CELERITEK INC/CA
Filed on Nov 13 1998
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements represent the Company's expectations or beliefs concerning future events and include statements, among others, regarding the length and timing of delays, the potential of the market sales volume and sales to significant customers and the sufficiency of capital resources. Actual results could differ materially from those projected in the forward-looking statements as a result of a variety of factors, including those set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Risks, Trends, and Uncertainties," and elsewhere in this report.
RESULT OF OPERATIONS - SECOND QUARTER OF FISCAL 1998 COMPARED TO SECOND QUARTER
OF FISCAL 1999:
Total net sales decreased 20% from $13.5 million for the second quarter of fiscal 1998 to $10.8 million for the second quarter of fiscal 1999. Total net sales to commercial customers decreased 24% from $7.4 million for the second quarter of fiscal 1998 to $5.6 million for the second quarter of fiscal 1999, primarily as a result of delayed contracts by several subsystem customers. The Company expects the subsystems market, particularly the microwave radio segment, to remain sluggish at least through the end of the fiscal year. Total net sales to defense customers decreased 15% from $6.1 million in the second quarter of fiscal 1998 to $5.2 million for the second quarter of fiscal 1999, as the Company had expected. See "Risks, Trends, and Uncertainties Potential Fluctuations in Quarterly Results."
Gross margin decreased from 36% of net sales in the second quarter of fiscal 1998 to 24% of net sales in the second quarter of fiscal 1999. The decrease in gross margin was primarily due to increased manufacturing overhead to support an anticipated increase in sales volume. Gross margin, in the second quarter of fiscal 1999, also benefited from the sales of previously written down product. See "Risks, Trends, and Uncertainties Yields and the High Degree of Fixed Costs in the Manufacturing Operation."
Research and development expenses increased 7% from $1.3 million, or 9% of net sales, in the second quarter of fiscal 1998 to $1.4 million, or 13% of net sales, in the second quarter of fiscal 1999 reflecting the Company's continuing investment in commercial product development. The increase was primarily due to an increase in personnel and related expenses from the new design center in Ireland. See "Risks, Trends, and Uncertainties Dependence on Key Personnel."
Selling, general and administrative expenses decreased from $2.1 million, or 15% of net sales, in the second quarter of fiscal 1998 to $2.0 million, or 19% of net sales, in the second quarter of fiscal 1999. The dollar decrease was primarily due to lower selling costs related to the lower sales volume.
Interest income (expense) and other, net decreased 126% from $121,000 of interest income in the second quarter of fiscal 1998 to $31,000 of interest expense in the second quarter of fiscal 1999. The decreased in interest income was primarily due to lower average cash balances as a result of cash being used for working capital. The increased interest expense was due to equipment purchases financed through long-term debt and capital leases.
RESULT OF OPERATIONS - FIRST SIX MONTHS OF FISCAL 1998 COMPARED TO FIRST SIX
MONTHS OF FISCAL 1999:
Total net sales decreased 20% from $26.1 million for the first six months of fiscal 1998 to $21.0 million for the first six months of fiscal 1999. Total net sales to commercial customers decreased 22% from $13.9 million for the first six months of fiscal 1998 to $10.9 million for the first six months of fiscal 1999, primarily as a result of delayed contracts by several subsystem customers. The Company expects the subsystems market, particularly the microwave radio segment, to remain sluggish at least through the end of the fiscal year. Total net sales to defense customers decreased 17% from $12.2 million in the first six months of fiscal 1998 to $10.1 million for the first six months of fiscal 1999, as the Company had expected. See "Risks, Trends, and Uncertainties Potential Fluctuations in Quarterly Results."
Gross margin decreased from 36% of net sales in the first six months of fiscal 1998 to 7% of net sales in the first six months of fiscal 1999. The decrease in gross margin was primarily due to an inventory write down related to delayed or canceled contracts and to a lesser extent, increased manufacturing overhead to support an anticipated increase in sales volume and idle capacity. See "Risks, Trends, and Uncertainties Yields and the High Degree of Fixed Costs in the Manufacturing Operation."
Research and development expenses increased 30% from $2.5 million, or 9% of net sales, in the first six months of fiscal 1998 to $3.2 million, or 15% of net sales, in the first six months of fiscal 1999 reflecting the Company's continuing investment in commercial product development. The increase was primarily due to an increase in personnel and related expenses from the new design center in Ireland. See "Risks, Trends, and Uncertainties Dependence on Key Personnel."
Selling, general and administrative expenses increased from $3.9 million, or 15% of net sales, in the first six months of fiscal 1998 to $4.5 million, or 22% of net sales, in the first six months of fiscal 1999. The increase was primarily due to increased head count and bad debt expense.
Interest income (expense) and other, net decreased 114% from $269,000 of interest income in the first six months of fiscal 1998 to $37,000 of interest expense in the first six months of fiscal 1999. The decreased in interest income was primarily due to lower average cash balances as a result of cash being used for working capital. The increased interest expense was due to equipment purchases financed through long-term debt and capital leases.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash flows from operations and sales of equity securities including the initial public offering of common stock completed in December 1995 and January 1996, which generated net proceeds of approximately $12.1 million.
During the quarter ended September 30, 1998, the Company used cash for working capital.
The company has available two revolving lines of credit covered by a Master Loan Agreement (the "Loan Agreement"), as amended, which expires October 30, 1999. The first available line of credit is for $6,000,000 and will bear interest at the bank's reference rate (8.5% at September 30, 1998). The second line of credit has been converted to a term loan of thirty-six months. Borrowings under the second line of credit and term loan bears interest at the bank's reference rate plus 0.5%. As of September 30, 1998, the Company had borrowings totaling $1,861,111 under the second line of credit, outstanding as a term loan of thirty-six months, and no borrowings under the first line of credit. The loan agreement contains certain covenants, including among others, covenants to maintain certain financial ratios, profitability and liquidity levels, a minimum tangible net worth of $32,500,000 up to and including December 31, 1998 and $31,500,000 thereafter, and limits the payment of dividends. Such credit facilities are secured by the Company's assets.
As of September 30, 1998, the Company had $3.7 million of cash and cash equivalents, $4.0 million of short-term investments and $26.9 million of working capital. The Company believes that the current capital resources combined with cash generated from operations and borrowings available from its lines of credit will be sufficient to meet its liquidity and capital expenditure requirements at least through fiscal 1999.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued a Statement of Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive Income." This statement established requirements for disclosure of comprehensive income and becomes effective for the company for its fiscal year 1999, with reclassification of earlier financial statements for comparative purposes. Comprehensive income generally represents all changes in stockholders' equity except those resulting from investments or contributions by stockholders. SFAS 130 requires unrealized gains or losses on the Company" available-for-sale securities, which prior to adoption were reported separately in stockholders' equity, to be included in other comprehensive income. The Company has adopted SFAS 130, however, the effects of the adoption were immaterial to all periods presented.
IMPACT OF YEAR 2000
Many currently installed computer systems and software products are coded to accept only two-digit entries in date code fields. Beginning in the year 2000, these date code fields will need to accept four-digit entries to distinguish 21st century dates from 20th
century dates. Any of the Company's computer programs or hardware that have date-sensitive software or embedded chips and have not been upgraded to comply with such "Year 2000" requirements may recognize a date using "00" as the year 1900 rather that the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
Based on a review of the Company's computer systems, the Company has determined that it will be required to modify or replace significant portions of its software so that those systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with modifications or replacements of existing software through its maintenance contracts with third party vendors, such Year 2000 issues can be mitigated. However, if such modifications or replacements are not made, or are not completed timely, or modifications or replacements to software or hardware of the Company's vendors, suppliers, financial institutions, and service providers are not made, or are not completed timely, the Year 2000 issue could have a material adverse impact on the operations of the Company.
Based on a review of the Company's product lines, the Company has determined that the products it has sold and will continue to sell do not require remediation to be Year 2000 compliant. Accordingly, the Company does not believe that the Year 2000 issue presents a material exposure as it relates to the Company's products.
To date, the Company has upgraded its major business systems to be Year 2000 compliant. The Company is currently in the process of assessing and testing the equipment and software used to assemble and test its products to ensure their Year 2000 compliance. The Company does not have any significant systems that interface directly with third parties.
In addition, the Company is gathering information about the Year 2000 compliance status of its significant suppliers and subcontractors. To date, the Company is not aware of any external agent with a Year 2000 issue that would materially impact the Company's results of operations, liquidity, or capital resources. However, the Company has no means of ensuring that external agents will be Year 2000 compliant. The inability of external agents to complete their Year 2000 compliance process in a timely fashion, could materially impact the Company. The effect of non-compliance by external agents is not determinable.
The Company has determined that the costs associated with its Year 2000 compliance program are not material. The software upgrades are included with the software maintenance contracts with third party vendors. To date, the Company has not identified any hardware that needs to be upgraded or replaced to mitigate the Year 2000 issue.
The Company believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, the Company has not yet completed all necessary phases of the Year 2000 program. In the event that the Company does not complete such modifications or replacements are not made, or are not completed timely, or modifications or replacements to software or hardware of the Company's vendors,
suppliers, financial institutions, and service providers are not made, or are not completed timely, or in the event that coding errors or other defects are not discovered in a timely fashion, the Year 2000 issue could have a material adverse impact on the operations of the Company.
The Company currently has no contingency plans in place in the event it does not complete such modifications or replacements are not made, or are not completed timely, or modifications or replacements to software or hardware of the Company's vendors, suppliers, financial institutions, and service providers are not made, or are not completed timely. The Company plans to evaluate the status of completion in December 1998 and determine whether such a plan is necessary.
RISKS, TRENDS, AND UNCERTAINTIES
The following risk factors should be carefully reviewed in addition to the other information contained in this Quarterly Report on Form 10-Q.
Potential Fluctuations in Quarterly Results. The Company's quarterly results have fluctuated in the past, and may continue to fluctuate in the future, due to a number of factors, including: the timing, cancellation or delay of customer orders; the mix of products sold; changes in manufacturing capacity and variations in the utilization of this capacity; the timing of new product introductions by the Company or its competitors; the long sales cycle associated with the Company's application-specific products; market acceptance of the Company's and its customers' products; variations in average selling prices of semiconductors; variations in manufacturing yields; changes in inventory levels and other competitive factors. Any unfavorable changes in the factors listed above or others could have a material adverse effect on the Company's business, operating results and financial condition. For example, in the first quarter of fiscal 1999, a number of contracts were either terminated or delayed by both commercial and defense customers. There can be no assurance that additional contracts will not be cancelled or delayed or that customers will ever reinstate orders under contracts which have been delayed. There can be no assurance that the Company will be able to maintain quarterly profitability in the future. See "Risks, Trends, and Uncertainties - Dependence on Limited Number of OEM Customers."
Continued Penetration of Commercial Markets; New Product Introductions. The Company's ability to grow will depend substantially on its ability to continue to apply its radio frequency ("RF") and microwave signal processing expertise and GaAs semiconductor technologies to existing and emerging commercial wireless communications markets. If the Company is unable to design, manufacture and market new products for existing or emerging commercial markets successfully, its business, operating results and financial condition will be materially adversely affected. Furthermore, if the markets for the Company's products in the commercial wireless communications area fail to grow, or grow more slowly than anticipated, the Company's business, operating results and financial condition could be materially adversely affected.
Yields and the High Degree of Fixed Costs in the Manufacturing Operation. The Company has in the past and may in the future experience significant delays in product shipments due to lower than expected production yields, and there can be no assurance that the Company will not experience problems in maintaining acceptable yields in the future. The Company's manufacturing yields vary significantly among products, depending on a given product's complexity and the Company's experience in manufacturing the product. To the extent that the Company does not maintain acceptable yields, its business, operating results, and financial condition could be materially adversely affected. In addition, the Company's fixed costs, which consist primarily of investments in manufacturing equipment, repair, maintenance, and depreciation costs of such equipment and fixed labor costs related to manufacturing and process engineering, are high and during periods of decreased demand, the high fixed costs could have a material adverse effect on the Company's business, operating results, and financial condition.
In addition, the Company has completed its new facility to house its wireless subsystems manufacturing operations and has begun manufacturing operations in the new facility during the third quarter of fiscal 1998. Even though the Company has increased overall capacity, there can be no assurance that the Company will be successful in its efforts to generate orders to utilize the additional capacity, or that net sales and gross margin will increase.
Dependence on a Limited Number of OEM Customers. A relatively limited number of OEM customers historically have accounted for a substantial portion of the Company's sales. In fiscal 1998 and the six months ended September 30, 1998, sales to the Company's top ten customers accounted for approximately 63% and 67% of total net sales, respectively. In the six months ended September 30, 1998, one customer accounted for approximately 12% of total net sales. The Company expects that sales of its products to a limited number of OEM customers will continue to account for a high percentage of its sales for the foreseeable future, although sales to any single customer are subject to significant variability from quarter to quarter. Such fluctuations or a complete loss of one or more of these customers, could have a material adverse effect on the Company's business, operating results and financial condition.
No Assurance of Product Performance and Reliability. The Company's customers establish demanding specifications for performance and reliability. There can be no assurance that problems will not occur in the future with respect to performance and reliability of the Company's products. If such problems occur, the Company could experience increased costs, delays in or reductions, cancellations or rescheduling of orders and shipments, product returns and discounts, and product redesigns, any of which would have a material adverse effect on the Company's business, operating results and financial condition.
Rapid Technological Change. The markets in which the Company competes are characterized by rapidly changing technologies, evolving industry standards and continuous improvements in products and services. There can be no assurance that the Company will be able to respond to technological advances, changes in customer requirements or changes in regulatory requirements or industry standards, and any significant delays in the development, introduction or shipment of products could have a
material adverse effect on the Company's business, operating results and financial condition.
Competition. The markets in which the Company competes are intensely competitive and the Company expects competition to increase. Most of the Company's current and potential competitors have significantly greater financial, technical, manufacturing and marketing resources than the Company and have achieved market acceptance of their existing technologies. The ability of the Company to compete successfully depends upon a number of factors, including the rate at which customers incorporate the Company's products into their systems, product quality and performance, price, experienced sales and marketing personnel, rapid development of new products and features, evolving industry standards and the number and nature of the Company's competitors. There can be no assurance that the Company will be able to compete successfully in the future, which would have a material adverse effect on the Company's business, operating results and financial condition.
Dependence on Key Suppliers. Certain components used by the Company in its existing products are only available from single sources, and certain other components are presently available or acquired only from a limited number of suppliers. In the event that its single source suppliers are unable to fulfill the Company's requirements in a timely manner, the Company may experience an interruption in production until alternative sources of supply can be obtained, which could damage customer relationships or have a material adverse effect on the Company's business, operating results and financial condition.
In addition, the Company contracts with a third party vendor in Asia to assemble certain of its subsystem division components to reduce manufacturing labor costs. Additionally, the Company contracts with several third party vendors in Asia to assemble its GaAs chips into integrated circuit packages. Although the Company strives to maintain more than one vendor for each assembly process, it is not always possible due to volume and quality issues. To the extent that any of the assembly vendors are not able to provide a sufficient level of service with an acceptable quality level, the Company could have difficulty meeting its delivery commitments which could materially adversely impact the Company's financial, operating and financial results
Dependence on Key Personnel. The Company's future success depends in significant part upon the continued service of its key technical and senior management personnel and its continuing ability to attract and retain highly qualified technical and managerial personnel. In particular, the Company in the past has experienced difficulty attracting and retaining qualified engineers and thin-film microwave technicians. Competition for these kinds of experienced personnel is intense, and there can be no assurance that the Company can retain its key technical and managerial employees or that it can attract, assimilate or retain other highly qualified technical and managerial personnel in the future. The failure to attract, assimilate or retain key personnel could have a material adverse effect on the Company's business, operating results and financial condition.
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