-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TXTFXX8ns+/tMsPafDPwuer4K+KSavGYaY5Qr1cE7VKDfKxmE9cfU+LtWmoUxZkw uZkk7/GvnBB9940EUljdRQ== 0001047469-99-012920.txt : 19990402 0001047469-99-012920.hdr.sgml : 19990402 ACCESSION NUMBER: 0001047469-99-012920 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: APPLIED MICROSYSTEMS CORP /WA/ CENTRAL INDEX KEY: 0001000787 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 911074996 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-26778 FILM NUMBER: 99582523 BUSINESS ADDRESS: STREET 1: 5020 148TH AVE NE STREET 2: P O BOX 97002 CITY: REDMOND STATE: WA ZIP: 98073-9702 BUSINESS PHONE: 2068822000 MAIL ADDRESS: STREET 1: 5020 148TH AVE NE CITY: REDMOND STATE: WA ZIP: 98073-9702 10-K 1 FORM 10-K - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES 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, 1998 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 0-26778 ---------------------- APPLIED MICROSYSTEMS CORPORATION (Exact name of registrant as specified in its charter) ---------------------- WASHINGTON 91-1074996 (State of incorporation) (I.R.S. Employer Identification Number) 5020 148TH AVENUE N.E. , REDMOND, WASHINGTON 98052-5172 (425) 882-2000 (Address, including zip code, of Registrant's principal executive offices and telephone number, including area code) ---------------------- 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 the Form 10-K or any amendment to this form 10-K. (1) Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common stock: 6,680,688 shares outstanding as of March 19, 1999 The aggregate market value of the Common Stock held by non-affiliates of the registrant, based on the closing price on March 19, 1999, as reported on NASDAQ, was $10,786,791. (1) (1) Excludes shares held of record on that date by directors, officers and greater than 10% shareholders of the registrant. Exclusion of such shares should not be construed to indicate that any such person directly or indirectly possesses the power to direct or cause the direction of the management of the policies of the registrant. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's Proxy Statement relating to the registrant's 1999 Annual Meeting of Stockholders to be held on May 25, 1999, are incorporated by reference into Part III of this Report. This report including exhibits consists of 50 pages. The exhibit index appears on page 46. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TABLE OF CONTENTS
PAGE PART I. ITEM 1. Business............................................................................................1 ITEM 2. Properties.........................................................................................11 ITEM 3. Legal Proceedings..................................................................................11 ITEM 4. Submission of Matters to a Vote of Security Holders................................................11 ITEM 4A. Executive Officers of the Registrant...............................................................11 PART II. ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters..............................13 ITEM 6. Selected Financial Data............................................................................14 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.........................................................................................14 ITEM 7A. Qualitative and Quantitative Disclosures about Market Risk.........................................21 ITEM 8. Financial Statements and Supplementary Data........................................................22 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.........................................................................................42 PART III. ITEM 10. Directors and Executive Officers of the Registrant.................................................42 ITEM 11. Executive Compensation.............................................................................42 ITEM 12. Security Ownership of Certain Beneficial Owners and Management.....................................42 ITEM 13. Certain Relationships and Related Transactions.....................................................42 PART IV. ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................................43
-i- PART I ITEM 1. BUSINESS OVERVIEW Applied Microsystems Corporation is a leader and innovator in embedded systems solutions. Applied develops, markets and supports a comprehensive suite of software and hardware enhanced development and test tools and engineering services for the development of complex embedded microprocessor based applications. Embedded systems are used extensively in industries such as avionics, internetworking, telecommunications, computer peripherals, office products, medical instrumentation and industrial process control, as well as in consumer markets such as the automotive and entertainment industries. Embedded systems are found in a wide variety of products, including automotive braking systems, hospital patient monitors, airplane flight control systems, modems and facsimile machines, set-top boxes, cellular telephones, automated teller machines and video games. Applied's solutions enhance manufacturers' productivity which improves their product's "time-to-market". Applied does this by providing a set of solutions that are useful throughout a product's lifecycle. Applied's debug solutions assist customers with the development of software and the integration of software and hardware in creating the embedded product. These tools include low-cost solutions, such as CodeTAP-Registered Trademark- and NetROM-TM- tools, and full-featured tools such as our patented, compact SuperTAP-TM- emulator. Applied's CodeTEST-Registered Trademark- optimization and test solutions give customers a way to enhance the performance and quality of their designs. Rapid Evaluation and Development Solutions integrate all the main components of a productive development environment: software tools, board support packages and intellectual property, operating on a reference hardware platform for quick prototyping. Applied's consulting services group provides customers with solutions to fit their unique development environment, toolchain and real time operating systems as well as actual design services. Applied distributes its solutions through a network of direct sales and service offices located in the United States, Japan, and Europe, and distributors throughout the rest of the world. A sampling of Applied's customers include Alcatel, Ascend, Boeing, Cabletron, Canon, Cisco, DSC Communications, Eastman Kodak, Fujitsu, General Instruments, Hewlett Packard, Hitachi, Honeywell, IBM, International Games Technology, Lucent, Matsushita, Mitsubishi, Motorola, NEC, Newbridge, Nortel, NTT, OKI Electric, Panasonic, Qualcomm, Ricoh, Rockwell, Samsung, Siemens, Storage Technology, Tellabs, Toshiba, and Xerox. Applied was incorporated in Washington in 1979 and is headquartered at 5020 148th Avenue. NE, Redmond, Washington. The Company is ISO 9002 certified. For more information, visit Applied's home page on the World Wide Web: http://www.amc.com. BACKGROUND Manufacturers worldwide are making increasing use of embedded systems to enhance the functionality and performance, reduce the cost and size, and improve the reliability of a broad variety of products. Embedded systems are incorporated within electronic devices and are dedicated to performing specific tasks quickly and reliably in response to rapidly occurring external events. Embedded systems generally include an embedded microprocessor (often referred to as a microcontroller or MCU), a read-only memory ("ROM"), real-time operating system ("RTOS") software and custom software to implement assigned applications. Embedded systems are used extensively in industries such as avionics, -1- internetworking, telecommunications, computer peripherals, office products, medical instrumentation and industrial process control, as well as in consumer markets such as the automotive and entertainment industries. For example, cellular telephone switching systems use embedded systems to coordinate the routing and connection of thousands of simultaneous calls as users move from cell to cell. Use of embedded systems is now widespread among manufacturers of a wide variety of products, including automotive braking systems, hospital patient monitors, airplane flight control systems, modems and facsimile machines, set-top boxes, cellular telephones, automated teller machines and video games. Manufacturers are faced with an expanding competitive market that requires them to bring ever increasing complex products to market faster and at reduced costs. As the computing power of embedded microprocessors has grown and moved toward 32-bit architectures, and as unit prices for embedded microprocessors have declined, manufacturers have been able to incorporate vastly improved features, speed and reliability into their products at relatively low incremental cost. This additional sophistication has resulted in significantly larger and more complicated applications software and increased the challenges associated with delivering a product on schedule. The development of embedded systems using today's high-speed microprocessors requires the design, debugging and testing of substantial amounts of complex custom applications software ("embedded software"), which is typically written in a high-level programming language such as C or C++. As the complexity and volume of such software increases, the need to eliminate performance shortcomings, the potential for programming errors, and the difficulty of thoroughly testing the complete system all increase dramatically. As embedded systems are used increasingly in medical diagnostic equipment, avionics systems, communications and other applications where software errors may have serious consequences, the need for careful debugging and testing of embedded software increases. In their efforts to remain competitive, manufacturers are increasingly faced with the demands of two fundamental but conflicting pressures. As they incorporate increasing numbers of 32-bit embedded microprocessors into their products, these manufacturers must hire more software engineers, develop more embedded software, and intensify their debugging and testing efforts, all of which tend to lengthen product development cycles or increase development costs. At the same time, competitive demands for technologically superior products without corresponding cost increases and decreasing electronics product life cycles create pressures to minimize development costs and time-to-market. Applied's solutions are designed to help electronics manufacturers respond successfully to both of these conflicting demands. PRODUCTS Applied provides design, debugging and testing tools and services for use principally by software engineers in the development of embedded software and associated products. Applied designs its products to support major industry segments over a broad range of 16- and 32-bit embedded microprocessors primarily manufactured by AMD, ARM, Intel, Hitachi, MIPS and Motorola. The Company's products are designed to address three distinct requirements of embedded software developers: software design and debugging, optimization and testing, and services. The Company's products generally enable engineers to perform debugging functions in high-level programming languages, such as C or C++, and operate on IBM-compatible personal computers or engineering workstations produced by Hewlett-Packard or Sun Microsystems. The Company's tools also enable engineers to observe software interaction and functions with several commercially available RTOS products (including certain of those produced by Integrated Systems, Mentor Graphics, Microsoft and Wind River Systems) and to read file format output from compatible compilers (including certain of those produced by Borland, GNU, Intel, Metrowerks and Microsoft). -2- SOFTWARE DESIGN AND DEBUGGING TOOLS The Company manufactures a wide range of hardware-enhanced software tools for the design and debugging of embedded software. These in-circuit microprocessor and ROM emulators are utilized primarily by software engineers during the highly iterative software development and system integration phases of the embedded systems development process. To a lesser extent, they are also used by software engineers for low-level testing of software functions and by hardware engineers in system integration and troubleshooting their designs. The Company's emulators perform four basic functions or subset thereof depending on product configuration: - DOWNLOAD AND RUN CONTROL--the ability to load the developer's software program into the system under development, to specify predetermined events or problems that may occur in the course of software execution, to stop system operation upon such an occurrence and to resume operation at the desired point after any alterations have been made to the system or software. - EXECUTION TRACE--the ability to detect, observe and provide an execution history of detailed software instructions and flow by collecting this data in a minimally intrusive manner in the probe's random access memory, a capability particularly important in identifying bugs or timing problems, or in reconstructing the events leading up to a system failure. - OVERLAY MEMORY--the ability to replace the system's memory with memory residing in the emulator where embedded software can be debugged and modified easily before it is permanently "burned into" the system's ROM. - HIGH-LEVEL LANGUAGE DEBUGGING--the ability to display source code, data and relevant RTOS information, and to control each of the tool's other basic functions through a high-level language interface to the system under development. Applied offers a broad selection of hardware-enhanced software design and debugging tools with a variety of features and prices. The tools are accessed through a high level language debugger human interface licensed from CAD UL, Mentor Graphics, Metrowerks, or Paradigm and generally resold with the product. The market segments for these tools are broken down into low cost, feature focused products and high end, high cost products. The low cost, feature focused products consist of CodeTAP and SuperTAP tools that are pocket sized and provide basic to full featured capabilities; and NetROM which provides low cost target ethernet access and memory substitution. These tools support the latest generation of microprocessors primarily from Motorola (Power PC and CPU 32), Intel (Pentium and x86), Hitachi (SH), AMD (Elan and x86), ARM and MIPS. This segment represents the largest revenue category for Applied in 1998. Prices for these class of tools range from $3,000 to $20,000, depending on the model and configuration. The high end, high cost products consist of the EL Series and CodeICE emulators that represent previous generation technology and have a form factor similar to a desktop personal computer. These products are full featured and support older families of microprocessors from Motorola (680X0 series) and Intel (80960 series). Based upon a shift in designs to newer microprocessors, demand for these products has been in decline. Prices for these class of tools range from $15,000 to $35,000, depending on the model and configuration. -3- Applied believes it will be necessary to develop additional products in 1999 to support existing and future microprocessors, as well as to continue to enhance and broaden its user-interface technology with third parties. The process of developing such additional products is subject to the challenges and uncertainties normally associated with product development, and there can be no assurance that the Company will be able to complete these development efforts successfully or in a timely manner. SOFTWARE TESTING TOOLS The Company produces a line of software testing tools called CodeTEST, which are designed specifically to offer a broad range of optimization and testing capabilities to developers of embedded software. These tools are designed to measure the performance and reliability of embedded software, as well as the adequacy of the test process itself, in a minimally intrusive manner, and to present these measurements in a format designed to be understood easily by software engineers. These products are expected to be utilized by software engineers during the software development, system integration, and system test and validation phases of embedded systems development. CodeTEST software testing tools are designed to perform five basic functions: - COVERAGE ANALYSIS - Basic Block Coverage: the ability to measure the percentage of a software program's routines actually exercised by certain tests, to identify redundancies among tests, to identify the optimal set of tests to maximize the percentage of code tested in the shortest test period, and to determine the point at which the cost of continued testing is likely to exceed the benefits to be derived. - CODETEST-ACT, ADVANCED COVERAGE TOOLS - adds a finer degree of granularity for analyzing test execution to the Statement, Decision and Modified Condition Decision Coverage (MCDC) levels. For mandated industries like avionics, the FAA specifies test methodologies for each type of software application based on the criticality of that application. MCDC shows what conditions, as well as, what decision paths and code statements have been tested. - PERFORMANCE ANALYSIS - the ability to measure the time that a software program takes to perform a particular function and the degree of embedded microprocessor utilization, and to identify any hindrances to high-speed processing so that system reaction times and compliance with performance specifications can be optimized. - MEMORY ALLOCATION ANALYSIS - the ability to monitor the use of memory during software execution, and to identify likely "memory leaks" and other memory allocation errors, in order to improve programming reliability and aid in minimizing the size and cost of the embedded system's memory. - SOFTWARE EXECUTION TRACE - the ability to observe software functions from the source code level to the task level at any point in execution history, in order to address software performance or memory problems. The CodeTEST line includes six software modules sold separately (Performance, Basic Block Coverage, MCDC, Decision Coverage, Memory Analysis, Software Trace), and a separate hardware probe designed for use with a specific embedded microprocessor. CodeTEST supports the most popular 32bit microprocessors including Motorola (680X0, Power PC and CPU 32), Intel (80960, Pentium and x86), Hitachi (SH), AMD (29000, Elan and x86) and MIPS, as well as the VME Bus. Applied plans to support additional embedded microprocessors with additional releases during 1999, but there can be no assurance as to the success or timeliness of such development efforts. Prices for the Company's software testing tools range from $11,000 to $50,000, depending on the software modules purchased. -4- In 1997, Applied entered into an OEM agreement with a third party developer of real time operating systems for integration of certain CodeTest modules within their integrated development environment. In 1998, Applied released and began shipping a software only version of two CodeTEST modules, basic block coverage and memory analysis, through this third party. The modules run on the embedded target within the third parties integrated development environment. Applied plans on expanding software only CodeTEST with additional module releases and distribution channels during 1999. RAPID EVALUATION AND DEVELOPMENT SOLUTION In 1998, Applied began developing technology to assist manufacturers with their "time to market" challenge through the rapid evaluation and development of product prototypes. Applied has assembled through internal development, licensing and procurement, a set of solutions that includes software and hardware tools, intellectual property, and hardware platforms and displays for multiple microprocessor families. The manufacturer has the option to license the intellectual property for use in their resulting product based upon a run time license fee. The initial focus for the solution set is supporting Microsoft-Registered Trademark- Windows-Registered Trademark- CE operating system based upon an agreement entered into with Microsoft in the Spring of 1998. The first products were introduced in October, 1998 as the Foundation-CE-TM- Embedded Development Suite. The solution includes a system development kit with a single board computer, packaged with a pre-installed and fully configured version of Windows CE; target porting kit , including board support source code and hardware schematics; Microsoft Windows CE embedded tool kit (ETK) for C++ 5.0; and consulting and support services. Product became available for shipment in the first quarter of 1999 for Power PC and X86 and will be available in the second quarter for Hitachi SH3. Applied believes that continual investment will be necessary in the future to expand the intellectual property, software and hardware tools, operating system and microprocessor coverage. The process of developing such additional products is subject to the challenges and uncertainties normally associated with product development, and there can be no assurance that the Company will be able to complete these development efforts successfully or in a timely manner. CONSULTING SERVICES Applied offers manufacturers consulting services focused on assisting with technical and resource issues surrounding embedded product development. The level of services include onsite training and installation, customization of Applied's products, design review, product development and full turnkey design with limited production. The efforts are coordinated through a consulting services group at Applied's headquarters and are supported either through internal engineering personnel and/or outside sub-contractors. CUSTOMERS The Company's sales are presently concentrated primarily in the internetworking, telecommunications and computer peripherals segments of the electronics industry. In addition, sales to leasing and rental companies serving customers in Japan are a significant portion of net sales. During 1998 and 1997, sales to Orix Rentec, a leasing and rental company in Japan, accounted for 9.6% and 9.1% of net sales, respectively. The Company expects that a substantial portion of its net sales will continue to be concentrated among a relatively limited number of customers for the foreseeable future. Sales are generally made pursuant to purchase orders. -5- SALES, MARKETING AND CUSTOMER SUPPORT The Company markets its products and services primarily through its domestic and international direct sales organization. As of December 31, 1998, the Company had 78 sales and support employees worldwide, including 44 field sales engineers, inside sales specialists and field application engineers located at the Company's headquarters and in direct or home sales offices throughout North America, and in the Company's wholly-owned subsidiaries in Japan, Germany, France and the United Kingdom. Due to the highly technical nature of its products, the Company believes that an important aspect of its direct sales strategy is the technical support and training provided to customers, and that a high level of customer service and support is critical to customer adoption and successful utilization of design, debugging and testing technology. The Company's field application engineers offer ongoing support and product demonstration, and assist customers to incorporate the Company's design, debugging and testing tools into their design process. International sales represented 44.0%, 49.4% and 47.6% of the Company's net sales in 1998, 1997 and 1996, respectively. Sales through the Company's subsidiary in Japan accounted for 28.8%, 33.6% and 33.3% of the Company's net sales in 1998, 1997 and 1996, respectively. The Company also has international distribution agreements covering 24 countries. Sales to the Company's international distributors in 1998, 1997 and 1996 accounted for approximately 6.4%, 8.3% and 11.0%, respectively, of the Company's net sales. Generally, the Company's agreements with its international distributors have a term of 12 months and are exclusive on a country-by-country basis. The sale of software development tools in foreign countries involves risks associated with currency exchange rate fluctuations and restrictions, export-import regulations, customs matters, longer payment cycles, foreign collection problems, and military, political and transportation risks. The Company's sales through its foreign subsidiaries are generally denominated in foreign currencies. As a result, fluctuations in currency exchange rates can have a significant effect on the Company's sales, even in the absence of an increase or decrease of unit sales to foreign customers. For example, the Company estimates that currency fluctuations affecting sales by the Company's foreign subsidiaries, especially in Japan, accounted for a 2.3% decrease, a 3.7% decrease and a 7.0% decrease in the dollar value of the Company's net sales value in 1998, 1997 and 1996, respectively. In addition, foreign sales involve uncertainties arising from local business practices and cultural considerations, and risks associated with international trade tensions. Sales of the Company's products in Japan, in particular, are subject to the risks associated with trade tensions between the United States and Japan, which could adversely affect the volume of U.S.-manufactured microprocessors purchased by Japanese embedded systems developers, thus reducing the need for the Company's products in Japan. The Company expects that international sales, in particular sales in Japan, will continue to account for a significant portion of the Company's net sales in the future. The Company participates in cooperative marketing activities with other embedded systems development tools providers such as Enea Data, CadUL, Mentor Graphics, Metrowerks, Paradigm, Microware, Signus Systems, Integrated Systems and Wind River Systems and embedded microprocessor manufacturers, such as Intel, AMD, Motorola, MTI, IBM, IDT, Toshiba, Philips, NEC, Sony, LSI Logic and ARM. These relationships enable the Company to further leverage its technical capabilities, customer relationships and international sales and support infrastructure. The Company believes that developing and maintaining these relationships is important to its ability to achieve broad market penetration. The Company's marketing efforts also include attending trade shows, publishing articles and advertising in trade magazines and journals, direct mail and product demonstrations. The Company also maintains a home page on the World Wide Web at http://www.amc.com. The time between order and delivery of the Company's products is often quite short. The number of orders, as well as the size of individual orders, can vary substantially from month to month. Because -6- of the short period between order receipt and shipment of products, the Company typically does not have a meaningful backlog of unfilled orders and believes a backlog is neither significant to an understanding of its business nor representative of potential revenue for any future period. COMPETITION The market for tools used in the development of embedded software is fragmented, highly competitive and characterized by relatively low barriers to entry, with over 50 providers offering technical solutions to address the design, debugging, testing and service needs of embedded software developers. This market is also subject to rapid change, as technological developments create new needs and render prior technical solutions obsolete. The Company's ability to compete successfully in this market will depend on its ability to develop and introduce new products and features that address the increasingly sophisticated needs of its customers, to respond to technological advances, emerging industry standards and practices and competitive developments, and to implement relationships and acquisitions that enable it to broaden its product offerings. The principal competition for the Company's hardware-enhanced software design and debugging tools comes primarily from Hewlett-Packard, from various other domestic and international providers of in-circuit emulators, many of which focus primarily on developing products to support either Intel or Motorola microprocessors, and, to a lesser extent, from domestic providers of embedded microprocessor simulators, RTOS debugging software, logic analyzers, ROM monitors and ROM emulators. Competition for its CodeTEST product line will come principally from domestic providers of embedded debug software, emulators and logic analyzers, which are generally able to perform only portions of the software testing functions offered by CodeTEST tools. The Company has also historically experienced competition from the engineering departments of major manufacturers, which occasionally develop internal technical solutions to their design, debugging or testing problems. Competition among providers of embedded software design, debugging, testing and services focuses on a variety of factors, including the availability of tools that are compatible with the customer's chosen embedded microprocessor, engineering workstation and other software development equipment; performance characteristics and features such as high-speed processing, real-time visibility and control, high-level programming language and ease-of-use; product reliability; price/performance characteristics; customer service and worldwide support; and product availability and delivery time. The Company believes that the relative importance of each of these factors to a prospective customer varies for each development project depending upon the complexity of the embedded system design, the microprocessor to be used, the project development schedule and the software engineer's budget and experience level. The Company believes its products are most competitive in situations involving high-speed, complex 16- thru 64-bit microprocessor designs. The Company anticipates that the embedded systems development market is likely to experience consolidation as providers of various embedded software development tools strive to broaden their product offerings. The Company expects competition to increase from both established and emerging companies. The Company believes that much of its competition is now, and will increasingly be, from larger companies having substantially greater technical, financial and marketing resources, as well as larger customer bases and greater name recognition, than the Company. To compete effectively, the Company may find it necessary to enter into alliances with other providers, or to acquire other technologies or product lines, in order to broaden its product offerings. Some of the Company's competitors bundle their design and debugging solutions with sales of other embedded systems development products, and the Company anticipates that such competitive tactics may increase as competitors broaden their product offerings. Major semiconductor manufacturers have increasingly been incorporating features into their newer embedded microprocessors which facilitate visibility into and control over internal software debugging functions. This trend may further lower technological barriers -7- to entry and encourage new or lower-cost competition, and could render the Company's technologies or products wholly or partially unnecessary or obsolete. Increased competition could result in price reductions, reduced margins or loss of market share, any of which could materially adversely affect the Company's business, financial condition and results of operations. If the Company is unable to compete successfully against current and future competitors, its business, financial condition and results of operations will be materially adversely affected. MANUFACTURING The Company's manufacturing operations consist of the procurement and inspection of parts and components, assembly, software duplication, and extensive testing of components and finished products. The Company's products incorporate the Company's proprietary software, as well as software licensed from others. The Company conducts virtually all steps of the assembly process, including board assembly, at its facility in Redmond, Washington. The Company has a computerized manufacturing inventory control system which integrates and monitors purchasing, inventory control and production. The Company thoroughly inspects and tests its products during the manufacturing process and tests finished products using tests designed and developed internally based on the custom requirements and functionality of the product. In addition, the Company's products undergo thorough quality inspection and testing, including "burn-in" procedures throughout the manufacturing process to ensure the quality and reliability of the Company's products. The Company also requires that all employees involved in the assembly process undergo thorough training. The Company was ISO 9002 certified in December, 1995. The Company warrants that its hardware, software and mechanical parts will be free from defects in materials and workmanship for 90 days domestically and from 90 days to one year internationally depending on the product and location. The Company pursues a strategy of using the latest high-performance hardware components in the manufacture of its software development tools. A number of these product components, such as microprocessors, ASICs, standard integrated circuits, memory chips, connectors and cables, are available only from a single source or a limited number of distributors. The Company has entered into agreements with a number of its vendors that include provisions requiring the vendor to maintain specified levels of key parts and components. In addition, due to high demand and limits on production, it is typical for a number of key components to be on "allocation" at any given time. There can be no assurance that the Company will be able in the future to obtain key components in a timely manner, in sufficient quantities, or on favorable price terms. The Company has a limited ability to avoid or offset future price increases by suppliers of key components. If the Company were in the future to experience significant delays, interruptions or reductions in its supply of key components, or unfavorable price terms, its business, financial condition and results of operations could be materially adversely affected. Although the Company's customers occasionally forecast projected purchase requirements in advance of shipment dates, more frequently customers order on an as-needed basis and products are often shipped within a few weeks after an order is received. As a result, the Company's ability to plan production and inventory levels is limited. The need for immediate delivery by many customers, as well as the numerous products and configurations sold by the Company, requires the Company to maintain a relatively high level of parts in inventory. The Company is subject to a variety of federal, state and local governmental regulations related to the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in its manufacturing process. There can be no assurance that changes in environmental regulations will not impose the need for additional capital equipment or other requirements. Any failure by the Company to control the use of, or adequately to restrict the discharge of, hazardous substances under present or future -8- regulations could subject the Company to liability. The Company does not believe such liability would have a material adverse effect on the Company's business, financial condition and results of operations. RESEARCH AND DEVELOPMENT Applied has made and intends to continue making substantial investments in the development of new technologies and products. Because of the competitive importance of offering tools that are compatible with the particular microprocessors and other equipment to be used in developing embedded systems, tool providers are under continuing pressure to support major new families of embedded microprocessors, as well as advances in other development software and hardware. Applied believes that its future growth and financial performance will depend heavily on its ability to enhance its existing products, develop and introduce new products and features that address the increasingly sophisticated needs of its customers, and respond to technological advances, emerging industry standards and practices and competitive developments. Applied's engineering and development group includes 83 full-time employees. During 1998, 1997 and 1996, research and development expenses were $10.4 million, $8.5 million and $8.0 million. PROPRIETARY RIGHTS The Company's success will depend in part on its ability to protect its technology and to preserve its trade secrets. Although the Company relies primarily upon continuing technological innovations, trade secrets and know-how to develop and maintain its competitive position, it also relies on a combination of patent, copyright and trademark laws, confidentiality procedures and contractual provisions to protect its proprietary rights. The Company has limited patent protection, and there can be no assurance that any patents will provide a competitive advantage or will afford protection against competitors with similar technology, or will not be successfully challenged or circumvented by competitors. There can be no assurance that the trade secrecy and other measures taken by the Company will be adequate to prevent or deter misappropriation of its technology, or that competitors will not be able independently to develop technologies having similar functions or performance characteristics. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that the Company will have an adequate legal remedy to prevent or seek redress for future unauthorized misappropriations of the Company's technology. The Company has been issued two U.S. patents and a Japanese patent covering certain technology incorporated in the Company's CodeTAP and SuperTAP products. A corresponding European patent application has been published for purposes of opposition, and a competitor has filed an opposition which is presently under review. If the opposition is dismissed, the European patent will be registered in France, Germany and the United Kingdom. The U.S. patents will expire in 2010 and the foreign patents will expire in 2011. The embedded systems development market is characterized by rapid technological change, with frequent introductions of new products and technologies. As a result, industry participants often find it necessary to develop products and features similar to those introduced by others, increasing the risk that their products and processes may give rise to claims that they infringe the patents of others. Accordingly, the Company's current and future products and processes, or uses thereof, may conflict with patents that have been granted or may be granted to competitors or others. Such competitors or others could bring legal actions against the Company or its customers, claiming damages and seeking to enjoin manufacturing, marketing or use of the affected product or processes. Similarly, the Company may in the future find it necessary to commence litigation in order to enforce and protect its proprietary rights. If the Company becomes involved in such litigation, it could consume a substantial portion of the Company's resources and result in a significant diversion of management attention. If the outcome of any such litigation were adverse to the Company or its customers, the Company's business, financial condition and results of operations could be materially and adversely affected. In addition to any -9- potential liability for damages, the Company or its customers could be enjoined from continuing to manufacture or market the affected product or use the affected process, and could be required to obtain a license to continue to manufacture or market the affected product or use the affected process. There can be no assurance that the Company or its customers would prevail in any such action or that any license required under any such patent would be made available on acceptable terms, if at all . Third parties have in the past made patent infringement claims against the Company. In certain cases, the Company has resolved these claims by obtaining a license to the technology. The Company has also asserted claims of infringement of its trade secrets and certain of its patents against various competitors and in has brought suits to protect trade secrets and enforce patent rights relating to its CodeTAP product. In those instances, the competitors have settled by paying damages for past infringement and obtaining a license to the patented technology or have discontinued production of the infringing product. There can be no assurance as to the outcome of any pending or future claims, litigation or proceedings involving the Company's proprietary rights. Although the Company believes that it currently owns or has adequate rights to utilize all material technologies relating to its existing products, as it continues to develop new products and features it anticipates that it may find it desirable or necessary to obtain other nonexclusive or exclusive licenses from third parties entitling it to use certain technologies or software solutions. There can be no assurance that such licenses would be available to the Company on acceptable terms, if at all. The Company currently has licenses to several software programs, which are used in its design, debugging and testing products. Termination of any such agreement, or failure to renew any such agreement upon its expiration with respect to products the Company intended to continue to market, would require product redesign and could significantly increase the cost to the Company of manufacturing such products and have a material adverse effect on the Company's business, financial condition and results of operations. The Company's loss of or inability to obtain necessary or desirable licenses from third parties could have a material adverse effect on the Company's business, financial condition and results of operations. EMPLOYEES As of December 31, 1998, the Company had 262 employees, of whom 233 were based in the United States and 29 were based overseas. Of the total, 140 were engaged in Sales, General and Administrative, 83 were in research and development and 39 were in manufacturing. None of the Company's employees is represented by a labor union. The Company has not experienced any work stoppages and considers its relations with its employees to be good. -10- ITEM 2. PROPERTIES The Company's principal administrative, sales, marketing, research and development and manufacturing facility is located in an approximately 59,000 square-foot building in Redmond, Washington that is leased through May 31, 2001. The Company also leases nine other domestic sales and support offices in the United States and five international sales offices in Japan, France, Germany and the United Kingdom. The Company believes that its facilities are adequate to satisfy its projected requirements, including its requirements for production capacity into 1999 and that additional space will be available as needed. ITEM 3. LEGAL PROCEEDINGS From time to time, Applied is involved in legal proceedings, none of which is material. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are elected annually at the meeting of the Board of Directors held in conjunction with the annual meeting of stockholders. The following are the current executive officers of the Company:
NAME AGE POSITION ---- --- -------- Robert L. Deinhammer 53 Chairman of the Board Stephen J. Verleye 43 President, Chief Executive Officer and Director Douglas A. Fullaway 47 Executive Vice President A. James Beach 42 Vice President, Secretary, Treasurer and Chief Financial Officer Larry Ritter 40 Vice President and Division General Manager John Stressing 54 Vice President World Wide Sales
ROBERT L. DEINHAMMER joined the Company in July 1992 and served as a director since then. He assumed the role of Chairman of the Board in April 1999. From July 1992 through March 1999, he served as the Company's President and Chief Executive Officer. Before joining the Company, he served as an independent consultant from January 1991 to July 1992, and held senior management positions at several high-technology companies, including President and Chief Operating Officer of ADAC Laboratories from May 1985 to December 1990. From April 1984 to May 1985, Mr. Deinhammer served as President and Chief Operating Officer of Silicon General, after serving as Vice President and General Manager of one of its operating divisions from April 1979 to March 1984. STEPHEN J. VERLEYE will join the Company in April 1999 as its President, Chief Executive Officer and Director. Prior to joining the Company, Mr. Verleye spent six years at RadiSys Corp. first as its Vice President of Marketing, and subsequently served as the Company's Vice President of Business Development. In May 1996 he was appointed Vice President and General Manager, Commercial Equipment Division and in October 1998 he was appointed joint responsibility of the merged Automation Equipment Division. From 1986 to 1993, Mr. Verleye held various marketing management roles at Sequent Computer Systems, Inc., the most recent being Director of Product Marketing. From 1977 to 1986, Mr. Verleye held various sales and marketing roles at Intel. DOUGLAS A. FULLAWAY has served as the Company's Executive Vice President since July 1998 and has served as the Company's Vice President Worldwide Sales, since January 1995, after serving as Vice President, International Sales from November 1993 to December 1994. Prior to joining the Company, Mr. Fullaway held positions of increasing management responsibility at Mentor Graphics Corporation from January 1984 to October 1993, including Pacific Rim General Manager from August 1987 to August 1989, European Operations Manager from August 1985 to August 1987 and Manufacturing Manager from January 1984 to August 1985. From 1980 to 1983, he was employed by Tektronix Inc. in a variety of operational positions. -11- A. JAMES BEACH has served as the Company's Vice President and Chief Financial Officer since October 1992, and was elected Secretary and Treasurer in November 1992. Before joining the Company, Mr. Beach spent eight years at Microcosm Inc., where he served as Vice President of Finance & Administration from June 1984 to October 1988 and as President and General Manager from October 1988 to May 1992. Microcosm Inc. was acquired by Microtek International Inc. in April 1990. From April 1981 to June 1984, he served as a senior auditor with the Technology and Emerging Business Practice at the accounting and consulting firm of Deloitte & Touche. LARRY RITTER joined the Company as Director of Marketing in January 1995 and has served as the Company's Vice President and Division General Manager since February 1996. Before joining the Company, Mr. Ritter spent 15 years at Hewlett Packard where he served as Product Marketing Manager at the Colorado Springs Division from June 1992 to January 1995, and in various positions of increasing marketing and sales responsibility prior to June 1992. JOHN STRESSING joined the Company as Vice President of World Wide Sales in June 1998. Before joining the Company, Mr. Stressing spent 5 years at IKOS Systems where he served first as European Director, then as Vice President of International Sales before becoming Vice President of Worldwide Sales from August 1995 to May 1998. Prior to joining IKOS, he ran his own consulting firm, Premier Consultants, from January 1989 to October 1993. From 1985 to 1989 Mr. Stressing was European Director for Zycad and from 1981 to 1985 was a sales representative for Teradyne Incorporated. From 1968 to 1981, held various positions of increasing development and management responsibility at British Aerospace. -12- PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Applied Microsystems' common stock has been traded on the NASDAQ National Market System under the symbol APMC. The Company estimates that at March 19, 1999, there were approximately 3,000 beneficial owners of the common stock of the Company. The closing price of the Company's common stock as reported by the NASDAQ National Market on March 19, 1999 was $3.00 per share. The price per share in the following table sets forth the low and high closing prices in the NASDAQ National Market for the quarter indicated below:
LOW HIGH --- ---- 1996 First Quarter............................................ 7 3/4 12 3/4 Second Quarter........................................... 9 20 3/4 Third Quarter............................................ 11 1/4 23 7/8 Fourth Quarter........................................... 9 23 3/4 1997 First Quarter............................................ 4 7/8 16 Second Quarter........................................... 3 7/8 10 1/2 Third Quarter............................................ 8 12 7/8 Fourth Quarter........................................... 5 12 5/8 1998 First Quarter............................................ 4 1/2 8 7/8 Second Quarter........................................... 3 13/16 7 5/8 Third Quarter............................................ 2 5/8 4 5/8 Fourth Quarter........................................... 2 1/8 4 3/4
The Company has not paid dividends and does not plan to pay dividends on its common stock in the foreseeable future. Proceeds from the Company's initial public offering were $13.0 million net of costs. Since the offering, the Company has used $4.0 million to purchase capital equipment, $2.5 million to pay off bank debt, $.5 million to purchase a product line and the remaining proceeds of $6.0 million have been invested in short term commercial and government paper and money market funds. -13- ITEM 6 SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------ (in thousands, except for earnings per share) 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- STATEMENT OF INCOME DATA: Net sales..................................... $37,020 $39,124 $38,662 $31,039 $25,663 Cost of sales................................. 9,587 10,532 10,793 9,530 8,903 --------- ------- ------- ------- ------- Gross profit.................................. 27,433 28,592 27,869 21,509 16,760 Operating expenses: Sales, general and administrative....... 18,104 18,542 15,142 13,321 11,715 Research and development................ 10,438 8,468 7,988 6,275 4,482 --------- ------- ------- ------- ------- Total operating expenses................ 28,542 27,010 23,130 19,596 16,197 --------- ------- ------- ------- ------- Income from operations........................ (1,109) 1,582 4,739 1,913 563 Interest expense and other income............. 783 669 559 (154) (465) --------- ------- ------- ------- ------- Income (loss) before income taxes............. (326) 2,251 5,298 1,759 98 Provision for income taxes.................... 19 349 1,582 305 68 --------- ------- ------- ------- ------- Net income (loss)............................. (345) 1,902 3,716 1,454 30 --------- ------- ------- ------- ------- --------- ------- ------- ------- ------- Diluted income (loss) per share .............. ($0.05) $0.26 $0.52 $0.27 $ 0.01 Average number of common and equivalent shares outstanding...................... 6,811 7,297 7,097 5,329 3,502
DECEMBER 31, ------------------------------------------------------------------ (in thousands) 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- BALANCE SHEET DATA: Working capital............................... $20,116 $20,547 $19,415 $15,756 $1,800 Total assets.................................. 33,290 32,582 30,824 26,846 14,011 Long-term debt, net of current................ - - 15 68 385 Shareholders' equity.......................... 23,931 24,291 22,607 18,654 4,286
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with "Selected Consolidated Financial Data" and the Company's Consolidated Financial Statements and Notes thereto included elsewhere in this document. OVERVIEW From its inception in 1979 until 1994, the Company has focused on designing, manufacturing and marketing tools used in the debugging of embedded software. The Company's product line initially consisted primarily of chassis-style in-circuit emulators, highly technical tools utilized at that time by hardware engineers. In the late 1980s, customer demand focused increasingly on tools with greater speed, software sophistication, ease-of-use and price/performance value. By 1991, the Company's sales and profitability began to decline due to various factors, including a poorly targeted product development strategy, slowness in responding to changing customer requirements and increasing competition. Beginning in mid-1992, the Company assembled a new management team that devised and began implementing a new business strategy. As a part of this new strategy, management effected a restructuring of the Company, which included significant headcount reductions and a refocusing of its product line by concentrating marketing and engineering activity on new hardware-enhanced software tools for use with a broad range of Intel and Motorola 16- and 32-bit embedded microprocessors, employing advanced hardware designs to reduce size and cost, and emphasizing ease-of-use by software engineers. Following this restructuring, the Company reengineered its pocket-sized CodeTAP emulator in late 1993; introduced its compact and more affordable CodeICE emulator in 1994; and began shipping CodeTEST software testing tools focused on embedded test in late 1995. In 1996, the Company released SuperTAP, which brings full featured emulation into a CodeTAP form factor. In 1997, the Company -14- released CodeTEST(R)-ACT, an enhanced suite of MCDC software test and analysis tools for C language applications, and CodeTRACE(TM), a source-level trace analysis tool. The Company's strategy has resulted in lower average selling prices and increased unit volumes. The Company's sales through its foreign subsidiaries are generally denominated in foreign currencies, and as a result fluctuations in currency exchange rates can have a significant effect on the Company's reported net sales. The effect of currency exchange rate fluctuations on the Company's net sales is dependent in part upon the Company's pricing policies. The Company is, however, unable to predict currency exchange rate fluctuations and anticipates that such fluctuations will continue to affect its net sales to varying degrees in the future. The Company expects international sales, especially in Japan, to continue to account for a significant percentage of its net sales. To enhance its competitive position, it will be necessary for the Company to continue developing its technology base and broadening its product offerings to address additional needs within the embedded software development process. These objectives may require expansion of the Company's internal product development efforts or acquisitions of or investments in complementary businesses, products or technologies in related market segments. The Company believes that the growth rates reflected in results of operations for prior periods should not be relied upon as an indication of growth rates for future periods. The Company also believes that competition is likely to increase, which could result in loss of market share, price reductions or reduced margins, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain items from the Company's Consolidated Statements of Income, expressed as a percentage of sales.
YEAR ENDED DECEMBER 31, -------------------------------------------------------------------- 1998 1997 1996 ---- ---- ---- Net sales................................... 100.0% 100.0% 100.0% Cost of sales............................... 25.9 26.9 27.9 ----- ----- ----- Gross profit................................ 74.1 73.1 72.1 Operating expenses: Sales, general and administrative..... 48.9 47.4 39.2 Research and development.............. 28.2 21.6 20.7 ----- ----- ----- Total operating expenses.............. 77.1 69.0 59.9 ----- ----- ----- Operating income (loss)..................... (3.0) 4.1 12.2 Interest expense and other income........... 2.1 1.7 1.5 ----- ----- ----- Income (loss) before income taxes........... (0.9) 5.8 13.7 Income taxes................................ 0.0 0.9 4.1 ----- ----- ----- Net income (loss)........................... (0.9%) 4.9% 9.6% ----- ----- -----
NET SALES Net sales decreased by 5.4% to $37.0 million in 1998 from $39.1 million in 1997 and increased by 1.2% in 1997 from $38.7 million in 1996. The decrease in 1998 over 1997 was primarily attributable to a decline in unit sales of high end debug products and to a lesser extent currency exchange rate fluctuations affecting the dollar value of international sales which were partially offset by an increase in unit growth and average selling price of low cost debug tools and to a lesser extent patent license royalties and consulting services. Net sales increased slightly in 1997 over 1996 which was primarily attributable to the unit growth and average selling price in sales of low cost debug tools and to a lesser extent increase in units sales of CodeTEST tools and an increase in support contract revenues which were partially offset by a decline in unit sales of higher priced debug tools and to a lesser extent currency -15- exchange rate fluctuations affecting the dollar value of international sales. The Company's net sales are presently derived predominantly from sales of software design, debugging and testing tools. The Company's net sales also include product support revenues, which represented 12.6%, 11.9% and 8.3% of net sales in 1998, 1997 and 1996, respectively, as well as increased patent license royalties and fees from consulting services. The Company generally recognizes revenues from product sales upon shipment, and recognizes product support revenues ratably over the life of each maintenance contract, typically 12 months, and consulting revenues as performed. See Note 1 of Notes to Consolidated Financial Statements. International sales represented 44.0%, 49.4% and 47.6% of total net sales in 1998, 1997 and 1996, respectively. International sales outside of North America in U.S. dollars decreased by 15.7% in 1998 over 1997, and increased by 4.9% in 1997 over 1996. The decrease in 1998 over 1997 is attributable to a reduction in units sales and average selling price directly related to the Asian financial crisis, particularly in Japan and Korea, partially offset by an increase in unit sales in Europe. The increase in 1997 over 1996 is attributable to increased unit sales primarily in Asia, which is due primarily to increased sales and marketing efforts. The Company estimates that unfavorable currency rate fluctuations affecting the dollar value of sales by the Company's foreign subsidiaries, especially in Japan, resulted in a 2.3% reduction in the dollar value of the Company's net sales in 1998 based upon the change from the average 1997 rate and a 3.7% reduction in the dollar value of 1997 based upon the change in the average 1996 rate. GROSS PROFIT Cost of sales included materials, labor and overhead incurred in the manufacturing of products as well as the cost of providing consulting services and maintenance. Gross profit margins as a percentage of net sales were 74.1%, 73.1% and 72.1% in 1998, 1997 and 1996, respectively. The increase in 1998 over 1997 was primarily attributable to an increase in the percentage of net sales of newer low cost debug products that have lower material costs as a percentage of sales price and to a lesser extent an increase in royalties and software licenses which were partially offset by lower production over which to spread fixed manufacturing overhead costs and, to a lesser extent, due to declines in sales revenue due to unfavorable currency exchange rate fluctuations. The increase in 1997 over 1996 was primarily attributable to an increase in the percentage of net sales attributable to newer low cost debug and CodeTEST products that have lower material costs as a percentage of sales price and to a lesser extent an increase in higher margin support contract revenue and favorable cost reductions on certain hardware components which were partially offset by declines in sales revenue due to unfavorable currency exchange rate fluctuations and an increase in factory overhead. The Company expects its gross profit to fluctuate based upon its product mix, geographic mix, product and patent licenses and variances in volume and related absorption of factory overhead costs. Accordingly, there can be no assurance that the Company will be able to sustain its recent gross margins. SALES, GENERAL AND ADMINISTRATIVE Sales, general and administrative expenses were $18.1 million or 48.9% of net sales, $18.5 million, or 47.4% of net sales and $15.1 million, or 39.2% of net sales, in 1998, 1997 and 1996, respectively. The dollar amount slightly decreased in 1998 over 1997 was due to a reduction in foreign currency exchange losses and reduction in general operating expenses partially offset by increased headcount and compensation related expenses and promotional costs in connection with the company's expansion of its sales and marketing efforts. The percentage between comparable periods was basically the same due to the continued budgeted investment in sales and marketing and lower than anticipated revenues. The dollar amount increase in 1997 over 1996 was primarily attributable to increased compensation-related expenses resulting principally from increased headcount and compensation related expenses, and to a lesser extent, increases in operating expenses, promotional costs and foreign exchange -16- losses. The percentage increase between comparable periods was primarily attributable to lower than anticipated revenues for the year as compared to the increase in budgeted costs. The Company expects its sales and marketing expenditures to continue to increase in absolute dollars in the future as it introduces and markets new products, and continues to expand its sales, general and administrative organization. Foreign exchange gains and losses are included in sales, general and administrative expenses. In order to mitigate certain intercompany risks associated with exchange rate fluctuations, the Company, does from time to time, hedge a portion of its foreign exchange risk in Japan as it relates to the trade debt the Company's Japanese subsidiary owes to the Company. Although the Company generally plans to continue to engage in exchange rate hedging activities with respect to certain exchange rate risks, there can be no assurance that it will do so or that any such activities will successfully protect the Company against such risks. RESEARCH AND DEVELOPMENT Research and development expenses were $10.4 million or 28.2% of net sales, $8.5 million, or 21.6% of net sales and $8.0 million, or 20.7% of net sales, in 1998, 1997 and 1996, respectively. The dollar amount increase in 1998 over 1997 was primarily attributable to an increase in contract labor, headcount and compensation related expenses which was partially offset by a reduction in prototype expenses. The dollar amount increase in 1997 over 1996 was primarily attributable to a decrease in external development funding received from third parties that offsets expenses and to an increase in hardware prototype related costs. The Company intends to continue to make substantial investments in product development, including development of software design, debugging and test tools for additional embedded microprocessors as well as continued advanced development in future directions. As a result, the Company anticipates that net research and development expenses are likely to increase for the foreseeable future. INCOME TAXES The Company's income tax provision for 1998, 1997 and 1996 reflect utilization of Net Operating Loss (NOL) and General Business Credit carryforwards. As of December 31, 1998 the Company had remaining NOL carryforwards of $3.5 million and research and development credit carryforwards of $1.7 million, both of which will expire in various amounts through 2018. The utilization of these amounts in the future is subject to an annual limit of approximately $392,000 under the Internal Revenue Code. As a result of these limitations, the Company anticipates that in the future its effective tax rate will approach the statutory rate in future years. A full valuation allowance has been established for net deferred tax assets due to the uncertainty whether they will be realized. See Note 7 of Notes to Consolidated Financial Statements. QUARTERLY RESULTS OF OPERATIONS The Company's results of operations have in the past fluctuated substantially from quarter to quarter, and the Company expects such fluctuations to continue as a result of a variety of factors. Product and price competition, research and development requirements, the volume and timing of customer development projects and orders, introductions of new embedded microprocessors, announcements or introductions of new products or technologies by the Company or its competitors, foreign currency exchange rates, investments in marketing and distribution, price increases by suppliers, parts shortages, conditions in the embedded systems market and the electronics industry in general, and national and global economic conditions may be expected to cause significant variations in the Company's quarterly operating results. As a result, the results of operations for any quarter are not necessarily indicative of -17 results for any future period. Moreover, a significant portion of the Company's net sales in each quarter generally results from shipments during the last few weeks of the quarter. LIQUIDITY AND CAPITAL RESOURCES The Company requires capital principally for the financing of inventory, capital equipment and accounts receivable, and for investment in product development activities and new technologies. To date, the Company has financed its operations primarily through cash flow from operations, bank borrowings and private placements of equity securities. In November 1995, the Company completed its initial public offering pursuant to which it sold 1,500,000 shares of common stock and received net proceeds of approximately $13 million. During 1998, the Company generated $1.8 million of cash from operations; utilized $1.3 million of cash for equipment purchases; and utilized $15,000 of cash for net debt reduction. As of December 31, 1998, the Company had working capital of $20.1 million, including $17.1 million of cash and cash equivalents. The Company has revolving credit facilities aggregating $7.0 million from a commercial bank. There were no outstanding balances under these facilities as of December 31, 1998. The credit facilities bear interest at the bank's floating prime rate and are unsecured. The loan documents also contain customary negative covenants. The credit facilities expire in May 1999 and the Company anticipates renegotiating a new line at comparable terms. The Company currently has no specific commitments with regard to capital expenditures, but expects to spend an aggregate of approximately $1.5 million in 1999 for new capital equipment. The Company anticipates that its annual capital expenditures will increase gradually in the future as a function of replacement cycles and anticipated growth of the Company's business. The Company's capital needs may be further affected by its plans to broaden product offerings through a combination of internal development, third party relationships and acquisitions of other business products or technologies. The Company believes that its current cash and cash equivalent balances at year end together with funds from operations and borrowings, will provide the Company with sufficient funds to finance its operations for at least the next 12 months. The Company's future capital requirements will, however, depend on a number of factors, including costs associated with product development efforts, the success of the commercial introduction of the Company's products and the acquisition of complementary businesses, products or technologies. To the extent additional capital is required, the Company may sell additional equity, debt or convertible securities, or obtain additional credit facilities. IMPACT OF YEAR 2000 The Company is taking steps to evaluate and minimize the risk presented by the potential impact of the Year 2000 issue. The Company formed a committee to conduct an assessment of the Company's preparedness for the Year 2000, as well as the preparedness of third parties relevant to the Company's business. The assessment consists of five phases: Awareness, which consists of making Company personnel, and those at third parties, aware of the Year 2000 issue; Inventory, which consists of identifying the Company's operations or systems which are Year 2000 sensitive; Analysis, which consists of determining whether sensitive areas will in fact be adversely impacted by Year 2000 issues; Remediation, which consists of addressing potential Year 2000 issues; and Contingency Planning, which consists of developing strategies for those areas where remediation may not be effective or practicable. In conducting its assessment, the committee evaluated the Company's internal information systems, the engineering and product development software, the Company's hardware, and general facilities infrastructure. The assessment has been completed for the Company's information system and general facilities infrastructure. The Company has completed the awareness, inventory and analysis phases with -18- respect to other systems. Based on results of these analyses , the Company believes the remediation phase will be completed prior to March 31, 1999. The Company anticipates that it will complete its contingency planning within 2 months after completing the other phases of its assessment. The Company's business operations information system was upgraded in the standard course of systems maintenance early in 1998. The current version has been certified by Oracle to be Year 2000 compliant. The Company is currently in the analysis phase with respect to its assessments of its own product. The Company believes it will have completed the analysis and remediation by March, 1999. The Company estimates that it has expended approximately $100,000 in assessing and re-mediating internal Year 2000 issues, in addition to those upgrades that have been made as part standard system maintenance. The Company does not believe that its assessment and remediation activities have resulted in any material delay or deferral of systems maintenance or upgrades. The Company believes the additional aggregate costs of its internal assessment and upgrade, other than those implemented in the course of normal maintenance and equipment upgrades, will not exceed $150,000, to be expended over the next two to three quarters. The Company cannot predict yet the effect of the Year 2000 problem on its suppliers or the resulting effect on the Company. The Company has not yet developed a contingency plan to operate in the event that critical systems of vendors, suppliers, or other third parties are not Year 2000 compliant and have a material adverse effect on the Company. The Company expects to develop such contingency plan by April 30, 1999. If any of the Company's critical systems are not in fact Year 2000 compliant, or if preventive and/or corrective actions by those entities with whom the Company does business are not made in a timely matter, the Year 2000 issue could have a material adverse effect on the Company's business, financial condition, and results of operations. OUTLOOK: ISSUES AND UNCERTAINTIES The Company does not provide forecasts of future financial performance or sales volumes, although this Annual Report contains certain other forward-looking statements that involve risks and uncertainties. The Company may, in discussions of its future plans, objectives and expected performance in periodic reports filed by the Company with the Securities and Exchange Commission (or documents incorporated by reference therein) and in written and oral presentations made by the Company, include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 or Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements are based on assumptions which the Company believes are reasonable, but are by their nature inherently uncertain. In all cases, there can be no assurance that such assumptions will prove correct or that projected events will occur. Actual results could differ materially from those projected depending on a variety of factors, including, but not limited to, the issues discussed below. While Company management is optimistic about the Company's long-term prospects, the following issues and uncertainties, among others, should be considered in evaluating its growth outlook and for forward-looking statements. RAPIDLY CHANGING TECHNOLOGY AND PRODUCT DEVELOPMENT UNCERTAINTIES. The introduction of products embodying new technologies and the emergence of new industry standards and practices can render existing products obsolete and unmarketable. The Company's future business, financial condition and results of operations will depend upon its ability to anticipate market demand for specific embedded microprocessors, develop new products and features that address the increasingly sophisticated needs of its customers, and respond to technological advances and emerging industry standards and practices. MANUFACTURING UNCERTAINTIES. A number of the Company's components are manufactured by a single source or distributed through a limited number of outlets. There can be no assurance that the -19- Company will be able in the future to obtain key components in a timely manner, in sufficient quantities, or on favorable price terms. PRODUCT SHIP SCHEDULES. Delays in new-product releases could impact revenue growth rates and cause the Company's customer base to become dissatisfied and erode. PRICES. Prices the Company can obtain for its products may decrease from historical levels, depending on competitive market or cost factors which could have an adverse effect on revenues and gross margin. COST OF SALES. Although cost of sales as a percentage of net sales decreased in 1997 and 1998, it varies with channel mix and product mix within channels. Such mix factors may increase cost of sales as a percentage of revenues in future periods. SEMICONDUCTOR MANUFACTURERS. A substantial decline in the number of design starts for 16-bit or 32-bit embedded microprocessors produced by Intel, AMD or Motorola or delays by such manufacturers in the release of embedded microprocessors for which the Company has developed tools could have an adverse effect on the Company's revenues. INDUSTRY FOCUS. The Company's sales are concentrated primarily in the internetworking, telecommunications and computer peripherals markets and any negative events affecting the electronics industry or these markets in particular could have an adverse effect on revenues. COMPETITION. The Company expects competition to increase from established and emerging companies. Sales and marketing and research and development costs may increase in dollar amounts and as a percentage of sales in order for the Company to successfully compete. KEY PERSONNEL. The Company believes that its future success will depend largely upon its ability to retain and attract key personnel and skilled employees. MANAGEMENT OF GROWTH. The Company plans to continue to invest in product lines and sales and marketing. The Company's growth plans will present management, competitive and other challenges to the Company's managers and employees. INTELLECTUAL PROPERTY. The Company's success will depend in part on its ability to protect its technology and preserve its trade secrets. PRODUCT LIABILITY. The use of the Company's tools in the development of embedded systems that are incorporated in products used by or affecting the general public, or that otherwise pose a risk of serious consequences if they do not perform flawlessly under critical conditions, could expose the Company to significant product liability claims. GLOBAL ECONOMIC CONDITIONS. Almost half of the Company's business occurs outside of North America. Economic crisis in any of these regions could have a material adverse effect on the Company's business. FOREIGN EXCHANGE. A large percentage of the Company's sales, costs of sales and marketing is transacted in local currencies. As a result, the Company's international results of operations are subject to foreign exchange rate fluctuations. -20- LITIGATION. The Company may become subject to litigation regarding intellectual property rights, patents, and copyrights. If an adverse judgment were entered against the Company, such a proceeding could adversely affect the Company's financial condition and results of operation. ITEM 7A..QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK The Company develops products in the United State and sells in North America, Asia and Europe. As a result, financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since sales are currently priced in U.S. Dollars and translated to local currency amounts, a strengthening of the dollar could make the Company's products less competitive in foreign markets. Interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of Company investments are in short-term instruments. Due to the nature of these short-term investments, the Company has concluded that there is no material market risk exposure. -21- ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA APPLIED MICROSYSTEMS CORPORATION INDEX TO FINANCIAL STATEMENTS
AUDITED ANNUAL FINANCIAL STATEMENTS: PAGE ---- Report of Ernst & Young LLP, Independent Auditors................................................................23 Balance Sheets as of December 31, 1998 and 1997..................................................................24 Statements of Operations for the Years Ended December 31, 1998, 1997 and 1996....................................25 Statements of Stockholders' Equity for the Years Ended December 31, 1998, 1997 and 1996........................26 Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996....................................27 Notes to Financial Statements....................................................................................28
-22- REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Shareholders and Board of Directors Applied Microsystems Corporation We have audited the accompanying consolidated balance sheets of Applied Microsystems Corporation as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule 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 consolidated 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, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Applied Microsystems Corporation at December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Seattle, Washington February 2, 1999 -23- APPLIED MICROSYSTEMS CORPORATION CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 1997 ------------------ ------------------ (in thousands) ASSETS Current assets: Cash and cash equivalents.................................................. $ 6,041 $ 6,336 Short term investments..................................................... 11,101 10,345 Accounts receivable, net of allowance for sales returns and doubtful accounts of $649 and $611, respectively.................................... 8,483 7,741 Inventories................................................................ 3,332 3,465 Prepaid and other current assets........................................... 518 951 ------------------ ------------------ Total current assets....................................................... 29,475 28,838 Property and equipment, net................................................ 2,918 2,900 Other assets............................................................... 897 844 ------------------ ------------------ Total assets............................................................... $33,290 $32,582 ------------------ ------------------ ------------------ ------------------ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable........................................................... $3,283 $2,804 Accrued payroll............................................................ 1,840 1,684 Other accrued expenses..................................................... 1,129 991 Deferred revenue........................................................... 3,107 2,797 Current portion of long-term obligations................................... ---- 15 ------------------ ------------------ Total current liabilities.................................................. 9,359 8,291 Shareholders' equity: Preferred stock, par value $.01 Authorized - 5,000,000 shares ---- ---- Common stock, par value $.01 Authorized - 25,000,000 shares Issued - 6,681,000 shares (6,827,000 shares in 1997) 25,383 26,387 Cumulative translation adjustment.......................................... 120 (869) Accumulated deficit........................................................ (1,572) (1,227) ------------------ ------------------ Total shareholders' equity................................................. 23,931 24,291 ------------------ ------------------ Total liabilities and shareholders' equity................................. $ 33,290 $ 32,582 ------------------ ------------------ ------------------ ------------------
See accompanying notes. -24- APPLIED MICROSYSTEMS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, -------------------------------------------------------------- 1998 1997 1996 ------------------ ------------------ ------------------ (in thousands, except per share amounts) Net sales............................................ $ 37,020 $ 39,124 $ 38,662 Cost of sales........................................ 9,587 10,532 10,793 ------------------ ------------------ ------------------ Gross profit......................................... 27,433 28,592 27,869 Operating expenses: Sales, general and administrative.................... 18,104 18,542 15,142 Research and development............................. 10,438 8,468 7,988 ------------------ ------------------ ------------------ Total operating expenses............................. 28,542 27,010 23,130 ------------------ ------------------ ------------------ Income (loss) from operations....................... (1,109) 1,582 4,739 Interest income and other............................ 784 682 601 Interest expense..................................... (1) (13) (42) ------------------ ------------------ ------------------ Income (loss) before income taxes.................... (326) 2,251 5,298 Income taxes......................................... 19 349 1,582 ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ Net income (loss).................................... ($345) $1,902 $3,716 ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ Basic income (loss) per share........................ ($0.05) $0.28 $0.57 Shares used in basic per share calculation........... 6,811 6,769 6,545 Diluted income (loss) per share...................... ($0.05) $0.26 $0.52 Shares used in diluted per share calculation......... 6,811 7,297 7,097
See accompanying notes. -25- APPLIED MICROSYSTEMS CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
ACCUMULATED OTHER TOTAL COMMON STOCK ACCUMULATED COMPREHENSIVE SHAREHOLDERS SHARES AMOUNT DEFICIT INCOME (LOSS) EQUITY ------ ------ ------- ------------- ------ (in thousands) Balance at December 31, 1995 6,468 $25,655 ($6,845) ($156) $18,654 Issuance of common stock upon exercise of common stock warrants.............. 35 ---- ---- ---- ---- Stock options exercised..... 115 23 ---- ---- 23 Income tax benefit from stock plans................. ---- 204 ---- ---- 204 Sale of common stock to employees................... 16 186 ---- ---- 186 Comprehensive income: Net Income................ ---- ---- 3,716 ---- 3,716 Foreign currency translation adjustment... ---- ---- ---- (176) (176) ---------------- Comprehensive income........ 3,540 ---------------- ---------------- --------------- ---------------- ---------------- Balance at December 31, 1996 6,634 26,068 (3,129) (332) 22,607 Issuance of common stock upon exercise of common stock warrants.............. 59 ---- ---- ---- ---- Stock options exercised..... 88 17 ---- ---- 17 Income tax benefit from stock plans................. ---- 55 ---- ---- 55 Sale of common stock to employees................... 46 247 ---- ---- 247 Comprehensive income: Net Income................ ---- ---- 1,902 ---- 1,902 Foreign currency translation adjustment... ---- ---- ---- (537) (537) ---------------- Comprehensive income........ 1,365 ---------------- ---------------- --------------- ---------------- ---------------- Balance at December 31, 1997 6,827 26,387 (1,227) (869) 24,291 Stock options exercised..... 126 12 ---- ---- 12 Sale of common stock to employees................... 55 194 ---- ---- 194 Stock repurchase............ (327) (1,210) ---- ---- (1,210) Comprehensive income: Net Loss.................. ---- ---- (345) ---- (345) Foreign currency translation adjustment... ---- ---- ---- 989 989 ---------------- Comprehensive income........ 644 ---------------- ---------------- --------------- ---------------- ---------------- ---------------- ---------------- --------------- ---------------- ---------------- Balance at December 31, 1998 6,681 $25,383 ($1,572) $120 $23,931 ---------------- ---------------- --------------- ---------------- ---------------- ---------------- ---------------- --------------- ---------------- ----------------
See accompanying notes. -26- APPLIED MICROSYSTEMS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, -------------------------------------------------------------- 1998 1997 1996 ------------------ ------------------ ------------------ (in thousands) Cash flows from operating activities: Net income (loss).................................... ($345) $1,902 $3,716 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization................... 1,219 1,148 1,116 Changes in operating assets and liabilities: Accounts receivable............................. (742) 2,520 (2,751) Inventories..................................... 133 (268) (52) Prepaid expenses and other current assets....... 433 69 (566) Other assets.................................... (13) (217) (96) Accounts payable and accrued expenses........... 773 82 (566) Deferred revenue................................ 310 101 862 ------------------ ------------------ ------------------ Net cash provided by operating activities... 1,768 5,337 1,663 Cash flows from investing activities: Purchase of short-term investments.............. (756) (4,414) (5,931) Property and equipment additions................ (1,277) (1,469) (1,261) ------------------ ------------------ ------------------ Net cash used in investing activities....... (2,033) (5,883) (7,192) Cash flows from financing activities: Sale of common stock to employees..............` 194 247 186 Stock options exercised......................... 12 17 23 Stock repurchase................................ (1,210) ---- ---- Repayment of long-term obligations.............. (15) (53) (67) ------------------ ------------------ ------------------ Net cash provided by (used in) financing activities.................................. (1,019) 211 142 Effects of foreign exchange rate changes on cash..... 989 (537) (176) ------------------ ------------------ ------------------ Decrease in cash and cash equivalents................ (295) (872) (5,563) Cash and cash equivalents at beginning of year....... 6,336 7,208 12,771 ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ Cash and cash equivalents at end of year............. $6,041 $6,336 $7,208 ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ Supplemental disclosures of cash paid: Interest........................................ $1 $13 $42 Income Taxes.................................... $128 $642 $1,320 Supplemental disclosures of non-cash activities: Tax benefit realized from non-qualifying dispositions of stock ---- $55 $204 options.........................................
See accompanying notes. -27- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES Applied Microsystems Corporation (the Company) is a leader and innovator in embedded systems solutions. Applied develops, markets and supports a comprehensive suite of software and hardware enhanced development and test tools and engineering services for the development of complex embedded microprocessor based applications. The Company markets its products and services primarily through its domestic and international direct sales organizations in the United States, Japan, the United Kingdom, Germany, and France, and is supplemented with distributors throughout the rest of the world PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Applied Microsystems Corporation Limited (AML), Applied Microsystems Japan Limited (AMJ), Applied Microsystems Gmbh (AMG), Applied Microsystems SARL (AMF) and Applied Microsystems Foreign Sales Corporation (FSC). All significant intercompany accounts and transactions are eliminated in consolidation. INVENTORIES Inventories, including demonstration equipment, are stated at the lower of cost (first-in, first-out basis) or market. CASH EQUIVALENTS The Company considers all highly liquid investments purchased with an initial maturity of three months or less to be cash equivalents. SECURITIES AVAILABLE FOR SALE Securities available for sale consist primarily of investment-grade corporate obligations, all of which mature in 1999. Management currently classifies the Company's entire investment portfolio as available for sale. The portfolio is stated at fair value based on quoted market prices. Interest earned on securities available for sale is included in interest income. The cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion are included in interest income. Realized gains and losses and declines in value judged to be other than temporary on securities available for sale (none in 1998, 1997 or 1996) are also included in interest income. The cost of securities sold is calculated using the specific identification method. FINANCIAL INSTRUMENTS The Company's financial instruments consist of cash and cash equivalents, accounts receivable and payable, and long-and short-term borrowings. The fair value of these instruments approximates their recorded value. -28- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment are carried at cost. The Company provides for depreciation and amortization using the straight-line method for financial reporting purposes and accelerated methods for income tax purposes. Depreciation expense includes amounts amortized for assets recorded under capital leases. The estimated useful lives of equipment for financial reporting purposes are as follows:
Machinery and equipment............................................3 to 5 years Office furniture and equipment....................................5 to 15 years
LONG-LIVED ASSETS The Company's policy to recognize impairment losses relating to long-lived assets is based on several factors, including, but not limited to, management's plans for future operations, recent operating results and projected cash flows. REVENUE RECOGNITION The Company adopted Statement of Position 97-2, "Software Revenue Recognition" effective January 1, 1998, as it relates to revenue recognition on the Company's software product sales. Generally, revenues from sales of products are recognized when products are shipped unless the Company has obligations remaining under a sales or licensing agreement, in which case revenue is deferred until all obligations are satisfied. Revenues from sales of maintenance contracts are deferred and recognized ratably over the contract period. Revenues from maintenance contracts in 1998, 1997, and 1996 were $4,671,000, $4,644,000, and $3,158,000, respectively. Revenues from consulting services are recognized as performed. In December 1998, the AICPA issued SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition", with respect to certain transactions. SOP 98-9 amends SOP 97-2 and SOP 98-4 extending the deferral of the application of certain provisions of SOP 97-2 amended by SOP 98-4 through fiscal years beginning on or before March 15, 1999. All other provisions of SOP 98-9 are effective for transactions entered into in fiscal years beginning after March 15, 1999. We have not yet determined the effect of the final adoption of SOP 98-9 on our financial condition or results of operations. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. -29- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) RESEARCH AND DEVELOPMENT COSTS Research and development costs are expensed as incurred. The Company's policy is to capitalize software development from the time "technological feasibility" has been reached in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed". Technological feasibility is reached upon completion of a working model. No such costs have been capitalized because the impact on the accompanying consolidated financial statements would be immaterial. ACQUIRED TECHNOLOGY Costs to acquire technology are capitalized to the extent the products are technologically feasible. Costs of acquired technology capitalized are included in other assets in the balance sheet. The Company's policy is to amortize these costs to match the associated revenue stream for the products containing the acquired technology. As of December 31, 1998 and 1997, amounts capitalized, net of accumulated amortization of $139,000 and $139,000, were $553,000 and $561,000, respectively. Amortization expense was $150,000, $92,000 and $47,000 for the years ended December 31, 1998, 1997 and 1996, respectively. FOREIGN CURRENCIES The functional currencies of each of the Company's subsidiaries outside the United States is that country's local currency. The related gains and losses resulting from the translation of the subsidiaries' financial statements are credited or charged to shareholders' equity in the cumulative translation adjustments account. Realized and unrealized gains and losses on foreign currency transactions are included in other income and expense. The Company has a program in place to manage foreign currency risk. As part of that program, the Company has entered into foreign currency forward contracts to hedge anticipated foreign currency transactions, primarily intercompany accounts resulting from sales to international subsidiaries. The forward contracts typically mature within three months. Gains and losses on contracts that are designated and effective as hedges of such transactions are deferred and recognized in income in the same period as the hedged transactions. At December 31, 1998, no contracts were outstanding. INCOME TAXES The provisions for income taxes include federal, state and foreign taxes currently payable and the change in its deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. CONCENTRATION OF CREDIT RISK Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, short-term investments and trade accounts receivable. By policy, the Company places its investments only in high credit quality financial securities and limits the amounts invested in any one institution or in any type of instrument. The Company's trade accounts receivable -30- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) are geographically dispersed and include customers in many different industries. The Company performs ongoing credit evaluations of its customers' financial condition and limits its exposure to losses from bad debts by limiting the amount of credit extended whenever deemed necessary and generally does not require collateral. The Company sells certain trade account receivable in Japan with recourse in the ordinary course of business. At December 31, 1998, accounts receivable included $32,000 sold with recourse. EARNINGS (LOSS) PER SHARE Basic earnings per share excludes any dilutive effects of stock options. Basic earnings per share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted-average number of common shares and common stock equivalent shares outstanding during the period. Common stock equivalent shares are excluded from the computation if their effect is antidilutive. STOCK-BASED COMPENSATION As allowed by SFAS No. 123, "Accounting for Stock Based Compensation", the Company applies APB No. Opinion 25, "Accounting for Stock Issued to Employees", and related interpretations in accounting for its stock option plans and, accordingly, compensation expense, if any, is generally determined based on the difference between the exercise price of stock options or awards and the related fair market value of the common stock. Note 9 to the Consolidated Financial Statements contains a summary of the pro forma effects to reported net income and earnings per share if the Company had elected to recognize compensation expense based on the fair value of the options granted at grant date as prescribed by SFAS No. 123. SEGMENTS AND RELATED INFORMATION As of December 31, 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS No. 131 establishes new standards for the way that public enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial report issued subsequent to adoption. SFAS No. 131 also establishes new standards for related disclosures about products and services, geographic areas and major customers. The adoption of the Statement did not effect the Company's consolidated results of operations, financial position or cash flow. All prior period amounts have been presented to conform with SFAS No. 131. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year presentation. Such reclassifications have no effect on previously reported results of operations. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No.133 requires all derivatives to be recorded on the balance sheet at fair value and establishes "special accounting" for fair value hedges, cash flow hedges, and hedges of foreign -31- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) currency exposures of net investment in foreign operations. The Statement is effective for years beginning after June 15, 1999, but companies can early adopt as of the beginning of any fiscal quarter that begins after June 1998. The adoption of SFAS No. 133 is not expected to have a significant impact on the Company's consolidated results of operations, financial position or cash flow. 2. SECURITIES AVAILABLE FOR SALE Securities available for sale consist of the following as of December 31:
1998 ----------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE --------------- ---------------- ---------------- --------------- (in thousands) U.S. Treasury securities and other U.S Government obligations....... $8,135 $8 $---- $8,143 Corporate debt securities.............. 2,958 ---- ---- $2,958 --------------- ---------------- ---------------- --------------- --------------- ---------------- ---------------- --------------- $11,093 $8 $0 $11,101 --------------- ---------------- ---------------- --------------- --------------- ---------------- ---------------- ---------------
1997 ----------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE --------------- ---------------- ---------------- --------------- (in thousands) U.S. Treasury securities and other U.S Government obligations........ $2,956 $0 $---- $2,956 Corporate debt securities.............. 7,387 2 ---- $7,389 --------------- ---------------- ---------------- --------------- --------------- ---------------- ---------------- --------------- $10,343 $2 $0 $10,345 --------------- ---------------- ---------------- --------------- --------------- ---------------- ---------------- ---------------
As of December 31, 1998, the securities available for sale have contractual maturities of less than one year. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties. 3. INVENTORIES Inventories consist of:
DECEMBER 31, ------------------------------ 1998 1997 ------------- ------------- (in thousands) Finished goods..................................................... $1,501 $1,303 Work in process.................................................... 28 157 Purchased parts.................................................... 1,803 2,005 ------------- ------------- ------------- ------------- $3,332 $3,465 ------------- ------------- ------------- -------------
-32- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. PROPERTY AND EQUIPMENT Property and equipment consist of:
DECEMBER 31, ------------------------------ 1998 1997 ------------- ------------- (in thousands) Machinery and equipment............................................ $3,529 $3,973 Office furniture and equipment..................................... 2,802 2,465 Leased equipment................................................... ---- 410 ------------- ------------- 6,331 6,848 Less accumulated depreciation and amortization..................... 3,413 3,948 ------------- ------------- ------------- ------------- $2,918 $2,900 ------------- ------------- ------------- -------------
5. REVOLVING LINE OF CREDIT AGREEMENTS In May 1998, the Company negotiated a revolving line of credit agreement with a commercial bank aggregating $7.0 million, which expires in May 1999. Borrowings pursuant to this agreement bear interest at the bank's prime lending rate. The agreement provides the Company an option to amortize $2.0 million of the available line over a five year term. The line of credit agreement is unsecured, except for the term loan option, and includes certain financial covenants. There were no amounts outstanding under the line of credit at December 31, 1998 or 1997. 6. COMMITMENTS AND CONTINGENCIES The Company leases office space and equipment under noncancelable operating lease. Certain leases contain renewal options. Future minimum payments under these leases at December 31, 1998 are as follows:
1999........................................................ $1,260 2000........................................................ 1,221 2001........................................................ 527 2002........................................................ 119 2003........................................................ 91 Thereafter.................................................. 397 -------------------- -------------------- $3,615 -------------------- --------------------
Total rent expense for the years ended December 31, 1998, 1997 and 1996 was $1,393,000, $1,378,000, and $1,278,000, respectively. The Company is subject to various pending and threatened legal actions that arise in the normal course of business. In the opinion of management, liabilities arising from these claims, if any, will not have a material effect on the consolidated financial statements of the Company. -33- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. INCOME TAXES The provision for incomes taxes in 1998, 1997 and 1996 is as follows:
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 ---------------- ---------------- ---------------- (in thousands) Federal................................................ ($ 9) $179 $1,402 Foreign................................................ 28 105 90 State.................................................. -- 65 90 ---------------- ---------------- ---------------- $19 $349 $1,582 ---------------- ---------------- ---------------- ---------------- ---------------- ----------------
SFAS No. 109, "Accounting for Income Taxes", requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and operating loss and tax credit carryforwards. The tax effects of significant items comprising the Company's deferred taxes were as follows:
YEAR ENDED DECEMBER 31, ----------------------------------- 1998 1997 ----------------- ---------------- (in thousands) Deferred tax assets: Accrued and other expenses.......................................... $ 339 $ 166 Inventories......................................................... 709 568 Net operating loss carryforwards.................................... 1,220 791 Tax credit carryforwards............................................ 1,746 1,208 ----------------- ---------------- Total deferred tax assets........................................... 4,014 2,733 Deferred tax liabilities: Depreciation........................................................ -- 11 Foreign Currency.................................................... 467 -- Intangible and other assets......................................... 233 219 ----------------- ---------------- Total deferred tax liabilities...................................... 700 230 Valuation allowance...................................................... (3,314) (2,503) ----------------- ---------------- Net deferred taxes....................................................... $ 0 $ 0 ----------------- ---------------- ----------------- ----------------
As of December 31, 1998, the Company has net operating loss carryforwards for federal tax purposes of approximately $3,486,000 available to offset future taxable income. The Company also has research and development credits of approximately $1,746,000, which may be carried forward, subject to certain limitations, to offset future tax liabilities. The net operating loss and research and development tax credit carryforwards expire in various amounts from 1999 to 2018. Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, set forth annual limits for the utilization of tax net operating loss and credit carryforwards in the event of a significant change in ownership. The issuance of preferred stock in 1992 resulted in such "ownership change." Accordingly, utilization of the net operating loss carryforwards is limited to approximately $392,000 per year. -34- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) A full valuation allowance has been established for the net deferred tax assets due to the uncertainly whether or not they will be realized. The valuation allowance for deferred tax assets increased approximately $811,000 and $280,000 during 1998 and 1997, respectively. A reconciliation from the U.S. statutory rate to the effective tax rate is as follows:
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 ---------------- ---------------- ---------------- (in thousands) Tax at U.S. statutory rate of 34%...................... $ (114) $ 788 $1,854 Utilization of net operating loss and tax credit carryforwards..................................... -- (137) (532) Benefit of foreign sales corporation................... -- (122) (98) Alternative minimum tax................................ -- 57 -- Foreign taxes.......................................... 28 105 90 State taxes, net of federal effect..................... 7 42 59 Foreign losses with no tax benefit.................... 132 404 212 Loss on deemed liquidation of subsidiaries............. -- (845) -- Other.................................................. (34) 57 (3) ---------------- ---------------- ---------------- $ 19 $ 349 $1,582 ---------------- ---------------- ---------------- ---------------- ---------------- ----------------
Effective as of April 1, 1997, the Company elected, pursuant to newly issued Treasury Regulations, to treat its wholly-owned subsidiaries in the United Kingdom, Germany and France as branches for U.S. tax purposes. The effect of such election was a deemed liquidation of each subsidiary allowing its tax attributes to be utilized by the Company, thereby reducing the 1997 tax provision by $845,000. In 1997 and 1996, income tax benefits of $55,000 and $204,000, respectively, were allocated to stockholders equity. Such benefits were attributable to employee stock option transactions. -35- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. INCOME PER SHARE The following table sets forth the computation of basic and diluted income per share:
YEAR ENDED DECEMBER 31, -------------------------------------------------- (in thousands, except per share amount) 1998 1997 1996 ---------------- ---------------- ---------------- Numerator: Numerator for basic and diluted income per share - net income (loss).......................................... ($345) $1,902 $3,716 ---------------- ---------------- ---------------- ---------------- ---------------- ---------------- Denominator: Denominator for basic income per share - weighted average common shares...................................... 6,811 6,769 6,545 Effect of dilutive securities: Stock options and warrants based on the treasury stock method using average market price.................... -- 528 552 ---------------- ---------------- ---------------- Denominator for diluted income per share..................... 6,811 7,297 7,097 ---------------- ---------------- ---------------- ---------------- ---------------- ---------------- Basic income (loss) per share.................................... ($0.05) $0.28 $0.57 ---------------- ---------------- ---------------- ---------------- ---------------- ---------------- Diluted income (loss) per share.................................. ($0.05) $0.26 $0.52 ---------------- ---------------- ---------------- ---------------- ---------------- ----------------
9. SHAREHOLDERS' EQUITY STOCK OPTIONS Stock option plans (the Plans) have been established that authorize the issuance of options for 2,575,317 shares of common stock to selected directors, officers, employees, and consultants of the Company. As of December 31, 1998 options for 1,091,268 shares are outstanding and exercisable, of which options for 816,070 shares are unvested. Options for 282,250 shares are available to be granted. The Plans provide for granting incentive stock options, nonincentive stock options, and stock appreciation rights. The Plans vest substantial authority in the compensation committee of the Board of Directors to determine the terms of each option. Shares issued as a result of exercise of options are subject to repurchase rights by the Company in the event that the optionee's employment with the Company should terminate; most rights lapse at a rate of 25% per year from the date of grant. Options are not transferable and terminate following the optionholder's cessation of employment. Options issued to date have been at fair value at date of grant. On September 11, 1995, the Company's shareholders adopted the Director Stock Option Plan which authorized the issuance of options for 45,000 shares of common stock. The Plan authorized the annual issuance of options for 2,500 shares of common stock per outside director upon the exercise of stock options that may be granted pursuant to this plan. As of December 31, 1998, options for 22,500 shares are outstanding and exercisable and options for 7,500 shares contain repurchase rights. -36- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) A summary of stock option transactions for all plans for the years ended December 31 follows:
1998 1997 1996 ----------------------------- ------------------------------ ----------------------------- OPTIONS WEIGHTED-AVERAGE OPTIONS WEIGHTED-AVERAGE OPTIONS WEIGHTED-AVERAGE (000) EXERCISE PRICE (000) EXERCISE PRICE (000) EXERCISE PRICE ----- -------------- ----- -------------- ----- -------------- Outstanding-beginning of year...................... 864 $ 3.13 729 $ 5.99 541 $ .31 Granted................... 525 $ 4.45 631 $ 4.62 326 $ 13.18 Forfeited................. (150) $ 5.34 (407) $ 11.19 (25) $ 3.06 Exercised................. (125) $ .10 (89) $ .20 (113) $ .20 --------- ---------- ---------- Outstanding-end of year... 1,114 $ 3.79 864 $ 3.13 729 $ 5.99 --------- ---------- ---------- --------- ---------- ---------- Vested options............ 290 $ 2.34 262 $ .67 287 $ .14 --------- ---------- ---------- --------- ---------- ---------- Weighted-average fair value of options granted during the year........... $ 3.39 $ 3.19 $10.14
The following table summarizes information related to outstanding and exercisable options at December 31, 1998:
OUTSTANDING AND EXERCISABLE VESTED OPTIONS ------------------------------------------------------- -------------------------------- WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED EXERCISE REMAINING AVERAGE RANGE OF EXERCISE PRICES SHARES PRICE CONTRACTUAL LIFE SHARES EXERCISE PRICE (000) (000) - ---------------------------- -------------- ------------------ ------------------- -------------- ---------------- $ .02 - 2.00 170 $ .26 4.9 167 $ .24 $ 2.38 - 4.18 570 $ 4.01 8.5 107 $ 4.13 $ 4.56 - 7.00 366 $ 7.94 9.1 8 $ 6.98 $12.25 - 17.50 8 $ 16.75 7.4 8 $ 17.09 ------------------ ------------------- ---------------- -------------- -------------- $ .02 - 17.50 1,114 $ 3.79 8.1 290 $ 2.34 -------------- -------------- -------------- --------------
Had compensation expense for the Company's stock option plans been determined based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed under FSAS No. 123, the Company's net income and earnings per share would have been as follows:
(in thousands, except per share amount) 1998 1997 1996 ------------------- ------------------- -------------------- Net income (loss) - as reported..................... ($345) $1,902 $3,716 Net income (loss) - pro forma ....................... ($1,016) $1,411 $3,282 Diluted net income (loss) per share as reported...... ($ .05) $ .26 $ .52 Diluted net income (loss) per share pro-forma........ ($ .15) $ .19 $ .46
Compensation expense not recognized in providing pro forma disclosures may not be representative of the effects on pro forma net income for future years because the above amounts include only the amortization for the fair value of grants made in fiscal years 1998, 1997, and 1996. -37- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The fair value of each option is estimated on the date of grant using the Black-Scholes multiple-option approach pricing model with the following weighted average assumptions:
1998 1997 1996 ------------------- ------------------- -------------------- Annualized volatility................................ 94.7% 93.9% 89.6% Risk-free interest rate.............................. 5.0% 6.0% 6.4% Expected life........................................ 5.4 years 4.0 years 5.8 years Expected dividend rate............................... nil nil nil
STOCK WARRANTS During 1991, the Company granted a stock purchase warrant for 60,680 shares of common stock at $4.12 per share expiring after five years which were issued to a shareholder in consideration for a one-year personal guarantee of a $500,000 bank loan obtained by the Company. During 1996 all of the outstanding warrants were exercised on a net basis resulting in issuance of 35,679 shares of common stock. In 1992, in connection with an equity financing, the Company granted stock purchase warrants for 114,563 shares of Series I preferred stock at $4.12 per share expiring after five years. In connection with the initial public offering, these outstanding preferred stock warrants converted to common stock warrants. During 1997 all of the remaining outstanding warrants were exercised on a net basis resulting in issuance of 58,941 shares of common stock. EMPLOYEE STOCK PURCHASE PLAN On May 22, 1996, the Company's shareholders approved the 1996 Employee Stock Purchase Plan (ESPP) and reserved a total of 250,000 shares of common stock for issuance. The purpose of the ESPP is to provide eligible employees of the Company with a means of acquiring common stock of the Company through payroll deductions. The purchase price of such stock under the ESPP cannot be less than 85% of the lower of the fair market value on the specified purchase date or the beginning of the offering period. During 1998, 1997 and 1996, 55,193, 45,844 and 16,165 shares were sold through the ESPP, respectively. COMMON STOCK RESERVED Common stock reserved for future issuance at December 31, 1998 is as follows: Employee Stock Purchase Plan....................................... 132,798 Common stock options............................................... 1,418,793 ------------- ------------- 1,551,591 ------------- -------------
-38- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SHAREHOLDER RIGHTS PLAN In 1998, the Company adopted a Rights Plan, declaring a dividend of one preferred share purchase right ("Right") for each outstanding share of the Company's common stock. The Rights become exercisable upon the earlier of a person or group announcing (1) an acquisition of 15% or more of the common stock of the Company or (2) the commencement of a tender or exchange offer that would result in such person acquiring ownership of 15% or more of the common stock of the Company. Each Right entitles the holder to purchase 1/100th of a preferred share at a current price of $30. Upon a triggering event, each holder of a Right shall be entitled to purchase common stock that has a market value equal to two times the exercise price of the Right. The Company is entitled to redeem the Rights at $0.01 each under specified circumstances. STOCK REPURCHASE PLAN In 1998, the Board of Directors authorized the Company to repurchase up to 500,000 shares of its common stock using existing cash, from time-to-time at market prices, and as market and business conditions warrant, in open market, negotiated, or block transactions. The repurchase program seeks to offset dilution associated with stock options issued under the Company's stock incentive programs and for general corporate purposes. The Company has repurchased 326,000 shares for $1,210,000. 10. EMPLOYEE BENEFIT PLAN The Company maintains a Profit Sharing Plan (the Plan) under section 401K of the Internal Revenue Code. All U.S. based employees are eligible to participate in the Plan at the start of each calendar quarter. Contributions by the company are based on a matching formula as defined in the Plan. The Company may also make discretionary contributions. During 1998, 1997 and 1996, the Company made contributions of $192,000, $162,000 and $133,000, respectively. -39- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. SEGMENT AND RELATED INFORMATION The Company is engaged in one line of business: the design, manufacture, and distribution of development and test hardware and software tools for embedded product manufacturers. Certain financial information of operations by geographic area is provided in the table below based on the location of the Company's facilities. Sales are not recognized for financial statement purposes until there has been a sale to an unaffiliated customer.
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 ---------------- ---------------- ----------------- (in thousands) GEOGRAPHIC AREA DATA: Net Sales: United States.......................................... $22,325 $22,247 $22,615 Japan.................................................. 10,664 13,132 12,842 Europe................................................. 4,031 3,745 3,205 ---------------- ---------------- ----------------- Consolidated net sales................................. $37,020 $39,124 $38,662 ---------------- ---------------- ----------------- Export Sales to unaffiliated customers................. $ 1,597 $ 2,446 $ 2,367 ---------------- ---------------- ----------------- ---------------- ---------------- ----------------- Income (loss) before income taxes: United States.......................................... $ 1,139 $ 4,121 $ 5,900 Japan.................................................. 34 107 266 Europe................................................. (1,037) (623) (214) Corporate eliminations................................. (462) (1,354) (654) ---------------- ---------------- ----------------- Consolidated income (loss) before income tax........... ($326) $2,251 $5,298 ---------------- ---------------- ----------------- ---------------- ---------------- ----------------- Long-lived assets: Property, plant and equipment, net United States.......................................... $2,797 $2,778 $2,286 Japan.................................................. 50 53 61 Europe................................................. 71 69 94 ---------------- ---------------- ----------------- Consolidated assets.................................... $2,918 $2,900 $2,441 ---------------- ---------------- ----------------- ---------------- ---------------- ----------------- Other Assets, net United States.......................................... $723 $682 $558 Japan.................................................. 131 114 154 Europe................................................. 43 48 53 ---------------- ---------------- ----------------- Consolidated assets.................................... $897 $844 $765 ---------------- ---------------- ----------------- ---------------- ---------------- -----------------
-40- APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Summarized quarterly financial information for 1998 and 1997 is as follows:
1998 --------------------------------------------------------------------- For the quarters ended: MAR. 31 JUNE 30 SEPT. 30 DEC. 31 ------- ------- -------- ------- (In thousands, except per share data) Net sales........................ $8,251 $9,157 $9,957 $9,655 Gross profit..................... 5,938 6,832 7,432 7,230 Net Income (loss).............. (559) 58 113 43 Diluted income (loss) per share............................ ($0.08) $0.01 $0.02 $0.01 Shares used in diluted per share calculation................ 6,878 7,113 6,983 6,832 Market price per share: High......................... $8.88 $7.63 $4.63 $4.75 Low.......................... 4.50 3.81 2.63 2.13
1997 --------------------------------------------------------------------- For the quarters ended: MAR. 31 JUNE 30 SEPT. 30 DEC. 31 ------- ------- -------- ------- (In thousands, except per share data) Net sales........................ $8,902 $10,009 $10,758 $9,455 Gross profit..................... 6,446 7,310 7,897 6,939 Net Income..................... 42 647 1,012 201 Diluted income per share......... $0.01 $0.09 $0.14 $0.03 Shares used in diluted per share calculation................ 7,101 7,259 7,393 7,397 Market price per share: High......................... $16.00 $10.50 $12.88 $12.63 Low.......................... 4.88 3.88 8.00 5.00
-41- ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is contained in part in the sections captioned "Board of Directors -- Nominees for Director" and "Voting Securities and Principal Holders -- Exchange Act Compliance" in the Proxy Statement for the Company's Annual Meeting of Stockholders scheduled to be held on May 25, 1999, and such information is incorporated herein by reference. The remaining information required by this Item is set forth as Item 4A in Part I of this report under the caption "Executive Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to the information contained in the section captioned "Compensation and Benefits" of the Proxy Statement for the Company's Annual Meeting of Stockholders scheduled to be held on May 25, 1999. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference to the information contained in the sections captioned "Voting Securities and Principal Holders" and "Compensation and Benefits--Certain Transactions" of the Proxy Statement for the Company's Annual Meeting of Stockholders scheduled to be held on May 25, 1999. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference to the information contained in the section captioned "Compensation and Benefits--Certain Transactions" of the Proxy Statement for the Company's Annual Meeting of Stockholders scheduled to be held on May 25, 1999. -42- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K The following documents are filed as part of this report: (A)(1) FINANCIAL STATEMENTS - See Index to Financial Statements at Item 8 of this report. (A)(2) FINANCIAL STATEMENT SCHEDULES Schedule II: Valuation and Qualifying Accounts Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is included in the Consolidated Financial Statements or notes thereto. (A)(3) EXHIBITS The following exhibits are filed with this report: Exhibit No. 3: Articles of Incorporation and Bylaws 3.1 Second Restated Articles of Incorporation of Registrant 3.2 Restated Bylaws of Registrant Exhibit No. 10: Material Contracts EXECUTIVE COMPENSATION PLANS AND AGREEMENTS 10.2 1990 Stock Benefit Plan 10.3 1992 Performance Stock Plan 10.4 1995 Directors Stock Option Plan OTHER MATERIAL CONTRACTS -43- 10.7 Lease Agreement between W.R.C. Properties, Inc. and the Registrant dated February 27, 1989; and Amendments to Lease Agreement dated November 7, 1990, May 11, 1992, August 18, 1993 and March 31, 1994 10.8 Third Amended and Restated Investment Agreement dated as of September 15, 1995 10.10 Tools Development and Bond-Out License Agreement between the Registrant and Intel Corporation dated September 30, 1993, as amended April 13, 1994 10.11 Bond-Out License Agreement between the Registrant and Intel Corporation dated September 16, 1994 10.12 Source License and Distribution Agreement between the Registrant and Microtec Research, Inc. dated August 1, 1994 10.15 Processor feature Technology License Agreement between the Registrant and Intel Corporation dated September 21, 1995 10.16 Business Loan Agreement between the Registrant and U.S. Bank of Washington, N.A. dated February 9, 1996; Alternative Rate Options Promissory Note dated February 9, 1996. Exhibit No. 21: Subsidiaries of Registrant Exhibit No. 23: Consent of Ernst & Young LLP, Independent Auditors. (B) REPORTS ON FORM 8-K The Company filed a report on Form 8-K December 11, 1998 declaring a dividend distribution of one preferred share purchase right (each a "Right") for each outstanding share of Common Stock of the Company payable to the holders of record of the Common Shares on December 21, 1998. The Rights dividend was declared by the Board of Directors in connection with its adoption of the Shareholder Rights Plan, dated December 10, 1998 between the Company and Chasemellon Shareholder Services, L.L.C., which was incorporated by reference from Exhibit 1 to the Company's Registration Statement on Form 8-A12G, dated December 15, 1998. -44- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, State of Washington, on March 31, 1999. APPLIED MICROSYSTEMS CORPORATION By /s/ A. JAMES BEACH ------------------ A. James Beach CHIEF FINANCIAL OFFICER Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE /s/ Robert L. Deinhammer President, Chief Executive March 31, 1999 - ------------------------ Officer and Director Robert L. Deinhammer (Principal Executive Officer) /s/ A. James Beach Vice President, Chief March 31, 1999 - ------------------- Financial Officer, Secretary A. James Beach and Treasurer (Principal Financial and Accounting Officer) /s/ Anthony Miadich Chairman of the Board March 31, 1999 - -------------------- Anthony Miadich /s/ Charles H. House Director March 31, 1999 - -------------------- Charles H. House /s/ Elwood D. Howse, Jr. Director March 31, 1999 - ------------------------ Elwood D. Howse, Jr. /s/ Paul N. Risinger Director March 31, 1999 - -------------------- Paul N. Risinger -45- EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION 3.1 Restated Articles of Incorporation of Registrant (incorporated by reference from Exhibit 3.1 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)................................ 3.2 Restated Bylaws of Registrant (incorporated by reference from Exhibit 3.2 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)............................................................. 10.2 1990 Stock Benefit Plan (incorporated by reference from Exhibit 10.5 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)............................................................. 10.3 1992 Performance Stock Plan (incorporated by reference from Exhibit 10.6 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)............................................................. 10.4 1995 Directors Stock Option Plan (incorporated by reference from Exhibit 10.7 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)..............................................
-46-
10.7 Lease Agreement between W.R.C. Properties, Inc. and the Registrant dated February 27, 1989; and Amendments to Lease Agreement dated November 7, 1990, May 11, 1992, August 18, 1993 and March 31, 1994 (incorporated by reference from Exhibit 10.4 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)......... 10.8 Third Amended and Restated Investment Agreement dated as of September 15, 1995 (incorporated by reference from Exhibit 10.8 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)............................................................. **10.9 License Agreement between the Registrant and Intel Corporation dated March 30, 1990 (incorporated by reference from Exhibit 10.9 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)............................................................. **10.10 Tools Development and Bond-Out License Agreement between the Registrant and Intel Corporation dated September 30, 1993, as amended April 13, 1994 (incorporated by reference from Exhibit 10.10 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)............................................................. **10.11 Bond-Out License Agreement between the Registrant and Intel Corporation dated September 16, 1994 (incorporated by reference from Exhibit 10.11 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)..............................................
-47-
**10.12 Source License and Distribution Agreement between the Registrant and Microtec Research, Inc. dated August 1, 1994 (incorporated by reference from Exhibit 10.12 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002).................. **10.15 Processor feature Technology License Agreement between the Registrant and Intel Corporation dated September 21, 1995 (incorporated by reference from Exhibit 10.15 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002))................. 10.16 Business Loan Agreement between the Registrant and U.S. Bank of Washington, N.A. dated February 9, 1996; Alternative Rate Options Promissory Note dated February 9, 1996 (incorporated by reference from Exhibit 10.16 to the Company's annual report on form 10K for year ended December 31, 1995).............................................. 21 Subsidiaries of the Registrant (incorporated by reference from Exhibit 21.1 to the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002)............................................................. 23 Consent of Ernst & Young LLP, Independent Auditors....................
- --------- ** Confidential treatment has been granted for portions of this exhibit. -48- SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS APPLIED MICROSYSTEMS CORPORATION YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ---------------------------------------------------------------------------------------------------------------------- COL A. COL B. COL C. COL D. COL E. - ---------------------------------------------------------------------------------------------------------------------- ADDITIONS --------------------------------- (1) (2) DESCRIPTION BALANCE AT CHARGED TO CHARGED TO DEDUCTIONS: BALANCE BEGINNING COSTS OTHER DESCRIBE END OF OF PERIOD AND ACCOUNTS: PERIOD EXPENSES DESCRIBE - ---------------------------------------------------------------------------------------------------------------------- Year ended December 31, 1998: Deducted from asset accounts: Allowance for doubtful accounts $84,000 $12,000 -- ($15,000) (A) $81,000 Allowance for sales returns $527,000 -- 142,000 (B) (101,000) (C) $568,000 ------------- ------------- -------------- -------------- ------------ Totals $611,000 $12,000 $142,000 ($116,000) $649,000 ------------- ------------- -------------- -------------- ------------ ------------- ------------- -------------- -------------- ------------ Year ended December 31, 1997: Deducted from asset accounts: Allowance for doubtful accounts $52,000 $32,000 -- -- $84,000 Allowance for sales returns $212,000 -- 670,000 (B) (355,000) (C) $527,000 ------------- ------------- -------------- -------------- ------------ Totals $264,000 $32,000 $670,000 ($355,000) $611,000 ------------- ------------- -------------- -------------- ------------ ------------- ------------- -------------- -------------- ------------ Year ended December 31, 1996: Deducted from asset accounts: Allowance for doubtful accounts $55,000 ($3,000) -- -- $52,000 Allowance for sales returns $113,000 -- 507,000 (B) (408,000) (C) $212,000 ------------- ------------- -------------- -------------- ------------ Totals $168,000 ($3,000) $507,000 ($408,000) $264,000 ------------- ------------- -------------- -------------- ------------ ------------- ------------- -------------- -------------- ------------
(A) Uncollectible accounts written off, net of recoveries (B) Estimated future sales returns charged to revenue (C) Actual Sales Returns -49- EX-23 2 EXHIBIT 23 EXHIBIT 23 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-07331) pertaining to the Applied Microsystems Corporation 1996 Stock Purchase Plan, the Registration Statement (Form S-8 No. 333-03396) pertaining to the Applied Microsystems Corporation 1990 Stock Benefit Plan, the Applied Microsystems Corporation 1992 Performance Stock Plan, and the Applied Microsystems Corporation Director Stock Option Plan and the Registration Statement (Form S-8 No. 333-14823) pertaining to the 1992 Performance Stock Plan of our report dated February 2, 1999 with respect to the consolidated financial statements and schedule of Applied Microsystems Corporation included in its Annual Report (Form 10-K) for the year ended December 31, 1998 filed with the Securities and Exchange Commission. ERNST & YOUNG LLP Seattle, Washington March 31, 1999 EX-27.1 3 EX-27.1
5 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 6,041 11,101 8,483 0 3,332 29,475 2,918 0 33,290 9,359 0 0 0 25,383 (1,452) 33,290 37,020 37,020 9,587 28,542 (784) 0 1 (326) 19 (345) 0 0 0 (345) (.05) (.05)
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