credit of $0.2 million as part of its exit from the integrated high-end CD-ROM enterprise systems business. The credit related 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 to reflect the cost of its exit from the integrated high-end CD-ROM enterprise systems business, the related closure of its Nashua, New Hampshire facility and restructuring its management organization. The pre-tax special charge primarily consists of $1.0 million in employee severance and benefits, future lease payments, the write-off of certain fixed assets and capitalized software, and an increase in the allowance for evaluation units. The special charge also includes $0.8 million for the write-down of discontinued product inventories that was included as a component of cost of revenue. The special charge of $0.5 million recorded in the first quarter of 1999 represented severance expenses recorded to recognize the restructuring of the Company's management organization. These charges were offset by the special credit of $0.2 million that was recorded in the third quarter of 1999. As of September 30, 2000 and December 31, 1999, the Company had approximately $23,000 and $100,000, respectively, accrued for employee severance related to the Company's restructuring. The change in the accrual relates to severance payments made during the period. 7 8 (5) CHANGE IN ACCOUNTING PRINCIPLE: In accordance with AICPA Statement of Position 98-5, "Reporting on the Costs of Start-up Activities," the Company expensed $0.1 million, after the effect of income taxes, of previously capitalized international product translation costs during the first quarter of 1999. (6) SEGMENTS: The Company is organized into two reportable business segments: Network Test and Measurement ("NTM") and Network Appliance and Storage ("NAS"). The NTM business segment includes hand-held products used as network certification and troubleshooting tools in the installation and operation of computerized networks. The NTM segment consists of devices for testing fiber optic and copper networks, as well as, active operational local-area networks (LANs). 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 NAS business segment consists of a family of server appliances and server products. Server appliances are network infrastructure devices designed to facilitate the exchange of information over a computing network. The Company's server appliances use Linux as an open source operating system and encompass hard disk storage devices, as well as, optical (CD-ROM and DVD-ROM) storage devices. NAS products are designed to enable organizations to easily develop, store, manage, and access information and knowledge bases. The NAS reportable business segment includes the Company's H+H subsidiary that develops and sells several software products, CD-ROM networking systems and service maintenance contracts in Europe. In the second quarter of 1999, 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, allowed the Company to focus the Network Appliance and Storage Division exclusively on NAS thin-server appliances for the workgroup and departmental markets. The Company does not measure assets separately for the NTM and NAS business segments. 8 9 Information related to the operations of the Company in different business segments for the three months and nine months ended September 30, 2000 and September 25, 1999, respectively, is set forth below (in thousands).

(1) Includes net revenue and gross profit of $0.5 million and $0.3 million during the three months ended September 25, 1999, and $3.6 million and $1.3 million (net of special charge for write-down of discontinued product inventories of $0.8 million) during the nine months ended September 25, 1999, respectively, from the NAS CD-ROM enterprise systems business which the Company exited during the third quarter of 1999. Net revenues to unaffiliated customers by geographic area for the three months and nine months ended September 30, 2000 and September 25, 1999, respectively, follows (in thousands):

9 10 (7) MAJOR CUSTOMERS: Major customers accounting for more than 10% of total revenues for the three months and nine months ended September 30, 2000 and September 25, 1999, respectively, are summarized below. Percentage of revenue is not presented if less than 10%.

(8) COMMITMENTS AND CONTINGENCIES: The Company is subject to legal claims in the ordinary course of business. Management believes that the Company's liability, if any, with respect to such matters will not have a material adverse effect on the Company's financial condition and results of operations. On March 8, 1999 and April 7, 1999, the Company was named as a defendant in two purported class action lawsuits filed in the United States District Court for the District of Arizona. The two lawsuits contain substantially the same allegations and were brought on behalf of a class of persons who purchased Microtest common stock between April 14, 1998 and March 2, 1999. The complaints allege claims under Section 10(b) and SEC Rule 10b-5 of the Securities and Exchange Act of 1934. The claims further allege that the Company made misrepresentations or omissions concerning its financial statements that artificially inflated the price of the Company's common stock. During November 1999, a motion to dismiss the lawsuit was filed. During September 2000, the Court ruled in favor of the Company and granted the Company's motion to dismiss the lawsuit without prejudice. An amended complaint has been subsequently filed. The Company has, in turn, filed a motion to dismiss the amended complaint. The Company intends to continue to vigorously defend these actions. The Company is unable to predict the ultimate outcome of this litigation. If the lawsuits were ultimately determined adversely to the Company, it could have a material effect on our results of operations and financial condition. The Securities and Exchange Commission ("SEC") is engaged in an investigation relating primarily to accounting matters of the Company. They have requested and received documents from the Company and taken testimony from certain former employees. During November 2000, the SEC requested and the Company agreed to extend the statute of limitations for their investigation until April 30, 2001. They have not, to date, asserted any specific claims, or remedy. The Company is unable to predict the effect, if any, of this inquiry. 10 11 (9) NEW ACCOUNTING PRONOUNCEMENTS: In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." In June 2000, the FASB issued SFAS No. 138, which amends certain provisions of SFAS 133 to clarify four areas that the FASB believes were causing difficulties in implementation. SFAS 133, as amended by SFAS 138, is not expected to have a material impact on the Company's consolidated results of operations, financial position, or cash flows. 11 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT RESULTS Except for the historical information contained herein, this Report contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Words such as "believe," "expect," "intend," "anticipate," "estimate," "project," and similar expressions identify forward-looking statements, which speak only as of the date the statement was made. 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 our products or services, as well as assumptions relating to the foregoing. 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. Additional risk factors that could cause actual results to differ materially from those expressed in such forward-looking statements are set forth in Exhibit 99, which is attached hereto and incorporated by reference into this Quarterly Report on Form 10-Q. 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. This Report should be read in conjunction with our Report on Form 10-K for the fiscal year ended December 31, 1999. All references to "we," "our," "us," or "Microtest" refer to Microtest, Inc. and its subsidiaries. RESULTS OF OPERATIONS REVENUE. Net revenue for the three months ended September 30, 2000 was $10.5 million, representing a 7% decrease from net revenue of $11.3 million for the corresponding period last year. Net revenue for the nine months ended September 30, 2000 was $33.1 million, representing an increase of 11% from net revenue of $29.9 million for the corresponding period last year. Exclusive of the effect of the NAS enterprise systems business exited in the prior year, revenue decreased by 3% and increased by 26% for the three months and nine months ended September 30, 2000, respectively, in comparison to similar periods in 1999. Our products are distributed in both North American and international markets. North American net revenue was $6.9 million and $7.5 million, representing approximately 66% of total revenue, for the three months ended September 30, 2000 and September 25, 1999, respectively. North American revenue was flat, exclusive of the effect of the NAS enterprise systems business exited in the prior year. North American net revenue was $19.3 million and $18.4 million, representing 58% and 62% of total net revenue, for the nine months ended September 30, 2000 and September 25, 1999, respectively. Year-to-date North American revenue increased 30%, exclusive of the effect of the NAS enterprise systems business exited in the prior year, primarily the result of additional revenues from NTM products introduced during late 1999. International net revenue was $3.6 million and $3.8 million, respectively, for the three months ended September 30, 2000 and September 25, 1999, respectively, representing 34% of 12 13 total net revenue for both periods. The decrease in international revenue is primarily attributable to a stronger U.S. dollar to Euro currencies, which resulted in higher end-user prices for our products, and, to a lesser extent, to unfavorable currency translations from our German H + H subsidiary. International net revenue was $13.8 million and $11.5 million, respectively, for the three quarters ended September 30, 2000 and September 25, 1999, respectively, representing 42% and 38% of total net revenue, respectively, for these periods. The increase in year-to-date international net revenue is the result of expansion of our sales and marketing activities within these markets during the last half of 1999, offset by the effect of currency differences discussed above. GROSS PROFIT. Gross profit was $6.0 million, or 57.0% of net revenue, for the three months ended September 30, 2000, and $6.2 million, or 54.4% of net revenue for the three months ended September 25, 1999. Gross profit was $19.0 million, or 57.2% of net revenue, for the nine months ended September 30, 2000, and $16.2 million, or 54.0% of net revenue, exclusive of special charges, for the nine months ended September 25, 1999. The increase in gross margin percentage for the three months and nine months ended September 30, 2000, over the corresponding periods in 1999 (exclusive of special charges), was primarily attributable to greater sales of higher margin NTM products and a decrease in the sales of lower margin CD-ROM enterprise systems products. During the nine months ended September 25, 1999, overall gross margin was adversely affected by a special charge of $0.8 million. The special charge represented the write-down of discontinued product inventories as a result of our planned exit from the high-end CD-ROM enterprise business. SALES AND MARKETING. Sales and marketing expenses were $3.0 million, or 29% and 27% of net revenue, for the three months ended September 30, 2000 and September 25, 1999, respectively. Sales and marketing expenses were $9.2 million, or 28% and 31% of net revenue, for the nine months ended September 30, 2000 and September 25, 1999, respectively. The increase in sales and marketing expenses as a percentage of net revenue for the three months ended September 30, 2000, compared to the corresponding period in 1999 is due to increased marketing expenditures in the NAS segment for our products introduced during 2000. The decrease in sales and marketing expenses as a percentage of net revenue for the nine months ended September 30, 2000, compared to the corresponding periods in 1999, is primarily due to reduced expenses as a result of our exiting the CD-ROM enterprise system NAS business during the third quarter of 1999 and increased overall revenues. RESEARCH AND DEVELOPMENT. Research and development expenses were $2.0 million, or 19% of net revenue, and $1.7 million, or 15% of net revenue, for the three months ended September 30, 2000 and September 25, 1999, respectively. Research and development expenses were $5.8 million, or 18% of net revenue, and $5.5 million, or 18% of net revenue, for the nine months ended September 30, 2000 and September 25, 1999, respectively. The increase in research and development expenses for the three months and nine months ended September 30, 2000, compared to the corresponding periods in 1999, is primarily due to increased investment in research and development activities in connection with our NAS products. GENERAL AND ADMINISTRATIVE. General and administrative expenses were $1.4 million, or 13% of net revenue, and $1.2 million, or 11% of net revenue, for the three months ended September 30, 2000 and September 25, 1999, respectively. General and administrative expenses were $4.0 million, or 12% of net revenue, and $4.3 million, or 14% of net revenue, for the nine months ended September 30, 2000 and September 25, 1999, respectively. The increase in general and administrative expenses for the three months ended September 30, 2000, compared to the corresponding period in 1999, as well as the increase as a percentage of net revenue for the 13 14 indicated period, is primarily due to increased occupancy costs. The decrease in general and administrative expenses for the nine months ended September 30, 2000, compared to the corresponding period in 1999, as well as the decrease as a percentage of net revenue for the indicated period, is primarily due to a decrease in professional fees. SPECIAL CHARGE (CREDIT). In the third quarter of 1999, we recorded a special credit of $0.2 million as part of our exit from the integrated high-end CD-ROM enterprise systems business. The credit related to the sale of our active enterprise maintenance contracts and our enterprise customer database. For the nine months ended September 25, 1999, we recorded net special charges of $2.1 million to reflect the cost of our exiting the integrated high-end CD-ROM enterprise systems business. Approximately $1.0 million of this pre-tax special charge represents employee severance and benefits, future lease payments, the write-off of fixed assets and capitalized software, and an increase in our allowance for evaluation units. The charge also included $0.8 million for the write-down of discontinued product inventories that was included as a component of cost of revenue. The special charge of $0.5 million recorded in the first quarter of 1999 represented severance expenses recorded to recognize the restructuring of our management organization. These charges were offset by the special credit of $0.2 million that was recorded in the third quarter of 1999. 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 We held cash and cash equivalents of $13.6 million at September 30, 2000 compared to $10.4 million at December 31, 1999. Working capital was $24.4 million at September 30, 2000 compared to $20.9 million at December 31, 1999. During the nine months ended September 30, 2000, cash flows provided by operations were $2.9 million, resulting primarily from net income of $0.8 million, noncash depreciation and amortization of $1.7 million, decreases in inventory of $0.1 million, income tax receivables of $0.1 million, and other assets of $0.9 million, offset by decreases in accounts payable and accrued liabilities of $0.7 million. Cash flows used in investing activities were $0.7 million for the nine months ended September 30, 2000, primarily for purchases of equipment. Cash flows provided by financing activities were $1.1 million for the nine month ended September 30, 2000, associated with stock issued in connection with employee benefit plans. Historically, we have financed our cash requirements principally through cash flows from operating activities, the sale of common stock through an initial public offering in October 1992 and the exercise of stock options. We have no long-term debt and expect that our existing working capital, together with cash flows from operations, will be sufficient to meet our operating and capital needs for the next twelve months. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." In June 2000, the FASB issued SFAS No. 138, which amends certain provisions of SFAS 133 to clarify four areas that the FASB believes were causing difficulties in implementation. SFAS 133, as amended by SFAS 138, is not expected to have a material impact on the Company's consolidated results of operations, financial position, or cash flows. 14 15 MICROTEST, INC. AND SUBSIDIARIES PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time we are subject to litigation in the ordinary course of business. Our insurance coverage may not be adequate to cover all liabilities arising out of such claims. We are not engaged in any legal proceedings in the ordinary course of business that are expected to have a material adverse effect on our financial condition or results of operations. We, Richard G. Meise, our former Chief Executive Officer, Charles Mihaylo, our former Chief Operating Officer and John O'Block, our former Chief Financial Officer have been named as defendants in two purported class action lawsuits: Great Neck Capital Appreciation Investment Partnership, L.P., et. al. v. Microtest, Inc., et. al., CIV 99-0438 PHX EHC filed on March 8, 1999, in United States District Court for the District of Arizona and Banks v. Microtest, Inc., et. al., CIV 99-672 PHX EHC filed on April 7, 1999 in United States District Court for the District of Arizona. The two lawsuits contain substantially the same allegations and were brought on behalf of a class of persons who purchased our common stock between April 14, 1998 and March 2, 1999. The complaints allege claims under Section 10(b) and SEC Rule 10b-5 of the Securities and Exchange Act of 1934. The claims further allege that we made misrepresentations or omissions concerning our financial statements and public disclosures that artificially inflated the price of our common stock. The plaintiffs seek an unspecified amount of actual damages, attorney's fees and costs. On November 29, 1999, a motion to dismiss the lawsuit was filed. During September 2000, the Court ruled in our favor and granted our motion to dismiss the lawsuit without prejudice. An amended complaint has been subsequently filed. We have, in turn, filed a motion to dismiss the amended complaint. We intend to continue to vigorously defend these actions. We are unable to predict the ultimate outcome of this litigation. If the lawsuits were ultimately determined adversely to us, it could have a material effect on our results of operations and financial condition. The Securities and Exchange Commission ("SEC") is engaged in an investigation relating primarily to our accounting matters. They have requested and received documents from us and taken testimony from certain former employees. During November 2000, the SEC requested and we agreed to extend the statute of limitations for their investigations until April 30, 2001. They have not, to date, asserted any specific claims, or remedy. We are unable to predict the effect, if any, of this inquiry. 15 16 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits

(b) Reports on Form 8-K None. 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 13, 2000 /s/ Vincent C. Hren --------------------------------------- Vincent C. Hren President and Chief Executive Officer November 13, 2000 /s/ William R. Crowell --------------------------------------- William R. Crowell Vice President, Secretary and Chief Financial Officer (Principal Financial and Accounting Officer) 16

MICROTEST INC 10-Q