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 June 30, 1997
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
incorporation or organization)
(I.R.S. Employer
Identification Number)
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 August 1, 1997 there were 11,471,121 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
at September 30, 1996 and June 30, 1997 3
Condensed Consolidated Statements of Operations
for the three and nine months ended June 30, 1996 and 1997 4
Condensed Consolidated Statements of Cash Flows
for the nine months ended June 30, 1996 and 1997 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 25
SIGNATURE 26
INDEX TO EXHIBITS 27
PART I. FINANCIAL INFORMATION
Item 1. Condensed Financial Statements
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION> September 30, 1996 June 30, 1997
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 19,910 $ 16,964
Short-term investments 17,235 24,109
Trade accounts receivable, net
of allowances of $1,328 and
$1,276 at September 30, 1996 and
June 30, 1997, respectively 11,172 6,920
Inventories, net 6,295 5,452
Deferred tax asset 1,829 1,829
Prepaid expenses and other
current assets 1,457 782
-------- --------
Total current assets 57,898 56,056
======== =======
Furniture, fixtures, and
equipment, net 2,935 2,402
Deposits and other assets 785 754
-------- -------
Total assets $ 61,618 $ 59,212
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and
accrued liabilities $ 5,449 $ 3,057
Accrued compensation 2,023 1,612
Deferred revenue 787 1,159
Other current liabilities 170 88
-------- --------
Total current liabilities 8,429 5,916
Other long-term liabilities 46 -
------- -------
Total liabilities 8,475 5,916
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 11,386,229 shares
issued and outstanding at
September 30, 1996 and June 30,
1997, respectively 12 12
Additional paid-in capital 49,232 49,968
Deferred compensation (81) (68)
Retained earnings 3,980 3,384
-------- -------
Total stockholders' equity 53,143 53,296
-------- --------
Total liabilities and
stockholders' equity $ 61,618 $ 59,212
====== ======
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
1996 1997 1996 1997
<S> <C> <C> <C> <C>
Revenues:
Internet/Intranet products $ 4,614 $ 5,054 $11,055 $ 14,513
LAN products 11,013 7,102 34,016 23,786
------- ------- -------- -------
Total revenues 15,627 12,156 45,071 38,299
Cost of revenues:
Internet/Intranet products 1,080 1,482 2,318 4,740
LAN products 6,987 4,802 20,930 15,270
--------- ------- -------- --------
Total cost of revenues 8,067 6,284 23,248 20,010
--------- -------- -------- ---------
Gross profit 7,560 5,872 21,823 18,289
Operating expenses:
Research and development 2,368 2,212 6,680 6,625
Selling and marketing 4,044 3,600 11,622 11,308
General and administrative 823 907 2,664 2,576
--------- ------- -------- --------
Total operating expenses 7,235 6,719 20,966 20,509
Operating income (loss) 325 (847) 857 (2,220)
Other income, net 230 507 663 1,304
------- ------- ------- ----------
Income (loss) before income taxes 555 (340) 1,520 (916)
Income tax provision (benefit) 195 (119) (1,721) (320)
------- -------- --------- ---------
Net income (loss) $ 360 $ (221) $ 3,241 $ (596)
======= ====== ====== =====
Net income (loss) per share $ 0.03 $ (0.02) $ 0.30 $ (0.05)
======= ====== ====== ======
Shares used in per
share calculation 11,106 11,378 10,686 11,286
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
<TABLE>
<CAPTION>
Nine Months Ended June 30,
1996 1997
------ ------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 3,241 $ (596)
Adjustments to reconcile net income (loss)
to net cashash provided by operating
activities:
Depreciation and amortization 1,287 1,391
Deferred taxes (2,254) -
Amortization of deferred compensation - 13
Non-cash compensation 192 -
Changes in assets and liabilities:
Trade accounts receivable (2,036) 4,252
Inventories, net (2,178) 843
Prepaid expenses, deposits and other assets (336) 642
Accounts payable and accrued liabilities (1,390) (2,804)
Other liabilities (134) (127)
Deferred revenue 515 372
-------- --------
Net cash provided by (used in)
operating activities (3,093) 3,986
--------- --------
Cash flows from investing activities:
Purchase of short-term investments (70,507) (32,817)
Proceeds from the sale of short-term
investments 74,187 25,943
Acquisition of furniture, fixture and
equipment (1,789) (794)
-------- --------
Net cash provided by (used in)
investing activities 1,891 (7,668)
------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 24,964 736
--------- -------
Net cash provided by financing
activities 24,964 736
-------- -------
Net increase (decrease) in cash and
cash equivalents 23,762 (2,946)
Cash and cash equivalents, beginning of period 13,963 19,910
--------- ----------
Cash and cash equivalents, end of period $ 37,725 $ 16,964
======== ======
Supplemental disclosures of cash flow information:
Interest paid $ 2 $ 2
====== =======
Income taxes paid $ 554 $ 287
====== =======
</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 condensed consolidated financial
statements should be read in conjunction with the Company's consolidated
financial statements 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
June 30, 1997 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. Inventories consisted of the following
(in thousands):
September 30, 1996 June 30, 1997
<S> <C> <C>
Raw materials and work in process $ 2,477 $ 2,671
Finished goods 3,818 2,781
------- --------
$ 6,295 $ 5,452
===== ======
</TABLE>
<TABLE>
<CAPTION>
3. Furniture, Fixtures and Equipment, net (in thousands):
September 30, 1996 June 30, 1997
<S> <C> <C>
Furniture, fixtures and equipment $ 11,993 $ 12,788
Accumulated depreciation and amortization (9,058) (10,386)
--------- ---------
$ 2,935 $ 2,402
====== =====
</TABLE>
4. Net Income (Loss) Per Share
Net income per share for the three and nine months
ended June 30, 1996 is based on the weighted average number of shares
of common stock outstanding and dilutive common equivalent shares
from options outstanding during the period using the treasury stock
method and common equivalent shares from the convertible preferred
stock using the ''as-if-converted'' method. Net loss per share for the
three and nine months ended June 30, 1997 is based on the weighted
average number of shares of common stock outstanding. The inclusion of
common equivalent shares from options outstanding during the period using
the treasury stock method would have been antidilutive.
For the three and nine month periods ended June
30, 1996 pursuant to certain SEC Staff Accounting Bulletins,
common stock issued for consideration below the Initial Public
offering ("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.
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share". SFAS No. 128 requires the presentation of basic
earnings per share ("EPS") and, for companies with complex capital
structures, diluted EPS. SFAS No. 128 is effective for annual and
interim periods ending after December 15, 1997. The Company
expects that for profitable periods basic EPS will be higher than
primary earnings per share as the Company has historically presented.
Diluted EPS for profitable periods will not differ materially from primary
EPS. Computations for loss periods should not change significantly.
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 June 30, 1996 and 1997
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 software products, sales of Netopia Internet
connectivity products and fees for related services as well as revenue
from licensing its patent covering cross-platform screen-sharing
technology. 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 22.2% from $15.6 million
to $12.2 million for the three months ended June 30, 1996 and 1997,
respectively. Internet/Intranet products revenue increased 9.5% from
$4.6 million to $5.1 million for the three months ended June 30, 1996
and 1997, respectively. The increase in Internet/Intranet revenue was
primarily due to increased sales of Netopia Internet connectivity
products and revenue from the recently introduced Netopia Virtual
Office software product which was not available during the three months
ended June 30, 1996 as well as increased sales of the Windows versions
of Timbuktu Pro. Netopia Internet connectivity product revenue increased
from the same period in the prior year primarily due to sales of the
"So-Smart" and international Netopia ISDN routers as well as an increase
in the number of regional U.S. Internet Service Providers ("ISPs") selling
Netopia Internet connectivity products. Neither the "So-Smart" nor
international Netopia ISDN routers were available during the three
months ended June 30, 1996. Revenue from the Windows versions of
Timbuktu Pro increased primarily due to increased sales of volume
licenses and Original Equipment Manufacturer ("OEM") licenses.
These increases were partially offset by decreased revenue from the
Macintosh version of Timbuktu Pro which the Company believes was
adversely affected by the general confusion surrounding Apple Computer,
Inc. ("Apple") and the MacOS including Apple's recently reported
declining sales volumes of the Macintosh computers and substantial
losses. LAN products revenue decreased 35.5% from $11.0 million to
$7.1 million for the three months ended June 30, 1996 and 1997,
respectively, primarily due to declining volume and average selling
prices of EtherWave, certain Ethernet products and LocalTalk products
partially offset by increased sales of certain other of the Company's
Ethernet products for Macintosh clones and retrofit upgrades. The
Company believes LAN product revenue continue to be adversely
affected by the general confusion surrounding Apple and the MacOS
including Apple's substantial losses as well as vendor incorporation of
built-in Ethernet into new computers. LAN product revenue accounted
for 70.5% and 58.4% of the Company's total revenues for the three
months ended June 30, 1996 and 1997, respectively, while Internet/Intranet
products revenue accounted for 29.5% and 41.6% of the Company's total
revenues for the three months ended June 30, 1996 and 1997, respectively.
The Company continues to focus on the development of its
Internet/Intranet business. Due to price competition related to the
Company's LAN products, the erosion of pricing premiums on MacOS
products, Apple's continued difficulties, declining sales of MacOS
computers, and other competitive factors, the Company expects that
revenue from its LAN products will continue to decline. As a result,
the Company's future operating results are dependent upon continued
and increasing market acceptance and penetration of its Internet/Intranet
products and enhancements thereto, particularly in the Windows market.
However, the Company's operating results will continue to be adversely
affected to the extent that declines in revenues from LAN products are not
offset by increases from other sources, such as revenues from the Company's
Internet/Intranet products. To date, the Company has derived a substantial
majority of its revenue from LAN products, which represented 89%
and 73% of total revenues for fiscal years 1995 and 1996, respectively,
and 76% and 62% of total revenues for the nine month periods ended
June 30, 1996 and 1997, respectively. There can be no assurance that
the Company's increasing focus on its Internet/Intranet products will
offset the decline in revenues from its LAN products. Should the
Company's Internet/Intranet products and enhancements not continue
to gain market acceptance, particularly in the Windows market, the
Company's business, operating results and financial condition will by
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, higher education institutions and
through the Company's website. Revenues from distributors accounted
for 57% and 60% of total revenues for the three months ended
June 30, 1996 and 1997, respectively. Revenues from Ingram Micro
("Ingram") accounted for 17% and 16% of total revenues for the
three months ended June 30, 1996 and 1997, respectively, and
revenues from MicroWarehouse accounted for 10% and 11% of
total revenues for the three months ended June 30, 1996 and 1997,
respectively. No other customers have accounted for 10% or more
of the Company's total revenues during the three months ended
June 30, 1996 and 1997. The Company intends to continue to
use its existing distributors, VARs and ISPs to sell the Company's
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
and/or ISPs could have a material adverse effect on the
Company's business, operating results and financial condition.
International revenues accounted for 28% and 29% of
total revenues for the three months ended June 30, 1996 and 1997,
respectively. The Company believes international revenues,
both in Europe and the Pacific Rim continue to be adversely
affected by the general confusion surrounding Apple and the
MacOS including Apple's recently reported declining sales of
Macintosh computers and substantial losses, partially offset
by 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 LAN
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 was 48.4% and 48.3% for the three
months ended June 30, 1996 and 1997, respectively. The Company's gross
margin for Internet/Intranet products decreased from 76.6% to 70.7% for
the three months ended June 30, 1996 and 1997, respectively, primarily
due to increased sales of Netopia Internet connectivity products which
have lower gross margins than the Company's Internet/Intranet software
products. The Company's gross margin for LAN products decreased from
36.6% to 32.4% for the three months ended June 30, 1996 and 1997,
respectively, primarily due to declining sales of higher margin
products and average selling price reductions as a result of increased
price competition partially offset by increased sales of certain higher
margin Ethernet products for Macintosh clones and retrofit upgrades.
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 changes in product mix
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
decreased from $2.4 million to $2.2 million for the three months ended
June 30, 1996 and 1997, respectively. The decrease in research and
development expenses is primarily due to declining tooling, recruiting
and third party engineering expenses. Research and development
expenses represented 15.2% and 18.2% of total revenues for the three
months ended June 30, 1996 and 1997, respectively. The Company
believes that it will continue to devote substantial resources to product
development and that research and development expenses may increase
in absolute dollars for the remainder of fiscal 1997 and into fiscal 1998.
The Company believes its process for developing software is essentially
completed concurrent with the establishment of technological feasibility,
and no internal software development costs have been capitalized to date.
The Company may enter into future development or acquisition agreements
in which the Company may be required to capitalize the cost of certain
software or software development.
Selling and Marketing. Selling and marketing expenses decreased
from $4.0 million to $3.6 million for the three months ended
June 30, 1996 and 1997, respectively. The decrease in selling and
marketing expenses is primarily due to reduced print advertising and
related expenses as the company continues to focus on electronic
advertising efforts as well as reduced trade show related expenses,
partially offset by increased headcount and related expenses. Selling
and marketing expenses represented 25.9% and 29.6% of total revenues
for the three months ended June 30, 1996 and 1997, respectively. The
Company believes that selling and marketing expenses may increase in
absolute dollars for the remainder of fiscal 1997 and into fiscal 1998
primarily due to personnel related expenses and increased advertising
and promotional activities.
General and Administrative. General and administrative expenses
increased from $823,000 to $907,000 for the three months ended June 30,
1996 and 1997, respectively. The increase in general and administrative
expenses is primarily due to increased legal, insurance and other services
related to being a public company partially offset by decreased third party
contractor expenses. General and administrative expenses represented 5.3%
and 7.5% of total revenues for the three months ended June 30, 1996 and
1997, respectively. The Company believes that general and administrative
expenses may increase in absolute dollars for the remainder of fiscal
1997 and into fiscal 1998 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 increased professional fees and investor relations programs.
Other Income, net. Other income, net, primarily represents
interest earned by the Company on its cash equivalents and short-term
investments.
Provision for Income Taxes. The effective tax rate was 35% for
the each of three months ended June 30, 1996 and 1997. 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.
Nine Months Ended June 30, 1996 and 1997
The Company's total revenues decreased 15.0%
from $45.1 million to $38.3 million for the nine months ended
June 30, 1996 and 1997, respectively. Internet/Intranet products
revenue increased 31.3% from $11.1 million to $14.5 million for
the nine months ended June 30, 1996 and 1997, respectively.
The increase in Internet/Intranet revenue was primarily due to
increased sales of Netopia Internet connectivity products and revenue
from the recently introduced Netopia Virtual Office software product
which was not available during the nine months ended June 30, 1996
as well as increased sales of the Windows version of Timbuktu Pro.
Netopia Internet connectivity product revenue increased from the same
period in the prior year primarily due to sales of the "So-Smart" and
international Netopia ISDN routers as well as a great number of regional
U.S. ISPs selling Netopia Internet connectivity products. Neither the
"So-Smart" nor international Netopia ISDN routers were available
during the nine months ended June 30, 1996. Revenue from the Windows
versions of Timbuktu Pro increased primarily due to increased sales
of volume licenses and OEM licenses. These increases are partially
offset by decreased shrink wrap, volume licensing and upgrades of the
Macintosh version of Timbuktu Pro which the Company believes
continue to be adversely affected by the general confusion surrounding
Apple and the MacOS including Apple's recently reported declining
sales of Macintosh computers and substantial losses. LAN products
revenue decreased 30.1% from $34.0 million to $23.8 million for the
nine months ended June 30, 1996 and 1997, respectively, primarily
due to declining volume and average selling prices of EtherWave,
LocalTalk and certain Ethernet products partially offset by increased
sales of certain other of the Company's Ethernet products for
Macintosh clones and retrofit upgrades. The Company believes
LAN products continue to be adversely affected by the general
confusion surrounding Apple and the MacOS including Apple's
substantial losses and vendor incorporation of built-in Ethernet
into new computers. LAN products revenue accounted for 75.5%
and 62.1% of the Company's total revenues for the nine months
ended June 30, 1996 and 1997, respectively, while Internet/Intranet
products revenue accounted for 24.5% and 37.9% of the Company's
total revenues for the nine months ended June 30, 1996 and 1997, respectively.
The Company continues to focus on the development of its
Internet/Intranet business. Due to price competition related to the
Company's LAN products, the erosion of pricing premiums on MacOS
products, Apple's continued difficulties, declining sales of MacOS
computers, and other competitive factors, the Company expects that
revenue from its LAN products will continue to decline. As a result,
the Company's future operating results are dependent upon continued
and increasing market acceptance and penetration of its Internet/Intranet
products and enhancements thereto, particularly in the Windows market.
However, the Company's operating results will continue to be adversely
affected to the extent that declines in revenues from LAN products are not
offset by increases from other sources, such as revenues from the Company's
Internet/Intranet products. To date, the Company has derived a substantial
majority of its revenue from LAN products, which represented 89%
and 73% of total revenues for fiscal years 1995 and 1996, respectively,
and 76% and 62% of total revenues for the nine month periods ended
June 30, 1996 and 1997, respectively. There can be no assurance that
the Company's increasing focus on its Internet/Intranet products will
offset the decline in revenues from its LAN products. Should the
Company's Internet/Intranet products and enhancements not continue
to gain market acceptance, particularly in the Windows market, the
Company's business, operating results and financial condition will by
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
VARs and ISPs or directly by the Company to corporate accounts,
higher education institutions and through the Company's website.
Revenues from distributors accounted for 63% and 61% of total
revenues for the nine months ended June 30, 1996 and 1997,
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 accounted for 19% of total revenues for each of the nine
months ended June 30, 1996 and 1997, and revenues from
MicroWarehouse accounted for 11% and 10% of total revenues
for the nine months ended June 30, 1996 and 1997, respectively.
No other customers have accounted for 10% or more of the
Company's total revenues during the nine months ended June 30,
1996 and 1997. The Company intends to continue to use its existing
distributors, VARs and ISPs to sell the Company's 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 and/or ISPs could have a
material adverse effect on the Company's business, operating results
and financial condition.
International revenues accounted for 32% and 30% of total
revenues for the nine months ended June 30, 1996 and 1997,
respectively. The Company believes international revenues,
both in Europe and the Pacific Rim, continue to be adversely
affected by the general confusion surrounding Apple and the MacOS
including Apple's recently reported declining sales of Macintosh
computers and substantial losses, partially offset by 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 LAN 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 decreased from 48.4%
to 47.8% for the nine months ended June 30, 1996 and 1997, respectively.
The Company's gross margin for Internet/Intranet products decreased
from 79.0% to 67.3% for the nine months ended June 30, 1996 and 1997,
respectively, primarily due to increased sales of Netopia connectivity
products which have lower gross margins than the Company's
Internet/Intranet software products. The Company also reduced the
average selling prices of its Netopia routers due to price competition
which contributed to declining Internet/Intranet margins. The Company's
gross margin for LAN products decreased from 38.5% to 35.8% for the
nine months ended June 30, 1996 and 1997, respectively, primarily
due to declining sales of higher margin products and average selling
price reductions as a result of increased price competition partially
offset by increased sales of certain higher margin Ethernet products
for Macintosh clones and retrofit upgrades. 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 changes in product mix 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
decreased slightly from $6.7 million to $6.6 million for the nine months
ended June 30, 1996 and 1997, respectively. The decrease in research and
development expenses is primarily due to decreased tooling and third party
engineering expenses partially offset by increased headcount and related
expenses. Research and development expenses represented 14.8% and
17.3% of total revenues for the nine months ended June 30, 1996 and
1997, respectively. The Company believes that it will continue to devote
substantial resources to product development and that research and
development expenses may increase in absolute dollars for the remainder
of fiscal 1997 and into fiscal 1998. The Company believes its process
for developing software is essentially completed concurrent with the
establishment of technological feasibility, and no internal software
development costs have been capitalized to date. The Company may
enter into future development or acquisition agreements in which the
Company may be required to capitalize the cost of certain software or
software development.
Selling and Marketing. Selling and marketing expenses
decreased from $11.6 million to $11.3 million for the nine months
ended June 30, 1996 and 1997, respectively. The decrease in total
selling and marketing expenses was primarily due to decreased print
advertising and related expenses as the Company continues to focus
its efforts on electronic marketing partially offset by increased headcount
and related expenses. Selling and marketing expenses represented 25.8%
and 29.5% of total revenues for the nine months ended June 30, 1996
and 1997, respectively. The Company believes that selling and marketing
expenses may increase in absolute dollars for the remainder of fiscal 1997
and into fiscal 1998 primarily due to personnel related expenses and increased
advertising and promotional activities.
General and Administrative. General and administrative expenses
decreased from $2.7 million to $2.6 million for the nine months ended
June 30, 1996 and 1997 due to reduced recruiting and third party contractor
expenses partially offset by increased expenses related to being a public
company. General and administrative expenses represented 5.9% and 6.7%
of total revenues for the nine months ended June 30, 1996 and 1997, respectively
.
The Company believes that general and administrative expenses may 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 increased professional fees and investor relations programs.
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%
(excluding a non-recurring income tax benefit recorded in the three
months ended June 30, 1996) for the each of nine months ended June 30,
1996 and 1997. 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. During fiscal 1996, the
Company reversed a full valuation allowance that it had previously provided
against its deferred tax assets, resulting in a non-recurring income tax benefit
of approximately $2.3 million.
OTHER RISK FACTORS THAT MAY AFFECT FUTURE OPERATING
RESULTS
The Company operates in a rapidly changing environment
that involves a number of risks, many 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,
for example, the Company has recently experienced quarterly losses
and may experience a loss for the fiscal year. The Company's results
depend 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, customer deferrals for budgetary or other reasons,
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 shipped
and 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. The Company typically experiences significant volume of
shipments at the end of the quarter which may be exposed to delays
caused by shipping halts, such as the current strike at United Parcel
Service of America, Inc. or other factors beyond the Company's control.
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 seasonality 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 or loss is likely to be disproportionately affected.
Due to all of the foregoing factors, and other factors discussed herein,
revenues and net income or loss 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 return to or 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 in 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
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 89% and 73% of total revenues for
fiscal years 1995 and 1996, respectively, and 76% and 62% of total
revenues for the nine month periods ended June 30, 1996 and 1997,
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 nine months ended June 30, 1997, 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. 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.
Due to all of the foregoing factors, the Company continues
to focus on the development of its Internet/Intranet business.
As a result, the Company's future operating results are dependent
upon continued and increasing market acceptance and penetration
of its Internet/Intranet products and enhancements thereto,
particularly in the Windows market. However, the Company's
operating results will continue to be adversely affected to the extent t
hat declines in revenues from LAN products are not offset by increases
from other sources, such as revenues from the Company's Internet/Intranet
products. To date, the Company has derived a substantial majority of
its revenue from LAN products, which represented 89% and 73% of
total revenues for fiscal years 1995 and 1996, respectively, and 76%
and 62% of total revenues for the nine month periods ended June 30,
1996 and 1997, respectively. There can be no assurance that the
Company's increasing focus on its Internet/Intranet products will
offset the decline in revenues from its LAN products. Should the
Company's Internet/Intranet products and enhancements not continue
to gain market acceptance, particularly in the Windows market, the
Company's business, operating results and financial condition will
by 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 nine months ended June 30, 1997,
the Company believes revenues were adversely affected by declining
sales of Apple computers and continued confusion surrounding Apple
and the MacOS including Apple's substantial losses.
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
continued restructuring in process at Apple, including but not limited to
the search for a new chief executive officer, 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 their 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 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, Ramp
Networks (formerly Trancell Networks) and several other companies.
In the remote control and screen sharing software market, the
Company competes primarily with Symantec, Microsoft, Tivoli,,
IFS Industrial and Financial Systems (Avalon), 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 and has publicly stated that
they are committed to integrating Internet technology into existing
products at no additional cost to customer. 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 currently competes 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. Recently announced
consolidations in the networking environment continue to create
companies with substantially greater financial, technical, sales,
marketing and other resources than the Company, as well as
greater name recognition and a significantly larger customer base.
These companies 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. 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 and Frame Relay 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 over ISDN and Frame Relay telecommunication services.
As other communications technologies such as 56K analog modems,
Asynchronous Transfer Mode (''ATM''), Asymmetric Digital Subscriber
Line (''ADSL''), various other Digital Subscriber Line ("xDSL") 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, time consuming and have uncertain market acceptance.
If the Company is unable to modify its products to support new
Internet access technologies, or if ISDN and/or Frame Relay do
not achieve widespread customer acceptance as a result of the adoption
of alternative technologies or as a result of deemphasis of ISDN
and/or Frame Relay 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 purchases 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
(such as the recently introduced Netopia Frame Relay Routers, LAN
products and new software products/upgrades) 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.
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 capabilities. 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 73% and 60% of total revenues in fiscal 1995
and 1996, respectively, and 63% and 61% of total revenues for the nine months
ended June 30, 1996 and 1997, 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 43% and 35% of total
revenues in fiscal 1995 and 1996, respectively, and 35% and 33% of total
revenues for the nine months ended June 30, 1996 and 1997, respectively.
During fiscal 1995, 1996 and the nine months ended June 30, 1996 and 1997,
revenue from Ingram accounted for 22%, 18%, 19% and 19%, respectively,
of the Company's total revenues, and revenue from MicroWarehouse
accounted for 13%, 11%, 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 1995, 1996 or the nine months
ended June 30, 1996 and 1997. 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, that
these distributors will not devote greater resources to marketing products of
other companies or that internal staffing changes or other changes at the
Company's distributors will not disrupt historical purchasing or payment
patterns. 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
damages 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
29% of the Company's total revenues in fiscal 1995 and 1996, respectively,
and 32% and 30% of total Company revenues for the nine months ended
June 30, 1997, 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, potentially adverse tax consequences
and political and economic instability. In addition, the laws of
certain foreign countries in which the Company's products are
or may be manufactured or sold, including various countries in
Asia, may not protect the Company's products or intellectual
property rights to the same extent as do the laws of the United
Sates and thus make the possibility of piracy of the Company's
technology and products more likely. 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, however
in some instances the Company may find it necessary to release its
source code to certain parties, for example the Company recently
entered into a product development agreement pursuant to which it
released certain source code to a third party in the Asia.
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. 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 where
the Company's products are or may be manufactured or sold,
particularly developing countries including various countries in Asia
such as Asia, 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 is 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 and claims
related to the termination of potential acquisitions. 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
or other claims in the future with respect to the Company's current
or future products or activities. 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
overlap. 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. In the event of a successful claim against the Company, the
Company's business, operating results and financial condition would be
materially and adversely affected.
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 and telecommunications carriers.
These partnerships often involve lengthy testing and certification
studies as well as detailed agreements. As a result, partnerships
with ISPs and/or telecommunications carriers 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.
Risks Associated with Potential Acquisitions or Divestitures.
The Company may acquire or invest in companies, technologies or
products that complement the Company's business or its product
offerings. The Company continues to evaluate the performance of all its
products and product lines. Any acquisitions or dispositions may result in
potentially dilutive issuance of equity securities, the write-off of software
development costs or the amortization of expenses related to goodwill
and other intangible assets and/or the incurrence of debt, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations. Acquisitions or divestitures would
involve numerous additional risks including difficulties in the assimilation
or separation of operations, services, products and personnel, the
diversion of management's attention from other business concerns,
the disruption of the Company's business, the entry into markets in
which the Company has little or no direct prior experience and the
potential loss of key employees. There can be no assurance that the
Company would be successful in overcoming these or any other
significant risks encountered.
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
and ISDN lines) of the Federal Communications Commission
regulations. The Company's telecommunications products also
must be certified by certain 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 regulatory approvals and certification or foreign regulatory
approvals, including safety and telecommunications, 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.
As of July 31, 1997 the Company employed 231 persons,
including 51 in sales and marketing, 61 in research and development,
39 in customer service and support, 46 in manufacturing operations,
and 34 in general and administrative functions. Of the 61 research
and development employees 52 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
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB instituted SFAS No. 130 "Reporting
Comprehensive Income". This statement establishes standards for reporting
and displaying comprehensive income and its components in the financial
statements. It does not, however, require a specific format for the
statement, but rather requires the Company to display an amount
representing total comprehensive income for the period in those
financial statements. The Company is in the process of determining
its preferred format. This statement is effective for fiscal years
beginning after December 15, 1997.
Also in June 1997, the FASB issued SFAS No. 131
"Disclosures about Segments of an Enterprise and Related
Information". This statement establishes standards for the
manner in which public business enterprises report information
about operating segments in annual financial statements and
requires those enterprises to report selected information about
operating segments in interim financial reports issued to shareholders.
This statement is effective for financial statements for periods
beginning after December 15, 1997, and is not expected to have
a significant impact on the Company's reporting of segment information.
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
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 June 30, 1997, the
Company had cash, cash equivalents and short-term investments of
$41.1 million (representing 69.4% of total assets) and had working
capital of $50.1 million.
The Company generated cash from operating activities of
$4.0 million for the nine months ended June 30, 1997. The cash
generated from operations was primarily due to the collection of
accounts receivable of $4.3 million, accrual of income tax benefit
and a reduction in inventories, partially offset by reductions of
accounts payable of $1.8 million and decreased accrued expenses
and other liabilities. Inventory decreased 13.4% from $6.3 million
as of September 30, 1996 to $5.5 million as of June 30, 1997.
Netopia and Fast Ethernet products represented 12% and 23% of
total gross inventory as of September 30, 1996, respectively, and
represented 23% and 17% of total gross inventory as of June 30, 1997,
respectively.
The Company's investing activities have consisted primarily
of purchases of short-term investments and capital equipment.
Expenditures for capital equipment totaled $794,000 for the nine
months ended June 30, 1997, primarily representing acquisitions
of computer equipment used predominantly in information systems,
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.
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 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 Results
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No Reports on Form 8-K were filed during the quarter
ended June 30, 1997.
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: August 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 Results
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-END> JUN-30-1997
<CASH> 16964
<SECURITIES> 24109
<RECEIVABLES> 6920
<ALLOWANCES> 1276
<INVENTORY> 5452
<CURRENT-ASSETS> 56056
<PP&E> 12788
<DEPRECIATION> 10386
<TOTAL-ASSETS> 59212
<CURRENT-LIABILITIES> 5916
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 53296
<SALES> 38299
<TOTAL-REVENUES> 38299
<CGS> 20010
<TOTAL-COSTS> 20010
<OTHER-EXPENSES> 20509
<LOSS-PROVISION> 1276
<INTEREST-EXPENSE> (1304)
<INCOME-PRETAX> (916)
<INCOME-TAX> (320)
<INCOME-CONTINUING> (596)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (596)
<EPS-PRIMARY> (0.05)
<EPS-DILUTED> (0.05)
</TABLE>
EXHIBIT 11.1
STATEMENT OF COMPUTATION OF PER SHARE EARNINGS
(in thousands, except per share amounts; unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30 Nine Months Ended June 30,
1996 1997 1996 1997
<S> <C> <C> <C> <C>
Net income (loss) $ 360 $ (221) $ 3,241 $ (596)
==== ===== ===== =====
Weighted average number of
common stock outstanding 9,902 11,378 9,480 11,286
Number of common stock
equivalents as a result
of stock options outstanding
using the treasury
stock method 1,204 - 960 -
Number of common stock issued
and stock options granted in
accordance with Staff
Accounting Bulletin No. 83 - - 246 -
------- -------- -------- --------
Shares used in per share
calculation 11,106 11,378 10,686 11,286
====== ====== ====== ======
Net income (loss) per share $ 0.03 $(0.02) $ 0.30 $(0.05)
====== ======= ======== ======
</TABLE>
