UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1996
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 0-28450
FARALLON COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware, 94-3033136
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
2470 Mariner Square Loop
Alameda, California 94501
(Address of principal executive offices, including Zip Code)
(510) 814-5100
(Registrant's telephone number, including area code)
Indicate by check X whether the registrant (1) has filed all reports required
to be filed by Sections 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
As of February 1, 1997 there were 11,329,289 shares of the
Registrant's common stock outstanding.
FARALLON COMMUNICATIONS, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION PAGE
Item 1. Condensed Financial Statements
Condensed Condolidated Balance Sheets 3
At September 30, 1996 and December 31, 1996
Condensed Consolidated Statements of Earnings
For the three months ended December 31, 1995 and 1996 4
Condensed Consolidated Statements of Cash Flows
For the three months ended December 31, 1995 and 1996 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURE 22
INDEX TO EXHIBITS 23
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
September 30, 1996 December 31,1996
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 19,910 $ 16,423
Short-term investments 17,235 21,202
Trade accounts receivable, net of
allowances of $1,328 and $1,450 at
September 30, 1996 and December 31,
1996, respectively. 11,172 9,347
Inventories, net 6,295 6,770
Deferred tax assets 1,829 1,829
Prepaid expenses and other current
assets 1,457 1,364
Total current assets 57,898 56,935
Furniture, fixtures, and equipment, net 2,935 2,811
Deposits and other assets 785 819
Total assets $ 61,618 $ 60,565
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,979 $ 3,694
Accrued compensation 2,023 1,943
Accrued liabilities 470 723
Deferred revenue 787 755
Other current liabilities 170 172
Total current liabilities 8,429 7,287
Other long-term liabilities 46 3
Total liabilities 8,475 7,290
Commitments and contingencies
Stockholders' equity:
Preferred stock: $0.001 par value,
5,000,000 shares authorized; none outstanding
Common stock: $0.001 par value, 25,000,000
shares authorized; 11,119,961 and 11,134,652
shares issued and outstanding at September 30,
1996 and December 31, 1996, respectively. 12 12
Additional paid-in capital 49,232 49,242
Deferred compensation (81) (77)
Retained earnings 3,980 4,098
Total stockholders' equity 53,143 53,275
Total liabilities and stockholders'
equity $ 61,618 $ 60,565
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<TABLE>
<CAPTION>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMEN1 OF EARNINGS
(in thousands, except per share data; unaudited)
Three Months Ended
December 31
1995 1996
<S> <C> <C>
Revenues:
Internet/Intranet products $ 2,809 $ 4,805
LAN products 11,302 8,658
Total revenues 14,111 13,463
Cost of revenues:
Internet/Intranet products 458 1,554
LAN products 6,827 5,310
Total cost of revenues 7,285 6,864
Gross profit 6,826 6,599
Operating expenses:
Research and development 2,016 2,167
Selling and marketing 3,787 3,801
General and administrative 789 837
Total operating expenses 6,592 6,805
Operating income (loss) 234 (206)
Other income, net 227 388
Income before income taxes 461 182
Income tax provision 162 64
Net income $ 299 $ 118
Net income per share $ 0.03 $ 0.01
Shares used in per share
calculation 9,857 12,447
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<TABLE>
<CAPTION>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands; unaudited)
Three Months Ended
December 31, 1995 December 31, 1996
<S> <C> <C>
Cash flows from
operating activities:
Net income $ 299 $ 118
Adjustments to reconcile net
income to net cash provided by
operating activities:
Depreciation and amortization 376 474
Amortization of deferred compensation - 4
Changes in assets and liabilities:
Accounts receivable (105) 1,825
Inventories (505) (475)
Prepaid expenses and other assets (589) 40
Accounts payable (1,041) (1,285)
Accrued expenses and other liabilities 96 132
Deferred revenue 201 (32)
Net cash provided by (used in)
operating activities (1,268) 801
Cash flows from investing activities:
Purchase of short-term investments (23,438) (29,011)
Proceeds from the sale of short-term
investments 24,541 25,044
Acquisition of furniture, fixture and
equipment (358) (331)
Net cash provided by (used in)
investing activities 745 (4,298)
Cash flows from financing activities:
Proceeds from issuance of common stock, net 56 10
Net cash provided by financing activities 56 10
Net decrease in cash and cash equivalents (467) (3,487)
Cash and cash equivalents, beginning
of period 13,963 19,910
Cash and cash equivalents,
end of period $ 13,496 $ 16,423
Supplemental disclosures of cash
flow information:
Interest paid $ 1 $ 1
Income taxes paid $ 6 $ 1
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The unaudited condensed consolidated financial statements included herein
reflect all adjustments, consisting only of normal recurring adjustments which
in the opinion of management are necessary to fairly present the Company's
consolidated financial position, results of operations, and cash flows for the
periods presented. These consolidated financial statements should be read in
conjunction with the Company's consolidated financial statements as included
in the Company's Annual Report on Form 10-K and other filings with the
United States Securities and Exchange Commission. The consolidated
results of operations for the period ended December 31, 1996 are not
necessarily indicative of the results to be expected for any subsequent
quarter or for the entire fiscal year ending September 30, 1997.
2. Inventories
<TABLE>
<CAPTION>
Inventories are stated at the lower of cost or market. Cost is determined
by the first-in, first-out (FIFO) method. Inventory consisted of the
following (in thousands, net):
September 30, 1996 December 31, 1996
<S> <C> <C>
Raw materials and work in process $ 2,477 $ 2,618
Finished goods 3,818 4,152
$ 6,295 $ 6,770
</TABLE>
<TABLE>
<CAPTION>
3. Furniture, Fixtures and Equipment, net (in thousands):
September 30, 1996 December 31, 1996
<S> <C> <C>
Furniture, fixtures and equipment $ 11,993 $ 12,325
Accumulated depreciation and amortization (9,058) (9,514)
$ 2,935 $ 2,811
</TABLE>
4. Net Income Per Share
Net income per share is based on the weighted average
number of shares of common stock and dilutive common equivalent share
from options outstanding during the period using the treasury stock method,
and for the three months ended December 31, 1995, common equivalent
shares from the convertible preferred stock using the ''as-converted'' method.
For the three month period ended December 31, 1995
pursuant to certain SEC Staff Accounting Bulletins, common stock issued
for consideration below the IPO price and stock options granted with
exercise prices below the IPO price during the 12-month period prior to
the date of the initial filing of the registration statement, even when
antidilutive, have been included in the calculation of net income per
share, using the treasury stock method based on the IPO filing price,
as if they were outstanding for the entire period.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
The discussion in this Report contains forward-looking statements that
involve risks and uncertainties. The statements contained in this Report
that are not purely historical are forward-looking statements within the
meaning of Section 27A of the Securities Exchange Act of 1933, as
amended, including statements regarding the Company's expectations,
beliefs, intentions or strategies regarding the future. All forward-
looking statements included in this document are based on information
available to the Company on the date hereof, and the Company
assumes no obligation to update any such forward-looking statement.
The Company's actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in
"Other Risk Factors That May Affect Future Operating Results"
as well as those discussed in this section and elsewhere in this
Report, and the risks discussed in the Company's other United
States Securities and Exchange Commission Filings.
RESULTS OF OPERATIONS
Three Months Ended December 31, 1995 and 1996
Revenues. The Company's total revenues are derived from the sale of
Internet/Intranet and local area networking ("LAN") connectivity products.
Internet/Intranet product revenues include license revenues for the Company's
Timbuktu Pro software, sales of the Netopia family of products and fees for
related services. LAN products revenue is derived primarily from the sale
of EtherWave, Fast Ethernet, Ethernet and LocalTalk compatible products
which include the PhoneNET system network connectivity products, of
which a substantial majority have been sold to Macintosh operating
system ("MacOS") customers. Revenue relating to the sale and licensing
of hardware and software products is recognized upon shipment of the
products by the Company and service revenues are recognized ratably
over the term of the contract. Certain of the Company's sales are made
to customers under agreements permitting limited rights of return for
stock balancing. Revenue is recorded net of an estimated allowance for
returns. Any product returns or price decreases in the future that exceed
the Company's allowances will adversely affect the Company's
business, operating results and financial condition.
The Company's total revenues decreased 4.6% from $14.1
million to $13.5 million for the three months ended December 31,
1995 and 1996, respectively. Internet/Intranet products revenue
increased 71.1% from $2.8 million to $4.8 million for the three
months ended December 31, 1995 and 1996, respectively. The
increase in Internet/Intranet revenue was primarily due to increased
sales of Netopia Internet connectivity solutions as well as increased
volume licensing of the Windows version of Timbuktu Pro collaboration
software, particularly in corporate Intranets. Netopia products revenue
increased primarily due to increased international shipments of the
Netopia ISDN router, the introduction of the "So-Smart" Netopia
router in December, 1996, as well as a greater number of regional
U.S. Internet Service Providers ("ISPs") selling Netopia Internet
connectivity products. Netopia products were first shipped in
December, 1995. LAN products revenue decreased 23.4% from
$11.3 million to $8.7 million for the three months ended December 31,
1995 and 1996, respectively, primarily due to declining volume and
average selling prices of EtherWave and LocalTalk products, partially
offset by increased sales of certain of the Company's Fast Ethernet
products as well as sales of certain Ethernet products that were
not available during the three months ended December 31, 1995.
The Company believes LAN products revenue was adversely
affected by Apple Computer's ("Apple") delayed shipment of
Powerbooks, Performa technical problems and confusion surrounding Apple
and the MacOS. LAN products revenue accounted for 80.1% and 64.3% of
the Company's total revenues for the three months ended December 31,
1995 and 1996, respectively, while Internet/Intranet products revenue
accounted for 19.9% and 35.7% of the Company's total revenues for the
three months ended December 31, 1995 and 1996, respectively.
As the Company continues to focus on the development of its
Internet/Intranet business, and as a result of price competition related
to the Company's LAN products, declining sales of MacOS computers
and competitive factors, the Company expects that LAN products
revenue may decline and may account for a decreasing percentage
of total revenues in future periods to the extent that Internet/Intranet
product revenues increase. As a result, the Company's future operating
results are dependent upon continued market acceptance of its Internet
/Intranet products and enhancements thereto. However, the Company
is dependent upon sales of its LAN products for the foreseeable future,
and to the extent that any decline in revenues from LAN products is not
offset by increases in revenue from other sources, such as sales of the
Company's Internet/Intranet products, then the Company's business,
operating results and financial condition will be materially and adversely
affected.
Farallon sells its Internet/Intranet and LAN products and
related maintenance, support and other services primarily through
distributors, while certain products are also sold directly through
Value Added Resellers ("VARs") and ISPs or directly by the
Company to corporate accounts and higher education institutions.
Revenues from distributors accounted for 67% and 54% of total
revenues for the three months ended December 31, 1995 and 1996,
respectively. The decrease in the percentage of revenues from
distributors is primarily due to the increasing percentage of sales
of the Company's Internet/Intranet products, which are primarily
sold direct by the Company and through ISPs. Revenues from
Ingram Micro (''Ingram'') accounted for 20% of total revenues for
each of the three months ended December 31, 1995 and 1996,
and revenues from MicroWarehouse accounted for 11% and 10%
of total revenues for the three months ended December 31, 1995
and 1996, respectively. No other customers have accounted for 10%
or more of the Company's total revenues during the three months
ended December 31, 1995 and 1996. The Company intends to continue to
use its existing distributors, VARs and ISPs to sell the Company's Internet/
Intranet products, to recruit additional VARs and ISPs, and pursue other
marketing channels in the future. There can be no assurance that the
Company's current distributors, VARs and ISPs will choose to or be able
to market the Company's products effectively, that economic conditions
or industry demand will not adversely affect these or other distribution
channels, or that these distributors, VARs and ISPs will not devote greater
resources to marketing products of other companies. The loss of, or a
significant reduction in revenue from, one of the Company's distributors
could have a material adverse effect on the Company's business, operating
results and financial condition.
International revenues accounted for 33% and 28% of total
revenues for the three months ended December 31, 1995 and 1996,
respectively. The Company believes international revenues, particularly
in the Pacific Rim, were adversely affected by Apple's delayed
shipment of Powerbooks, Performa technical problems and confusion
surrounding Apple and the MacOS, partially offset by increased
international sales of Netopia ISDN routers. To the extent that
the Company continues to experience weakened international
demand for its products such as its Timbuktu Pro and Ethernet
products, the Company's business, operating results and financial
condition would be materially adversely affected. The Company's
international revenues are currently denominated in United States
dollars, and revenues generated by the Company's distributors
currently are paid to the Company in United States dollars. The results
of the Company's international operations may fluctuate from period
to period based on global economic factors including, but not limited
to, movements in currency exchange rates. Historically, movements
in exchange rates have not materially affected the Company's total
revenues. However, there can be no assurance that movements in
currency exchange rates will not have a material adverse effect on
the Company's revenues in the future.
Gross Margin. The Company's gross margin for Internet/
Intranet and LAN products is affected by many factors, including
pricing strategies, royalties paid to third parties, new versions of existing
products and product mix. The Company's total gross margin
remained relatively constant, increasing from 48.4% to 49.0% for the three
months ended December 31, 1995 and 1996, respectively. The Company's
gross margin for Internet/Intranet products decreased from 83.7% to 67.7%
for the three months ended December 31, 1995 and 1996, respectively,
primarily due to increased sales of the Netopia router and modem which
have lower gross margins than the Company's Internet/Intranet software
products. The Company also reduced the average selling prices of
Netopia routers due to price competition which contributed to declining
Internet/Intranet margins. The Company's gross margin for LAN products
decreased from 39.6% to 38.7% for the three months ended December 31,
1995 and 1996, respectively, primarily due to declining sales and average
selling prices as a result of increased price competition. The Company
expects gross margins for Internet/Intranet products to decrease in future
periods reflecting increased sales of hardware products that carry lower
gross margins than software products. In addition, the Company expects
gross margins for LAN products to decrease in future periods primarily
due to lower sales volumes and declining average selling prices. The
Company's gross margin has varied significantly in the past and will
likely vary significantly in the future depending primarily on the mix
of products sold by the Company and external market factors including
but not limited to price competition. The Company's Internet/Intranet
software products have a higher average gross margin than the balance
of the Company's products. Accordingly, to the extent the product mix
for any particular quarter includes a substantial proportion of lower
margin products, there will be a material adverse effect on the Company's
business, operating results and financial condition.
Research and Development. Research and development
expenses increased 7.5% from $2.0 million to $2.2 million for the
three months ended December 31, 1995 and 1996, respectively,
primarily due to increased headcount related to the development
of new Internet/Intranet products, particularly for the Netopia family
of Internet connectivity solutions and new Internet/Intranet collaboration
software products. Research and development expenses represented 14.3%
and 16.1% of total revenues for the three months ended December 31, 1995
and 1996, respectively. The Company believes that it will continue to devote
substantial resources to product development and that research and
development expenses will increase in absolute dollars for the remainder
of fiscal 1997. The Company believes its process for developing software
is essentially completed concurrent with the establishment of technological
feasibility, and no software costs have been capitalized to date. The
Company may enter into future development agreements in which the
Company may be required to capitalize the cost of software development.
Selling and Marketing. Selling and marketing expenses were
$3.8 million for each of the three months ended December 31, 1995
and 1996. Although total selling and marketing expenses were
unchanged year over year, increased headcount and other employee
related expenses as well as increased electronic marketing costs were
offset by declining print advertising and promotional expenses. Such
expenses represented 26.8% and 28.2% of total revenues for the three
months ended December 31, 1995 and 1996, respectively. The
Company believes that selling and marketing expenses will increase
in absolute dollars for the remainder of fiscal 1997 primarily due to
personnel related expenses and increased advertising and promotional activities.
General and Administrative. General and administrative
expenses increased 6.1% from $789,000 to $837,000 for the three months
ended December 31, 1995 and 1996, respectively, primarily due to increased
expenses related to directors' and officers' insurance and increased personnel
costs primarily related to the Company's initial public offering in June,
1996. Such expenses represented 5.6% and 6.2% of total revenues for the
three months ended December 31, 1995 and 1996, respectively. The
Company believes that general and administrative expenses will increase
in absolute dollars for the remainder of fiscal 1997 as the Company adds
infrastructure, such as expenses to maintain and support the Company's
web related activities and incurs additional costs related to being a public
company, such as expenses related to investor relations programs and
increased professional fees.
Other Income, net. Other income, net, primarily represents
interest earned by the Company on its cash, cash equivalents and short-term
investments.
Provision for Income Taxes. The effective tax rate was 35%
for the each of three months ended December 31, 1995 and 1996.
This rate differs from the statutory rate primarily due to state income
taxes, investment income from tax advantaged investments and the
utilization of research and tax credits.
OTHER RISK FACTORS THAT MAY AFFECT FUTURE OPERATING
RESULTS
The Company operates in a rapidly changing environment that
involves a number of risks, some of which are beyond the Company's control.
The following discussion highlights some of these risks. The Company's
actual results could differ materially from those discussed herein.
Factors that could cause or contribute to such differences include, but
are not limited to, those discussed in this section and elsewhere in this
Report, and the risks discussed in the Company's other United States
Securities and Exchange Commission Filings.
Fluctuations in Quarterly Results; Future Operating Results
Uncertain. The Company's quarterly operating results have varied
significantly in the past and are likely to vary significantly in the future,
depending on factors such as changes in networking and communications
technologies, price and product competition, usage of the Internet and
developments and changes in the Internet market, the demand for the
Company's products, demand for Apple's products, changes in pricing
policies by the Company or its competitors, including the grant of
price protection terms and discounts by the Company, changes in
the mix of products sold by the Company and the resulting change
in total gross margin, changes in the mix of channels through which
the Company's products are offered, product enhancements and new
product announcements by the Company and its competitors, market
acceptance of new products of the Company or its competitors, raw
material costs, write-offs of obsolete inventory, the size and timing of
distributor and end user orders and purchasing cycles, customer order
deferrals in anticipation of enhancements to the Company's or
competitors' products, customer order deferrals in anticipation of new
MacOS product offerings and a new operating system for the Macintosh
by Apple, manufacturing delays, disruptions in sources of supply, product
life cycles, product quality problems, personnel changes, changes in the
Company's strategy, changes in the level of operating expenses, the timing
of research and development expenditures, the level of the Company's
international revenues, fluctuations in foreign currency exchange rates,
general economic conditions, both in the United States and abroad, and
economic conditions specific to the industries in which the Company
competes, among others. The Company's limited Internet/Intranet operating
history makes the prediction of future Internet/Intranet operating results
difficult, if not impossible. Sales orders are typically shipped shortly after
receipt and, consequently, order backlog at the beginning of any quarter has
in the past represented only a small portion of that quarter's revenues.
Accordingly, the Company's net revenues in any quarter are substantially
dependent on orders booked and shipped during that quarter. Historically,
the Company has often recognized a significant portion of its revenues in
the last weeks, or even days, of a quarter. As a result, the magnitude of
quarterly fluctuations may not become evident until late in, or after the
close of, a particular quarter. In addition, the Company recognizes
revenue on products sold through distributors upon shipment to the
distributor. Although the Company maintains reserves for projected
returns and price decreases, there can be no assurance that such reserves
will be adequate. The Company's business also has experienced
seasonality in the past, largely due to customer buying patterns such
as budgeting cycles of educational institutions that purchase the Company's
products. There can be no assurance that the Company's operating results
will not be affected by seasonality in the future or that such will occur in
a manner consistent with prior periods.
The Company's expense levels are based in large part on
expectations as to future revenues and as a result are relatively fixed in the
short term. If revenues are below expectations in any given quarter, net
income is likely to be disproportionately affected. Due to all of the foregoing
factors, and other factors discussed herein, revenues and net income
for any future period are not predictable with any significant degree of
certainty. Accordingly, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful
and should not be relied upon as indications of future performance. There
can be no assurance that the Company's business strategies will be
successful or that the Company will be able to sustain profitability on a
quarterly or annual basis in the future. It is likely that in some future
quarter the Company's operating results will be below the expectations
of public market analysts and investors. In such event, the price of the
Company's Common Stock would likely be materially and adversely affected.
Dependence on Internet/Intranet Products. The Company's
business is substantially dependent upon continued growth in the sale
of its Internet/Intranet products. Rapid growth in the use of the Internet
and Intranets is a recent phenomenon. There can be no assurance that
communication or commerce over the Internet will become widespread. In
addition, to the extent that the Internet continues to experience significant
growth in the number of users and level of use, there can be no assurance
that the Internet infrastructure will continue to be able to support the
demands placed upon it by such potential growth, or will not otherwise lose
its utility due to delays in the development or adoption of new standards and
protocols required to handle increased levels of activity, or due to increased
government regulation. Although the Company has experienced significant
percentage growth rates of Internet/Intranet revenues, the Company does not
believe prior percentage growth rates are sustainable or indicative of future
operating results for these products and services. The Company's limited
Internet/Intranet operating history makes the prediction of future
Internet/Intranet operating results difficult, if not impossible. There can
be no assurance that the Company will continue to increase sales of its
Internet/Intranet products, that the Company's existing distribution channels
are appropriate for the sale of its Internet/Intranet products or that sales
of such products will reach levels significant enough to offset expected
declines in sales, average selling prices and gross margins of the Company's
LAN products. Accordingly, the failure of the Company's Internet/Intranet
products to gain market acceptance or to achieve significant sales would
materially and adversely affect the Company's business, operating results
and financial condition. The markets in which the Company competes
currently are subject to intense price competition and the Company expects
additional price and product competition as other established and emerging
companies enter these markets and new products and technologies are
introduced. Increased competition may result in further price reductions,
reduced gross margins and loss of market share, any of which could
materially adversely affect the Company's business, operating results
and financial condition.
Dependence on LAN Products; Declining LAN Business. To
date, the Company has derived a substantial majority of its revenue from
LAN products, which represented 91%, 89%, 73% and 64% of total
revenues for fiscal years 1994, 1995, 1996 and the three months ended
December 31, 1996, respectively. These products have experienced
variable average selling prices and gross margins, and declining sales
volumes. The Company anticipates that the average selling prices and gross
margins of its existing LAN products will continue to decline. Accordingly,
to the extent the product mix for any particular period includes a substantial
proportion of LAN products, the Company's total gross margin will be
adversely affected. To date, the Company has been able to partially reduce
the decline in total gross margin by reducing the manufacturing cost of
products and by introducing new products with higher margins. There can
be no assurance that the Company will achieve any such reductions in
the future or that new products will achieve market acceptance. Although
the Company's Internet/Intranet products currently carry a higher
average gross margin than its LAN products, the Company anticipates
that competitive pressures in its Internet/Intranet business may result
in declining average selling prices and gross margins in this business
as well. Historically, a substantial majority of the Company's LAN
products revenue have been derived from sales of products designed
for Apple MacOS and compatible computers. Net revenues from the
Company's LAN products fluctuated on a quarterly basis during fiscal
1996 and the three months ended December 31, 1996, and the
Company expects that net revenues from LAN products may decline
in the future as a result of declining sales and average selling prices
of the Company's LAN products, Apple's incorporation of built-in Ethernet
connectivity into certain of its computers, declining sales of MacOS
computers and competition in the LAN products market. Additionally,
sales related to certain of the Company's MacOS products are driven in
part by sales of the Apple PowerBooks which have experienced
delays, technical difficulties and interrupted supply. As a result of
technical characteristics in the MacOS environment, Fast Ethernet products, in
general, have not delivered expected performance levels. If these technical
characteristics are not addressed in the future, then Fast Ethernet product
sales in the MacOS market segment will be below the Company's
expectations, and operating results may be materially and adversely
affected. The Company is dependent upon sales and profitability of its
LAN products for the foreseeable future, and to the extent that any decline
in revenues and gross margins from LAN products is not offset by increases
in revenues from other sources, such as sales of the Company's
Internet/Intranet products, then the Company's business, operating
results and financial condition will be materially and adversely affected.
Dependence on Apple; Competition with Apple Products. To
date, the Company has derived approximately 85% to 90% of its LAN
products revenue from products designed for networking the Apple
MacOS family of personal computers. Accordingly, the Company is
substantially dependent on the market for MacOS computers and the
development and sale of new Apple computers, particularly sales of
such computers into business environments. There can be no assurance
that competitive personal computers will not displace the MacOS
products or reduce sales of MacOS products. In addition, sales of the
Company's products in the past have been adversely affected by the
announcement by Apple of new products with the potential to replace
existing products. The inability of Apple to successfully develop,
manufacture, market or sell new products, and any decrease in the sales
or market acceptance of the MacOS family of computers, would have a
material adverse effect on the Company's business, operating results and
financial condition. For example, in the three months ended December 31,
1996, the Company believes LAN products revenue was adversely affected
by Apple's delayed shipment of Powerbooks, Performa technical problems
and confusion surrounding Apple and the MacOS
The Company relies on an informal working relationship with
Apple in connection with the Company's LAN product development efforts.
Although the Company and Apple have maintained a cooperative
working relationship since the Company's founding, Apple is under no
obligation to continue to share product information or otherwise cooperate
with the Company. In addition, there can be no assurance that Apple will
continue to work cooperatively with the Company in connection with the
Company's product development efforts. The absence of such cooperation
in the future, as a result of the current restructuring in process at Apple,
including but not limited to the acquisition of Next Inc., or any other
factors,
could have a material adverse effect on the Company's business, operating
results and financial condition. Apple currently offers products that compete
directly with certain of the Company's products. The Company anticipates
that Apple will continue to incorporate additional connectivity technologies
into more of its products in the future, which will adversely affect sales of
the Company's LAN products. Since Apple has substantially greater financial,
technical, sales, marketing and other resources than the Company, as well
as greater name recognition and a significantly larger customer base, Apple
may be able to respond more quickly to new or emerging technologies and
changes in customer requirements or to devote greater resources to the
development, promotion and sales of its products. The Company believes
that it is likely that Apple will in the future sell separately or bundle with
its computers certain Internet access products, such as ISDN terminal
adapters similar to the Company's Netopia ISDN Modem. Any such
additional bundling or enhancement by Apple could have a material
adverse effect on the Company's business, operating results and financial
condition.
Competition. The markets for the Company's products and
services are intensely competitive, highly fragmented and characterized
by rapidly changing technology, evolving industry standards, price
competition and frequent new product introductions. A number of companies
offer products that compete with one or more of the Company's products.
The Company's current and prospective competitors include original
equipment manufacturer (''OEM'') product manufacturers of Internet
access and remote LAN access equipment, manufacturers of remote
control and screen sharing software and manufacturers of LAN client
access and network systems products. In the Internet access and remote
LAN access equipment market, the Company competes primarily with
Ascend, Cisco, Motorola, 3Com, U.S. Robotics, Gandalf and several
other companies. In the remote control and screen sharing software
market, the Company competes primarily with Symantec, Microsoft,
Tivoli, Microcom, Traveling Software, Stac Electronics and several
other companies. In the LAN client access and network systems
product market, the Company competes primarily with Apple,
Asante, Dayna, Global Village and several other companies. The
Company has experienced and expects to continue to experience
increased competition from current and potential competitors,
many of whom have substantially greater financial, technical, sales,
marketing and other resources, as well as greater name recognition
and a larger customer base, than the Company. Accordingly, such
competitors or future competitors may be able to respond more quickly
to new or emerging technologies and changes in customer requirements
or devote greater resources to the development, promotion and sales of
their products than the Company. In particular, established companies
in the personal computer industry may seek to expand their product
offerings by designing and selling products using competitive technology
that could render the Company's products obsolete or have a material
adverse effect on the Company's sales. For example, Microsoft has
available for free, via download on the Internet, communications and
collaboration software compatible with the Microsoft Internet Explorer.
This software product, which enables real-time communication within
a workgroup, as well as similar future product offerings from Microsoft,
could undermine the Company's ability to market its Timbuktu Pro
and/or Netopia Virtual Office collaboration software. In addition,
Netscape also offers software that enables dispersed work groups to
collaborate in the work environment. Accordingly, there can be no
assurance that the Company can continue to market its collaboration
software, which would have a material and adverse effect on the
Company's business, operating results and financial condition. In
addition, several of the Company's current competitors recently have
introduced free and/or paid guaranteed service and support programs
that appear to be similar to the Company's Up & Running, Guaranteed!
program. As a result, there can be no assurance that the Company can
continue to charge a fee for this support program, which could have a
material and adverse effect upon the Company's business, operating
results and financial condition. The markets in which the Company
competes currently are subject to intense price competition and the
Company expects additional price and product competition as other
established and emerging companies enter these markets and new
products and technologies are introduced. Increased competition
may result in further price reductions, reduced gross margins and
loss of market share, any of which could materially and adversely
affect the Company's business, operating results and financial
condition. There can be no assurance that the Company will be
able to compete successfully against current and future
competitors, or that competitive factors faced by the Company
will not have a material adverse effect on the Company's business,
operating results and financial condition.
New Product Development and Rapid Technological
Change; Dependence on ISDN Technology. The personal
computer industry is characterized by rapidly changing technologies,
evolving industry standards, frequent new product introductions,
short product life cycles and rapidly changing customer requirements.
The introduction of products embodying new technologies and the
emergence of new industry standards can render existing products obsolete
and unmarketable. The Company's future success will depend on its
ability to enhance its existing products and to introduce new products
to meet changing customer requirements and emerging technologies.
For example, the Company's Netopia products currently operate only
over ISDN telecommunication service. As other communications
technologies such as 56K analog modems, Frame Relay, Asynchronous
Transfer Mode (''ATM''), Asymmetric Digital Subscriber Line (''ADSL'')
and communication over cable or wireless networks, are developed or
gain market acceptance, the Company will be required to enhance its
Internet connectivity products to support such technologies, which
will be costly and time consuming. If the Company is unable to modify
its products to support new Internet access technologies, or if ISDN
does not achieve widespread customer acceptance as a result of the
adoption of alternative technologies or as result of deemphasis of ISDN
by telecommunications service providers, the Company's business,
operating results and financial condition would be materially and
adversely affected. In addition, the Company has historically derived
a substantial majority of its revenues from the sale of Ethernet
connectivity products. In the event that current Ethernet network
technology is modified or replaced and the Company is unable to
modify its products to support new Ethernet technologies or
alternative technologies, the Company's business, operating results
and financial condition could be materially and adversely affected.
The Company has in the past and may in the future experience
delays in new product development. There can be no assurance that
the Company will be successful in developing and marketing product
enhancements or new products that respond to technological change,
evolving industry standards and changing customer requirements,
that the Company will not experience difficulties that could delay
or prevent the successful development, introduction and marketing
of these products or product enhancements, or that its new products
and product enhancements will adequately meet the requirements
of the marketplace and achieve any significant degree of market
acceptance. Failure of the Company, for technological or other reasons,
to develop and introduce new products and product enhancements in a
timely and cost-effective manner would have a material adverse effect
on the Company's business, operating results and financial condition.
In addition, the future introduction or even announcement of products
by the Company or one or more of its competitors embodying new
technologies or changes in industry standards or customer requirements
could render the Company's then existing products obsolete or unmarketable.
There can be no assurance that the introduction or announcement of new
product offerings by the Company or one or more of its competitors will
not cause customers to defer purchase of existing Company products.
Any such deferral of purchases could have a material adverse effect on the
Company's business, operating results or financial condition.
Complex products such as those offered by the Company may
contain undetected or unresolved defects when first introduced or as new
versions are released. There can be no assurance that, despite testing by
the Company, defects will not be found in new products or new versions
of products following commercial release, resulting in loss of market share,
delay in or loss of market acceptance or product recall. Any such
occurrence could have a material adverse effect upon the Company's
business, operating results or financial condition.
As of December 31, 1996, Farallon's research and development
staff consisted of 62 employees. Of these employees 53 were focused
primarily on Internet/Intranet product development and 9 were
focused primarily on LAN product development. The Company believes that
its future success will depend in large part upon its ability to attract and
retain highly-skilled engineering personnel. Competition for such personnel
is intense, and there can be no assurance that the Company will be successful
in attracting and retaining such personnel, the failure of which could have
a material adverse effect on the Company's business, operating results and
financial condition.
Management of Changing Business. The Company has shifted its
business strategy from providing only LAN products to reducing its reliance
on LAN products and focusing development and management efforts on its
Internet/Intranet business. This transition represents a significant challenge
for the Company and its administrative, operational and financial resources
and places increased demands on its systems and controls. The Company's
ability to manage the continuing development of its Internet/Intranet business
will require the Company to continue to change, expand and improve its
operational, management and financial systems and controls and to expand
its manufacturing capacity. This transition has resulted in a continuing
increase in the level of responsibility for both existing and new management
personnel. The Company anticipates that any growth in its Internet/Intranet
business will require it to recruit and hire a substantial number of new
engineering, sales and marketing, customer service, administrative and
managerial personnel. There can be no assurance that the Company will
be successful in hiring or retaining these personnel, if needed. If the
Company is unable to manage the transition effectively, the Company's
business, operating results and financial condition will be materially and
adversely affected.
Dependence on Distributors. The Company relies primarily on
distributors for the sale of its Internet/Intranet and LAN products.
Revenues from distributors accounted for 76%, 73%, 60% and 54%
of the Company's total revenues in fiscal 1994, 1995, 1996 and the
three months ended December 31, 1996, respectively. A substantial amount
of the Company's revenues result from a limited number of these
distributors. The Company's three largest distributors accounted for 45%,
43%, 35% and 35% of the Company's total revenues in fiscal 1994, 1995,
1996 and the three months ended December 31, 1996, respectively.
During fiscal 1994, 1995, 1996 and the three months ended December 31,
1996, revenue from Ingram accounted for 24%, 22%, 18% and 20% of
the Company's total revenues, and revenue from MicroWarehouse
accounted for 12%, 13%, 11% and 10% of the Company's total revenues,
respectively. No other customers have accounted for 10% or more of the
Company's total revenues during fiscal 1994, 1995, 1996 or the three
months ended December 31, 1996. The distribution of LAN products
such as those offered by the Company has been characterized by rapid
change, including industry consolidations, financial difficulties of
distributors and the emergence of alternative distribution channels.
There can be no assurance that Ingram and MicroWarehouse will
continue to serve as distributors for the Company since the Company
does not currently have a written agreement regarding price or
quantity commitments with these or other distributors and operates
with these and other distributors on a purchase order basis. The
Company's distributors generally offer products of several different
companies, including products that are competitive with the Company's
products. There can be no assurance that future sales by the Company's
distributors will continue at current levels, that the Company will be able
to retain its current distributors in the future on terms which are
acceptable to the Company, that the Company's current distributors will
choose to or be able to market the Company's products effectively, that
economic conditions or industry demand will not adversely affect these
or other distributors, or that these distributors will not devote greater
resources to marketing products of other companies. Accordingly, the
loss of, or a significant reduction in revenue from, one of the Company's
distributors, could have a material adverse effect on the Company's
business, operating results and financial condition.
The Company grants to its distributors limited rights to return
unsold inventories of the Company's products in exchange for new
purchases and provides price protection to its distributors. Although
the Company provides allowances for projected returns and price
decreases, any product returns or price decreases in the future that
exceed the Company's allowances will materially and adversely
affect the Company's business, operating results and financial
condition. The Company also provides end users with a lifetime
warranty on certain products and permits end users to return any
product for its full purchase price if the product does not perform
as warranted. To date, the Company has not encountered material
warranty claims. Nevertheless, if future warranty claims exceed the
Company's reserves, the Company's business, operating results and
financial condition could be materially and adversely affected. In
addition, the Company attempts to further limit its liability to end
users through disclaimers of special, consequential and indirect dam
ages and similar provisions in its end user warranty. However, no
assurance can be given that such limitations of liability will be legally
enforceable.
International Operations. International revenues accounted
for 25%, 29%, 29% and 28% of the Company's total revenues in
fiscal 1994, 1995, 1996 and the three months ended December 31, 1996,
respectively. The Company expects that international revenues will
continue to represent a significant portion of its total revenues.
Any significant decline in international demand for the Company's
products would have a material adverse effect on the Company's
business, operating results and financial condition. The Company
believes that in order to increase sales opportunities and profitability
it will be required to expand its international operations. The
Company has committed and continues to commit significant
management attention and financial resources to developing international
sales and support channels. There can be no assurance that the Company
will be able to maintain or increase international market demand for its
products. In addition, the Company is dependent upon the international
demand for Apple products. To the extent that the Company is unable to
maintain or increase international demand for its products, or that
international demand for Apple products does not meet the Company's
expectations, the Company's international sales will be limited, and the
Company's business, operating results and financial condition would be
materially and adversely affected.
The Company's international business is subject to inherent risks,
including but not limited to the impact of possible recessionary environments
in economies outside the United States, costs of localizing products for
foreign countries, longer receivable collection periods and greater difficulty
in accounts receivable collection, unexpected changes in regulatory
requirements, difficulties and costs of staffing and managing foreign
operations, reduced protection for intellectual property rights in some
countries, particularly in developing countries, potentially adverse tax
consequences and political and economic instability. There can be no
assurance that the Company will be able to sustain or increase international
revenues, or that the foregoing factors will not have a material adverse
effect on the Company's future international revenues and its business,
operating results and financial condition. The Company's international
revenues are currently denominated in United States dollars, and revenues
generated by the Company's distributors currently are paid to the
Company in United States dollars. If, in the future, international
revenues are denominated in local currencies, foreign currency
translations may contribute to significant fluctuations in, and could
have a material adverse effect on, the Company's business, operating
results and financial condition. In addition, the Company has a
substantial portion of its products and components manufactured by foreign
suppliers. The Company's operating results are subject to the risks inherent
in international purchases, including, but not limited to, various regulatory
requirements, political and economic changes and disruptions
transportation delays, export/import controls, tariff regulations,
higher freight rates and potentially adverse tax consequences. Duty,
tariff and freight costs can materially increase the cost of crucial
components for the Company's products.
Dependence on Strategic Alliances; Dependence on Contract
Manufacturers and Limited Source Suppliers. The Company relies
on a number of strategic relationships to help achieve market
acceptance of the Company's products and to leverage the Company's
development, sales and marketing resources. Although the Company
views these relationships as important factors in the development and
marketing of the Company's products and services, a majority of the
Company's agreements with its strategic partners or customers do not
require future minimum commitments to purchase the Company's
products, are not exclusive and generally may be terminated at the
convenience of either party. There can be no assurance that the Company's
strategic partners regard their relationship with the Company as strategic to
their own respective businesses and operations, that they will not reassess
their commitment to the Company or its products at any time in the future,
or that they will not develop and/or market their own competitive technology.
The Company does not manufacture any of the components used in
its products and performs only limited assembly on some products. The
Company relies on independent contractors to manufacture to specification
the Company's components, subassemblies, systems and products. The
Company also relies upon limited source suppliers for a number of
components used in the Company's products, including certain key
microprocessors and integrated circuits. There can be no assurance
that these independent contractors and suppliers will be able to timely
meet the Company's future requirements for manufactured products,
components and subassemblies. The Company generally purchases
limited source components pursuant to purchase orders and has no
guaranteed supply arrangements with these suppliers. The Company
has maintained relationships with certain of its domestic manufacturing
suppliers whereby the Company will purchase components used in
certain of its products for resale to its manufacturing suppliers when
the Company can secure more favorable terms for the purchase of
such components. As a result of the Company moving certain of its
production offshore and terminating relationships with certain of its
previous manufacturing suppliers, the Company may be required to
repurchase certain of these component parts that the previous
manufacturing suppliers are unable to resell to the Company's new
manufacturing suppliers. The Company currently believes that the
component parts can be sold to its new manufacturing suppliers and
does not anticipate having to repurchase any of these components,
although there can be no assurance that such repurchases will not be
required. In addition, the availability of many of these components
to the Company is dependent in part on the Company's ability to
provide its suppliers with accurate forecasts of its future requirements.
However, any extended interruption in the supply of any of the key
components currently obtained from a limited source would disrupt
its operations and have a material adverse effect on the Company's
business, operating results and financial condition. In addition, the
Company anticipates that it will be necessary to establish additional
strategic relationships in the future, in particular with additional national
ISPs, and there can be no assurance that the Company will be able to
establish such alliances or that such alliances will result in increased
revenues.
Dependence on Proprietary Rights and Technology. The
Company's ability to compete is dependent in part on its proprietary
rights and technology. The Company relies primarily on a combination
of patent, copyright and trademark laws, trade secrets, confidentiality
procedures and contractual provisions to protect its proprietary rights.
The Company generally enters into confidentiality or license agreements
with its employees, resellers, distributors, customers and potential
customers and limits access to the distribution of its software, hardware
designs, documentation and other proprietary information. There can be
no assurance that the steps taken by the Company in this regard will be
adequate to prevent misappropriation of its technology. The Company
currently has ten issued United States patents, and one pending application
for patent in each of Australia and the European Patent Office. There can
be no assurance that the Company's patents will not be invalidated,
circumvented or challenged, that the rights granted thereunder will provide
competitive advantages to the Company or that any of the Company's
pending or future patent applications, whether or not being currently
challenged by applicable governmental patent examiners, will be issued
with the scope of the claims sought by the Company, if at all. Furthermore,
there can be no assurance that others will not develop technologies that
are similar or superior to the Company's technology or design around the
patents owned by the Company. Despite the Company's efforts to protect
its proprietary rights, unauthorized parties may attempt to copy aspects
of the Company's products or to obtain and use information that the
Company regards as proprietary. Policing unauthorized use of the Company's
products is difficult, and while the Company is unable to determine the
extent to which piracy of its software products exists, software piracy is
expected to be a persistent problem. In selling its software products, the
Company relies primarily on ''shrink wrap'' licenses that are not signed
by licensees and, therefore, it is possible that such licenses may be
unenforceable under the laws of certain jurisdictions. In addition, the
laws of some foreign countries, particularly developing countries, do
not protect the Company's proprietary rights as fully as do the laws of
the United States. There can be no assurance that the Company's means
of protecting its proprietary rights in the United States or abroad will
be adequate or that competing companies will not independently develop
similar technology.
The Company relies upon certain software, firmware and hardware
designs that it licenses from third parties, including firmware that
integrated with the Company's internally developed firmware and used
in the Company's products to perform key functions. There can be no
assurance that these third-party licenses will continue to be available to
the Company on commercially reasonable terms. The loss of, or inability
to maintain, such licenses could result in shipment delays or reductions
until equivalent firmware could be developed, identified, licensed and
integrated which would materially and adversely affect the Company's
business, operating results and financial condition.
Litigation. From time to time, the Company has received claims
of infringement of other parties' proprietary rights. Although the Company
believes that all such claims received to date are immaterial, there can
be no assurance that third parties will not assert infringement claims
in the future with respect to the Company's current or future products.
The Company expects that it will increasingly be subject to
infringement claims as the number of products and competitors in
the Company's industry segments grow and the functionality of products
in different industry segments overlaps. Any such claims, with or without
merit, could be time consuming to defend, result in costly litigation,
divert management's attention and resources, cause product shipment
delays or require the Company to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on
terms acceptable to the Company, if at all. In the event of a successful claim
of product infringement against the Company and failure or inability of the
Company to license the infringed or similar technology, the Company's
business, operating results and financial condition would be materially
and adversely affected.
From time to time, the Company may be involved in litigation
or administrative claims arising out of its operations in the normal course
of business. For example, in 1995 the Company terminated negotiations
with a manufacturer of router products regarding a potential acquisition.
Shortly thereafter, the Company received correspondence from such
manufacturer's counsel asserting that the Company's termination of
negotiations was improper and demanding that Farallon either
consummate an acquisition for cash and stock or license from such
manufacturer certain technology. The Company believes that any
potential claim by such manufacturer, if brought, would be entirely
without merit and the Company is prepared to vigorously defend
any such claim.
Lengthy Sales Cycle and Lengthy Partnership Development.
The Company's Internet/Intranet software products are often licensed
to customers on a volume license basis for use on private wide area
network (''WAN'') Intranets involving thousands of nodes. These
licenses often involve significant license and maintenance fees. As
a result, the license of the Company's Internet/Intranet software
products often involves a significant commitment of management
attention and resources by prospective customers. Accordingly, the
Company's sales process for these products is often subject to delays
associated with long approval processes that typically accompany
significant capital expenditures. For these and other reasons, the sales
cycle associated with the license of the Internet/Intranet software products
is often lengthy and subject to a number of significant delays over which
the Company has little or no control. There can be no assurance that the
Company will not experience these and additional delays in the future on
Internet/Intranet software or other products.
The Company's Netopia products are often distributed through
partnerships with ISPs. These partnerships often involve lengthy testing
and certification studies as well as detailed agreements. As a result,
partnerships with ISPs to distribute Netopia products involve a significant
commitment of management attention and resources by prospective partners.
Accordingly, the Company's business development process for these
distribution channels is often subject to delays associated with long
approval processes that typically accompany significant partnership
development and capital expenditures. For these and other reasons, the
business development process associated with the partnerships are often
lengthy and subject to a number of significant delays over which the
Company has little or no control. There can be no assurance that the
Company will not experience these and additional delays in the future
on partnership development.
Tariff and Regulatory Matters. The Company is not currently
subject to direct regulation by any government agency, other than
regulations applicable to businesses generally. However, rates for
telecommunications services are governed by tariffs of licensed carriers
that are subject to regulatory approval. Future changes in these tariffs
could have a material adverse effect on the Company's business, operating
results and financial condition. For example, if tariffs for public switched
digital services increase in the future relative to tariffs for private leased
services, then the cost-effectiveness of the Company's products would be
reduced, and its business, operating results and financial condition would
be materially and adversely affected. In addition, the Company's
telecommunications products must meet standards and receive
certification for connection to public telecommunications networks
prior to their sale. In the United States, such products must comply
with Part 15(a) (industrial equipment), Part 15(b) (residential equipment)
and Part 68 (analog lines) of the Federal Communications Commission
regulations. The Company's telecommunications products also must be
certified by domestic telecommunications carriers. In foreign countries,
such products are subject to a wide variety of governmental review and
certification requirements. While certain foreign countries and the
European Economic Community regulate the importation and certification
of the Company's products, most foreign customers typically require that
the Company's products receive certification from their country's primary
telecommunication carriers. Any future inability to obtain on a timely basis
or retain domestic certification or foreign regulatory approvals could have a
material adverse effect on the Company's business, operating results and
financial condition.
Dependence on Key Personnel. The Company's business and
prospects depend to a significant degree upon the continuing
contributions of its key management, sales, marketing, product
development and administrative personnel. The Company does not
have employment contracts with its key personnel and does not
maintain any key person life insurance policies. The loss of key
management or technical personnel could materially and adversely
affect the Company's business, operating results and financial
condition. The Company believes that its prospects depend in large
part upon its ability to attract and retain highly-skilled engineering,
managerial, sales and marketing, and administrative personnel.
Competition for such personnel is intense, and there can be no assurance
that the Company will be successful in attracting and retaining such
personnel. Failure to attract and retain key personnel could have a material
adverse effect on the Company's business, operating results and financial
condition.
Volatility of Stock Price. The market price of the shares of the
Company's Common Stock is highly volatile and may be significantly
affected by factors such as actual or anticipated fluctuations in the
Company's results of operations, announcements of technological
innovations, introduction of new products by the Company or its
competitors, developments with respect to patents, copyrights or proprietary
rights, conditions and trends in the networking and other technology
industries, changes in or failure by the Company to meet securities
analysts' expectations, general market conditions and other factors. In
addition, the stock market has from time to time experienced significant
price and volume fluctuations that have particularly affected the market
prices for the common stocks of technology companies. These broad market
fluctuations may adversely affect the market price of the Company's Common
Stock. In the past, following periods of volatility in the market price of a
particular company's securities, securities class action litigation has often
been brought against that company. There can be no assurance that such
litigation will not occur in the future with respect to the Company. Such
litigation could result in substantial costs and a diversion of management's
attention and resources, which could have a material adverse effect upon
the Company's business, operating results and financial condition.
California Headquarters . The Company's corporate
headquarters and a large portion of its research and development
facilities as well as other critical business operations are located in
California, near major earthquake faults. The Company's business,
financial condition and operating results could be materially adversely
affected in the event of a major earthquake.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily
through cash flow from operations, the private sale of equity securities
and the Initial Public Offering ("IPO") of the Company's Common Stock.
Since inception, the Company has raised $19.4 million from the private
sale of equity securities and approximately $24.8 million of cash, net
of offering expenses, from the Company's IPO completed in June, 1996
As of December 31, 1996, the Company had cash, cash equivalents and
short-term investments of $37.6 million (representing 62% of total assets)
and had working capital of $49.6 million.
The Company generated cash from operating activities of
$801,000 for the three months ended December 31, 1996. The cash
generated from operations was primarily due to the collection of
accounts receivable of $1.8 million, partially offset by reductions of
accounts payable of $1.3 million. Total inventory increased 7% from
$6.3 million as of September 30, 1996 to $6.8 million as of December 31,
1996. Netopia and Fast Ethernet products represented 12% and 23% of total
gross inventory as of September 30, 1996, respectively, and represented 11%
and 19% of total gross inventory as of December 31, 1996, respectively.
The Company's investing activities have consisted primarily of
purchases of short-term investments and capital equipment. Expenditures
for capital equipment totaled $331,000 for the three months ended
December 31, 1996, representing acquisitions of computer equipment
used predominantly in product development as well as tooling and test
fixtures for new products. The Company expects that its capital
expenditures will increase in future periods to support new product
development and production. The Company's principal commitments
consist primarily of leases on its headquarters facilities and certain
operating equipment.
As of December 31, 1996, the Company had a $5.0
million credit facility, which expires on February 28, 1997. There
were no borrowings under the credit facility as of December 31,
1996. The Company does not anticipate renewing this credit facility.
The Company believes that its existing cash, cash
equivalents and short-term investments will be adequate to meet
its cash needs for working capital and capital expenditures for at least
the next 12 months. Thereafter, if cash generated from operations is
insufficient to satisfy the Company's liquidity requirements, the Company
may seek to sell additional equity or convertible debt securities or obtain
additional credit facilities. The sale of additional equity or convertible
debt securities could result in additional dilution to the Company's
stockholders. A portion of the Company's cash may be used to acquire
or invest in complementary businesses or products or to obtain the right
to use complementary technologies. From time to time, in the ordinary
course of business, the Company evaluates potential acquisitions of such
businesses, products or technologies. The Company has no agreements
or commitments, and is not currently engaged in any negotiations with
respect to any such transaction.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11.1 Statement of Computation of Per Share Earnings
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No Reports on Form 8-K were filed during the quarter ended
December 31, 1996.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: February 13, 1997 FARALLON COMMUNICATIONS, INC.
(Registrant)
By: /s/ James A. Clark
James A. Clark
Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer)
INDEX TO EXHIBITS
Exhibit Description
11.1 Statement of Computation of Per Share Earnings
<TABLE>
<CAPTION>
EXHIBIT 11.1
STATEMENT OF COMPUTATION OF PER SHARE EARNINGS
(in thousands, except per share amounts)
Three Months Ended December 31,
1995 1996
<S> <C> <C>
Net income $ 299 $ 118
Weighted average number of common stock
outstanding(using as-converted method) 9,252 11,129
Number of common stock equivalents as
a result of stock options outstanding
using the treasury stock method 236 1,318
Number of common stock issued and
stock options granted in accordance
with Staff Accounting Bulletin No. 83 369 -
Shares used in per share calculation 9,857 12,447
Net income per share $ 0.03 $ 0.01
</TABLE>
[ARTICLE] 5
[CIK] 0001012482
[NAME] FARALLON COMMUNICATIONS, INC.
[MULTIPLIER] 1,000
<TABLE>
[PERIOD-TYPE] 3-MOS
[FISCAL-YEAR-END] SEP-30-1997
[PERIOD-START] OCT-01-1996
[PERIOD-END] DEC-31-1996
<S> <C>
[CASH] 16423
[SECURITIES] 21202
[RECEIVABLES] 10797
[ALLOWANCES] 1450
[INVENTORY] 6770
[CURRENT-ASSETS] 56935
[PP&E] 12325
[DEPRECIATION] 9514
[TOTAL-ASSETS] 60565
[CURRENT-LIABILITIES] 7287
[BONDS] 0
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[COMMON] 12
[OTHER-SE] 53263
[TOTAL-LIABILITY-AND-EQUITY] 60565
[SALES] 13463
[TOTAL-REVENUES] 13463
[CGS] 6864
[TOTAL-COSTS] 6864
[OTHER-EXPENSES] 6805
[LOSS-PROVISION] 1450
[INTEREST-EXPENSE] (388)
[INCOME-PRETAX] 182
[INCOME-TAX] 64
[INCOME-CONTINUING] 118
[DISCONTINUED] 0
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] 118
[EPS-PRIMARY] 0.01
[EPS-DILUTED] 0.01
</TABLE>
