UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 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 May 1, 1997 there were 11,362,621 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 March 31, 1997 3
Condensed Consolidated Statements of Operations
for the three and six months ended March 31, 1996 and 1997 4
Condensed Consolidated Statements of Cash Flows
for the six months ended March 31, 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
Item 4. Submission of Matters to a Vote of Security Holders 25
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 March 31,1997
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 19,910 $ 17,001
Short-term investments 17,235 23,397
Trade accounts receivable, net of allowances
of $1,328 and $1,228 at September 30, 1996
and March 31, 1997, respectively 11,172 7,396
Inventories, net 6,295 5,467
Deferred tax asset 1,829 1,829
Prepaid expenses and other current assets 1,457 1,358
Total current assets 57,898 56,448
Furniture, fixtures, and equipment, net 2,935 2,596
Deposits and other assets 785 760
Total assets $ 61,618 $ 59,804
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,979 $ 3,698
Accrued compensation 2,023 1,445
Accrued liabilities 470 85
Deferred revenue 787 1,000
Other current liabilities 170 130
Total current liabilities 8,429 6,358
Other long-term liabilities 46 ----
Total liabilities 8,475 6,358
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 11,361,207
shares issued and outstanding at September 30,
1996 and March 31, 1997, respectively 12 12
Additional paid-in capital 49,232 49,901
Deferred compensation (81) (72)
Retained earnings 3,980 3,605
Total stockholders' equity 53,143 53,446
Total liabilities and stockholders' equity $ 61,618 $ 59,804
See accompanying notes to Condensed Consolidated Financial Statements.
</TABLE>
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended March 31, Ended March 31,
1996 1997 1996 1997
<S> <C> <C> <C> <C>
Revenues:
Internet/Intranet products $ 3,633 $ 4,654 $ 6,442 $ 9,459
LAN products 11,701 8,026 23,003 16,684
Total revenues 15,334 12,680 29,445 26,143
Cost of revenues:
Internet/Intranet products 780 1,704 1,238 3,258
LAN products 7,115 5,158 13,942 10,468
Total cost of revenues 7,895 6,862 15,180 13,726
Gross profit 7,439 5,818 14,265 12,417
Operating expenses:
Research and development 2,299 2,246 4,315 4,413
Selling, marketing & service 3,795 3,907 7,582 7,708
General and administrative 1,052 832 1,841 1,669
Total operating expenses 7,146 6,985 13,738 13,790
Operating income (loss) 293 (1,167) 527 (1,373)
Other income, net 206 409 433 797
Income (loss) before income
taxes 499 (758) 960 (576)
Income tax provision (2,077) (265) (1,915) (201)
Net income (loss) $ 2,576 $ (493) $ 2,875 $ (375)
Net income (loss) per share $ 0.25 $ (0.04) $ 0.27 $ (0.03)
Shares used in per
share calculation 10,494 11,350 10,477 11,239
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
FARALLON COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands; unaudited)
<TABLE>
<CAPTION>
Six Months Ended
March 31, 1996 March 31, 1997
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 2,875 $ (375)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 817 933
Deferred tax asset (2,254) ---
Amortization of deferred compensation 6 9
Non-cash compensation 192 ---
Changes in assets and liabilities:
Trade accounts receivable (437) 3,776
Inventories, net (2,243) 828
Prepaid expenses, deposits and other assets (115) 84
Accounts payable (1,026) (1,281)
Accrued expenses and other liabilities (26) (1,049)
Deferred revenue 265 213
Net cash provided by (used in) operating
activities (1,946) 3,138
Cash flows from investing activities:
Purchase of short-term investments (999) (11,164)
Proceeds from the sale of short-term
investments 4,175 5,002
Acquisition of furniture, fixture and
equipment (1,190) (554)
Net cash provided by (used in)
investing activities 1,986 (6,716)
Cash flows from financing activities:
Proceeds from issuance of common stock, net 76 669
Net cash provided by financing activities 76 669
Net increase (decrease) in cash and cash
equivalents 116 (2,909)
Cash & cash equivalents,beginning of period 13,963 19,910
Cash and cash equivalents, end of period $ 14,079 $ 17,001
Supplemental disclosures of cash flow information:
Interest paid $ 2 $ 2
Income taxes paid $ 477 $ 150
</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 March 31, 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
Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out (FIFO) method. Inventory
consisted of the following (in thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
September 30,1996 March 31, 1997
Raw materials and work in process $ 2,477 $ 2,538
Finished goods 3,818 2,929
$ 6,295 $ 5,467
</TABLE>
3. Furniture, Fixtures and Equipment, net (in thousands):
<TABLE>
<S> <C> <C>
September 30,1996 March 31, 1997
Furniture, fixtures and
equipment $ 11,993 $ 12,547
Accumulated depreciation and
amortization (9,058) (9,951)
$ 2,935 $ 2,596
</TABLE>
4. Net Income (Loss) Per Share
Net income per share for the three and six months ended March 31,
1996 is based on the weighted average number of shares of common stock 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-converted'' method. Net loss per
share for the three and six months ended March 31, 1997 is based on the
weighted average
number of shares of common stock. 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 six month periods ended March 31, 1996
pursuant to certain SEC Staff Accounting Bulletins, common stock issued for
consideration below the IPO price and stock options granted with exercise
prices below the IPO price during the 12-month period prior to the date of
the initial filing of the registration statement, even when antidilutive, have
been included in the calculation of net income per share, using the treasury
tock method based on the IPO filing price, as if they were outstanding for
the entire period.
The Financial Accounting Standards Board recently 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 presented
in the accompanying condensed consolidated financial statements.
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 March 31, 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
Timbuktu Pro software, sales of Netopia Internet connectivity products and
fees for related services. LAN products revenue is derived primarily from
the sale of EtherWave, Fast Ethernet, Ethernet and LocalTalk compatible
products which include the PhoneNET system network connectivity
products, of which a substantial majority have been sold to Macintosh
operating system ("MacOS") customers. Revenue relating to the sale
and licensing of hardware and software products is recognized upon
shipment of the products by the Company and service revenues are
recognized ratably over the term of the contract. Certain of the
Company's sales are made to customers under agreements permitting
limited rights of return for stock balancing. Revenue is recorded net of
an estimated allowance for returns. Any product returns or price decreases
in the future that exceed the Company's allowances will adversely affect
the Company's business, operating results and financial condition.
The Company's total revenues decreased 17.3% from $15.3 million
to $12.7 million for the three months ended March 31, 1996 and 1997,
respectively. Internet/Intranet products revenue increased 28.1% from $3.6
million to $4.7 million for the three months ended March 31, 1996 and
1997, respectively. The increase in Internet/Intranet revenue was primarily
due to increased sales of Netopia Internet connectivity products and
increased licensing of the Windows version of Timbuktu Pro
collaboration software, particularly for corporate Intranets. This increase
was partially offset by decreased licensing of the Macintosh version of
Timbuktu Pro which the Company believes were adversely affected by
limited sell-through of Apple Computer's ("Apple") Powerbook 1400
and general confusion surrounding Apple and the MacOS including
Apple's recently reported declining sales of Macintosh computers,
substantial losses and a substantial reduction in workforce. Netopia
Internet connectivity product revenue increased primarily due to
international sales of the Netopia ISDN router, the introduction of the
"So-Smart" Netopia router in December 1996 as well as a greater number
of regional U.S. Internet Service Providers ("ISPs") selling Netopia
Internet connectivity products. Windows versions of Timbuktu Pro
revenue increased primarily due to increased sales of Original Equipment
Manufacturer ("OEM") licenses, maintenance contracts and volume
licenses. LAN products revenue decreased 31.4% from $11.7 million
to $8.0 million for the three months ended March 31, 1996 and 1997,
respectively, primarily due to declining volume and average selling
prices of EtherWave, LocalTalk products and certain Ethernet products
partially offset by increased sales of certain of the Company's Ethernet
products that were not available during the three months ended March
31, 1996. The Company believes LAN products revenues were adversely
affected by limited sell-through of the Apple PowerBook 1400 and general
confusion surrounding Apple and the MacOS including Apple's recently
reported declining sales of Macintosh computers, substantial losses and a
substantial reduction in workforce as well as vendor incorporation of built-in
Ethernet into new computers. LAN products revenue accounted for 76.3%
and 63.3% of the Company's total revenues for the three months ended
March 31, 1996 and 1997, respectively, while Internet/Intranet products
revenue accounted for 23.7% and 36.7% of the Company's total revenues
for the three months ended March 31, 1996 and 1997, respectively.
As the Company continues to focus on the development of its
Internet/Intranet business, and as a result of price competition related to
the Company's LAN products, the erosion of pricing premiums on MacOS
products, Apple's continued difficulties, declining sales of MacOS computers
and competitive factors, the Company expects that LAN products revenue
may decline and may account for a decreasing percentage of total revenues
in future periods to the extent that Internet/Intranet product revenues
increase.
As a result, the Company's future operating results are dependent upon continued
market acceptance of its Internet/Intranet products and enhancements
thereto. However, the Company is dependent upon sales of its LAN
products for the foreseeable future and to the extent that any decline in
revenues from LAN products is not offset by increases in revenue from
other sources, such as revenues from the Company's Internet/Intranet
products, then the Company's business, operating results and financial
condition will be materially and adversely affected.
Farallon sells its Internet/Intranet and LAN products and related
maintenance, support and other services primarily through distributors,
while certain products are also sold directly through Value Added Resellers
("VARs") and ISPs or directly by the Company to corporate accounts and
higher education institutions. Revenues from distributors accounted for 65%
and 61% of total revenues for the three months ended March 31, 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 Micro ("Ingram")
accounted for 20% and 19% of total revenues for each of the three months
ended March 31, 1996 and 1997, and revenues from MicroWarehouse
accounted for 11% and 10% of total revenues for the three months ended
March 31, 1996 and 1997, respectively. No other customers have
accounted for 10% or more of the Company's total revenues during the
three months ended March 31, 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 36% and 34% of total revenues
for the three months ended March 31, 1996 and 1997, respectively. The
Company believes international revenues, both in Europe and the Pacific
Rim were adversely affected by limited sell-through of the Apple PowerBook
1400 and the general confusion surrounding Apple and the MacOS including
Apple's recently reported declining sales of Macintosh computers, substantial
losses and a substantial reduction in workforce, 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 48.5%
to 45.9% for the three months ended March 31, 1996 and 1997,
respectively. The Company's gross margin for Internet/Intranet products
decreased from 78.5% to 63.4% for the three months ended March 31,
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 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 39.2% to 35.7% for the
three months ended March 31, 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. 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 $2.3 million to $2.2 million for the three months
ended March 31, 1996 and 1997, respectively. The decrease in research
and development expenses is primarily due to declining tooling and third
party engineering expenses partially offset by increased headcount
related to the development of new Internet/Intranet products. Research
and development expenses represented 15.0% and 17.7% of total revenues
for the three months ended March 31, 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. The Company
believes its process for developing software is essentially completed
concurrent with the establishment of technological feasibility, and no software
costs have been capitalized to date. The Company may enter into future
development agreements in which the Company may be required to
capitalize the cost of software development.
Selling and Marketing. Selling and marketing expenses increased slightly
from $3.8 million to $3.9 million for the three months ended March 31, 1996
and 1997, respectively. The increase in selling and marketing expenses is
primarily due to increased headcount and other employee related expenses
partially offset by reduced advertising and promotional expenses. Selling and
marketing expenses represented 24.8% and 30.8% of total revenues for the
three months ended March 31, 1996 and 1997, respectively. The Company believes
that selling and marketing expenses may increase in absolute dollar terms for
the remainder of fiscal 1997, primarily due to personnel related expenses and
increased advertising and promotional activities.
General and Administrative. General and administrative expenses decreased
from $1.1 million to $832,000 for the three months ended March 31, 1996 and
1997, respectively. The decrease in general and administrative expenses is
primarily due to consulting fees related to the acquisition of the Netopia
trademark which were incurred during the three months ended March 31, 1996.
General and administrative expenses represented 6.9% and 6.6% of total
revenues for the three months ended March 31, 1996 and 1997, respectively. The
Company believes that general and administrative expenses may increase in
absolute dollar terms for the remainder of fiscal 1997 as the Company adds
infrastructure such as expenses to maintain and suport the Company's web
related activities, and incurs additional costs related to being a public
company, such as expenses related to investor relations programs and
increased professional fees.
Other Income, net. Other income, net, primarily represents interest earned
by the Company on its cash equivalents and short-term investments.
Provision for Income Taxes. The effective tax rate (excluding a
non-recurring income tax benefit recorded in the three months ended March 31,
1996) was 35% for the each of three months ended March 31, 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. At March 31, 1996, the Company reversed a full
valuation allowance that it had previously provided against its deferred tax
asset, resulting in a non-recurring income tax benefit of approximately $2.3
million.
Six Months Ended March 31, 1996 and 1997
The Company's total revenues decreased 11.2% from
$29.4 million to $26.1 million for the six months ended March 31, 1996
and 1997, respectively. Internet/Intranet products revenue increased
46.8% from $6.4 million to $9.5 million for the six months ended
March 31, 1996 and 1997, respectively. The increase in Internet/
Intranet revenue was primarily due to increased sales of Netopia
Internet connectivity products as well as increased licensing of the
Windows version of Timbuktu Pro collaboration software,
particularly for corporate Intranets. The increase was partially offset
by decreased licensing of the Macintosh version of Timbuktu Pro which
the Company believes were adversely affected by limited sell-through
of the Apple PowerBook 1400 and general confusion surrounding
Apple and the MacOS including Apple's recently reported declining
sales of Macintosh computers, substantial losses and a substantial
reduction in workforce. Netopia products revenue increased primarily
due to the introduction of the "So-Smart" Netopia router in December
1996, international sales of the Netopia ISDN router as well as a greater
number of regional U.S. ISPs selling Netopia Internet connectivity
products. Timbuktu Pro for Windows revenue increased primarily due
to increased volume and OEM licensing as well as increased sales of
maintenance contracts. LAN products revenue decreased 27.5% from
$23.0 million to $16.7 million for the six months ended March 31,
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 of the Company's
Ethernet products that were not available during the six months ended
March 31, 1996. The Company believes LAN products were adversely
affected by limited sell-through of the Apple PowerBook 1400 and general
confusion surrounding Apple and the MacOS including Apple's recently
reported declining sales of Macintosh computers, substantial losses and a
substantial reduction in workforce as well as vendor incorporation of
built-in Ethernet into new computers. LAN products revenue accounted
for 78.1% and 63.8% of the Company's total revenues for the six months
ended March 31, 1996 and 1997, respectively, while Internet/Intranet
products revenue accounted for 21.9% and 36.2% of the Company's total
revenues for the six months ended March 31, 1996 and 1997, respectively.
As the Company continues to focus on the development of its
Internet/Intranet business, and as a result of price competition related to
the Company's LAN products, the erosion of pricing premiums on MacOS
products, Apple's continued difficulties, declining sales of MacOS computers
and competitive factors, the Company expects that LAN products revenue
may decline and may account for a decreasing percentage of total revenues
in future periods to the extent that Internet/Intranet product revenues increase
As a result, the Company's future operating results are dependent upon
continued market acceptance of its Internet/Intranet products and enhancements
thereto. However, the Company is dependent upon sales of its LAN products
for the foreseeable future, and to the extent that any decline in revenues from
LAN products is not offset by increases in revenue from other sources, such
as revenue from the Company's Internet/Intranet products, then the Company's
business, operating results and financial condition will be materially and
adversely affected.
Farallon sells its Internet/Intranet and LAN products and related
maintenance, support and other services primarily through distributors,
while certain products are also sold directly through VARs and ISPs or
directly by the Company to corporate accounts and higher education institutions.
Revenues from distributors accounted for 66% and 57% of total revenues for
the six months ended March 31, 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 20% of total revenues for each of the six months
ended March 31, 1996 and 1997, and revenues from MicroWarehouse
accounted for 11% and 10% of total revenues for the six months ended
March 31, 1996 and 1997, respectively. No other customers have
accounted for 10% or more of the Company's total revenues during the
six months ended March 31, 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 34% and 31% of total revenues
for the six months ended March 31, 1996 and 1997, respectively. The Company
believes international revenues, both in Europe and the Pacific Rim, were
adversely affected by limited sell-through of the Apple PowerBook 1400
and general confusion surrounding Apple and the MacOS including Apple's
recently reported declining sales of Macintosh computers, substantial losses
and a substantial reduction in workforce, 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 47.5% for
the six months ended March 31, 1996 and 1997, respectively. The Company's
gross margin for Internet/Intranet products decreased from 80.8% to 65.6% for
the six months ended March 31, 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 39.4% to 37.3% for the six months ended March 31, 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. 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
increased slightly from $4.3 million to $4.4 million for the six months
ended March 31, 1996 and 1997, respectively. The increase in research
and development expenses is primarily due to increased headcount related
to the development of new Internet/Intranet products partially offset by
decreased tooling and third party engineering expenses. Research and
development expenses represented 14.7% and 16.9% of total revenues
for the six months ended March 31, 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. The Company
believes its process for developing software is essentially completed
concurrent with the establishment of technological feasibility, and no
oftware costs have been capitalized to date. The Company may enter
into future development agreements in which the Company may be
required to capitalize the cost of software development.
Selling and Marketing. Selling and marketing expenses increased
slightly from $7.6 million to $7.7 million for the six months ended March 31,
1996 and 1997, respectively. The increase in total selling and marketing
expenses was primarily due to increased headcount and other employee
related expenses partially offset by reduced advertising and promotional
expenses. Selling and marketing expenses represented 25.7% and 29.5%
of total revenues for the six months ended March 31, 1996 and 1997,
respectively. The Company believes that selling and marketing expenses
may increase in absolute dollars for the remainder of fiscal 1997 primarily
due to personnel related expenses and increased advertising and promotional
activities.
General and Administrative. General and administrative expenses
decreased from $1.8 million to $1.7 million for the six months ended
March 31, 1996 and 1997, respectively, primarily due to consulting fees
related to the acquisition of the Netopia trademark which were incurred
during the three months ended March 31, 1996. General and administrative
expenses represented 6.3% and 6.4% of total revenues for the six months
ended March 31, 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 investor relations programs and increased
professional fees.
Other Income, net. Other income, net, primarily represents
interest earned by the Company on its cash, cash equivalents and short-term
investments.
Provision for Income Taxes. The effective tax rate was (excluding
a non-recurring income tax benefit recorded in the three months ended March 31,
1996 35% for the each of three months ended March 31, 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. At March 31, 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, some of which are beyond the Company's
control. The following discussion highlights some of these risks. The
Company's actual results could differ materially from those discussed
herein. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed in this section and elsewhere in
this Report, and the risks discussed in the Company's other United States
Securities and Exchange Commission Filings.
Fluctuations in Quarterly Results; Future Operating Results
Uncertain. The Company's quarterly operating results have varied
significantly in the past and are likely to vary significantly in the future.
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
recognized a significant portion of its revenues in the last weeks, or even
days, of a quarter. As a result, the magnitude of quarterly fluctuations may not
become evident until late in, or after the close of, a particular quarter.
In addition, the Company recognizes revenue on products sold through
distributors upon shipment to the distributor. Although the Company maintains
reserves for projected returns and price decreases, there can be no assurance
that such reserves will be adequate. The Company's business also has
experienced seasonality in the past, largely due to customer buying patterns
such as budgeting cycles of educational institutions that purchase the
Company's products. There can be no assurance that the Company's
operating results will not be affected by seasonality in the future or that
such 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
dversely 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 78% and 64% of total revenues for the six
month periods ended March 31, 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
six months ended March 31, 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. Additionally, sales related to certain of the
Company's MacOS products are driven in part by sales of the Apple
PowerBooks which have experienced delays, technical difficulties
and interrupted supply. As a result of technical characteristics in the
MacOS environment, Fast Ethernet products, in general, have not
delivered expected performance levels. If these technical characteristics
are not addressed in the future, then Fast Ethernet product sales in the
MacOS market segment will be below the Company's expectations,
and operating results may be materially and adversely affected. The
Company is dependent upon sales and profitability of its LAN products
for the foreseeable future, and to the extent that any decline in revenues
and gross margins from LAN products is not offset by increases in
revenues from other sources, such as sales of the Company's Internet/
Intranet products, then the Company's business, operating results and
financial condition will be materially and adversely affected.
Dependence on Apple; Competition with Apple Products. To
date, the Company has derived approximately 85% to 90% of its LAN
products revenue from products designed for networking the Apple
MacOS family of personal computers. Accordingly, the Company is
substantially dependent on the market for MacOS computers and the
development and sale of new Apple computers, particularly sales of
such computers into business environments. There can be no assurance
that competitive personal computers will not displace the MacOS
products or reduce sales of MacOS products. In addition, sales of the
Company's products in the past have been adversely affected by the
announcement by Apple of new products with the potential to replace
existing products. The inability of Apple to successfully develop,
manufacture, market or sell new products, and any decrease in the
sales or market acceptance of the MacOS family of computers, would
have a material adverse effect on the Company's business, operating
results and financial condition. For example, in the six months ended
March 31, 1997, the Company believes revenues were adversely
affected by sell through of the Apple Powerbook 1400, continued
confusion surrounding Apple and the MacOS including Apple's
recently reported declining sales of Macintosh computers, substantial
losses and a substantial reduction in workforce.
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 acquisition
of Next Inc., or any other factors, could have a material adverse
effect on the Company's business, operating results and financial
condition. Apple currently offers products that compete directly
with certain of the Company's products. The Company anticipates
that Apple will continue to incorporate additional connectivity
technologies into more of its products in the future, which will
adversely affect sales of the Company's LAN products. Since Apple
has substantially greater financial, technical, sales, marketing and
other resources than the Company, as well as greater name recognition
and a significantly larger customer base, Apple may be able to respond
more quickly to new or emerging technologies and changes in customer
requirements or to devote greater resources to the development, promotion
and sales of its products. The Company believes that it is likely that Apple
will in the future sell separately or bundle with its computers certain
Internet
access products, such as ISDN terminal adapters, similar to the Company's
Netopia ISDN Modem. Any such additional bundling or enhancement by
Apple could have a material adverse effect on the Company's business,
operating results and financial condition.
Competition. The markets for the Company's products and
services are intensely competitive, highly fragmented and characterized
by rapidly changing technology, evolving industry standards, price
competition and frequent new product introductions. A number of
companies offer products that compete with one or more of the
Company's products. The Company's current and prospective
competitors include 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,
Microcom, Traveling Software, Stac Electronics and several other
companies. In the LAN client access and network systems product
market, the Company competes primarily with Apple, Asante,
Dayna, Global Village and several other companies. The Company
has experienced and expects to continue to experience increased
competition from current and potential competitors, many of whom
have substantially greater financial, technical, sales, marketing and
other resources, as well as greater name recognition and a larger
customer base than the Company. Accordingly, such competitors or future
competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements or devote greater
resources to the development, promotion and sales of their products than
the Company. In particular, established companies in the personal
computer industry may seek to expand their product offerings by
designing and selling products using competitive technology that could
render the Company's products obsolete or have a material adverse
effect on the Company's sales. For example, Microsoft has available
for free, via download on the Internet, communications and collaboration
software compatible with the Microsoft Internet Explorer. This software
product, which enables real-time communication within a workgroup, as
well as similar future product offerings from Microsoft, could undermine
the Company's ability to market its Timbuktu Pro and/or Netopia Virtual
Office collaboration software. In addition, Netscape also offers software
that enables dispersed work groups to collaborate in the work environment
. Accordingly, there can be no assurance that the Company can continue
to market its collaboration software, which would have a material and
adverse effect on the Company's business, operating results and financial
condition. In addition, several of the Company's current competitors
recently have introduced free and/or paid guaranteed service and support
programs that appear to be similar to the Company's Up & Running,
Guaranteed! program. As a result, there can be no assurance that the
Company can continue to charge a fee for this support program, which
could have a material and adverse effect upon the Company's business,
operating results and financial condition. The markets in which the
Company competes currently are subject to intense price competition
and the Company expects additional price and product competition as
other established and emerging companies enter these markets and new
products and technologies are introduced. 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 Technology. The personal computer industry is
characterized by rapidly changing technologies, evolving industry standards,
frequent new product introductions, short product life cycles and rapidly
changing customer requirements. The introduction of products embodying
new technologies and the emergence of new industry standards can render
existing products obsolete and unmarketable. The Company's future success
will depend on its ability to enhance its existing products and to introduce
new products to meet changing customer requirements and emerging
technologies. For example, the Company's Netopia products currently
operate only over ISDN telecommunication service. As other communications
technologies such as 56K analog modems, Frame Relay, Asynchronous
Transfer Mode (''ATM''), Asymmetric Digital Subscriber Line (''ADSL''),
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
does not achieve widespread customer acceptance as a result of the
adoption of alternative technologies or as result of deemphasis of ISDN
by telecommunications service providers, the Company's business,
operating results and financial condition would be materially and
adversely affected. In addition, the Company has historically derived
a substantial majority of its revenues from the sale of Ethernet
connectivity products. In the event that current Ethernet network
technology is modified or replaced and the Company is unable to
modify its products to support new Ethernet technologies or alternative
technologies, the Company's business, operating results and financial
condition could be materially and adversely affected. The Company
has in the past and may in the future experience delays in new product
development. There can be no assurance that the Company will be
successful in developing and marketing product enhancements or
new products that respond to technological change, evolving industry
standards and changing customer requirements, that the Company
will not experience difficulties that could delay or prevent the successful
development, introduction and marketing of these products or product
enhancements, or that its new products and product enhancements will
adequately meet the requirements of the marketplace and achieve any
significant degree of market acceptance. Failure of the Company, for
technological or other reasons, to develop and introduce new products
and product enhancements in a timely and cost-effective manner would
have a material adverse effect on the Company's business, operating
results and financial condition. In addition, the future introduction or
even announcement of products by the Company or one or more of its
competitors embodying new technologies or changes in industry standards
or customer requirements could render the Company's then existing
products obsolete or unmarketable. There can be no assurance that the
introduction or announcement of new product offerings by the Company
or one or more of its competitors will not cause customers to defer
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 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 capacity. This transition has resulted in a continuing
increase in the level of responsibility for both existing and new management
personnel. The Company anticipates that any growth in its Internet/Intranet
business will require it to recruit and hire a substantial number of new
engineering, sales and marketing, customer service, administrative and
managerial personnel.
There can be no assurance that the Company will be successful in hiring or
retaining these personnel, if needed. If the Company is unable to manage the
transition effectively, the Company's business, operating results and financial
condition will be materially and adversely affected.
Dependence on Distributors. The Company relies primarily on
distributors for the sale of its Internet/Intranet and LAN products. Revenues
from distributors accounted for 73% and 60% of total revenues in fiscal
1995 and 1996, respectively, and 66% and 57% of total revenues for the
six month periods ended March 31, 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
37% and 35% of total revenues for the six month periods ended March 31,
1996 and 1997, respectively. During fiscal 1995, 1996 and the six month
periods ended March 31, 1996 and 1997, revenue from Ingram accounted
for 22%, 18%, 20% and 20% 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 six month periods ended March 31, 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, or that
these distributors will not devote greater resources to marketing products of
other companies. Accordingly, the loss of, or a significant reduction in revenue
from, one of the Company's distributors, could have a material adverse effect
on the Company's business, operating results and financial condition.
The Company grants to its distributors limited rights to return unsold
inventories of the Company's products in exchange for new purchases and
provides price protection to its distributors. Although the Company provides
allowances for projected returns and price decreases, any product returns or
price decreases in the future that exceed the Company's allowances will
materially and adversely affect the Company's business, operating results
and financial condition. The Company also provides end users with a
lifetime warranty on certain products and permits end users to return any
product for its full purchase price if the product does not perform as
warranted. To date, the Company has not encountered material warranty
claims. Nevertheless, if future warranty claims exceed the Company's
reserves, the Company's business, operating results and financial condition
could be materially and adversely affected. In addition, the Company
attempts to further limit its liability to end users through disclaimers of
special, consequential and indirect 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%
and 29% of the Company's total revenues in fiscal 1995, 1996, repectively,
and 34% and 31% of total Company revenues for the six months ended March 31,
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. There can be no assurance that the steps taken
by the Company in this regard will be adequate to prevent
misappropriation of its technology. The Company currently has ten
issued United States patents, and one pending application for patent in
each of Australia and the European Patent Office. There can be no
assurance that the Company's patents will not be invalidated, circumvented
or challenged, that the rights granted thereunder will provide competitive
advantages to the Company or that any of the Company's pending or future
patent applications, whether or not being currently challenged by applicable
governmental patent examiners, will be issued with the scope of the claims
sought by the Company, if at all. Furthermore, there can be no assurance
that others will not develop technologies that are similar or superior to the
Company's technology or design around the patents owned by the Company.
Despite the Company's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy aspects of the Company's products or to
obtain and use information that the Company regards as proprietary.
Policing unauthorized use of the Company's products is difficult, and
while the Company is unable to determine the extent to which piracy
of its software products exists, software piracy is expected to be a
persistent problem. In selling its software products, the Company
relies primarily on ''shrink wrap'' licenses that are not signed by licensees
and, therefore, it is possible that such licenses may be unenforceable
under the laws of certain jurisdictions. In addition, the laws of some
foreign countries where the Company's products are or may be manufactured
or sold, particularly developing countries including various countries in
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. Although the Company
believes that all such claims received to date are immaterial, there can be
no assurance that third parties will not assert infringement claims in the
future with respect to the Company's current or future products. The
Company expects that it will increasingly be subject to infringement
claims as the number of products and competitors in the Company's
industry segments grow and the functionality of products in different
industry segments overlaps. Any such claims, with or without merit,
could be time consuming to defend, result in costly litigation, divert
management's attention and resources, cause product shipment delays
or require the Company to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available
on terms acceptable to the Company, if at all. In the event of a successful
claim of product infringement against the Company and failure or inability
of the Company to license the infringed or similar technology, the Company's
business, operating results and financial condition would be materially and
adversely affected.
From time to time, the Company may be involved in litigation or
administrative claims arising out of its operations in the normal course of
business. For example, in 1995 the Company terminated negotiations
with a manufacturer of router products regarding a potential acquisition.
Shortly thereafter, the Company received correspondence from such
manufacturer's counsel asserting that the Company's termination of
negotiations was improper and demanding that Farallon either
consummate an acquisition for cash and stock or license from such
manufacturer certain technology. The Company believes that any
potential claim by such manufacturer, if brought, would be entirely
without merit and the Company is prepared to vigorously defend any
such claim.
Lengthy Sales Cycle and Lengthy Partnership Development.
The Company's Internet/Intranet software products are often licensed to
customers on a volume license basis for use on private wide area
network (''WAN'') Intranets involving thousands of nodes. These
licenses often involve significant license and maintenance fees. As a
result, the license of the Company's Internet/Intranet software products
often involves a significant commitment of management attention and
resources by prospective customers. Accordingly, the Company's sales
process for these products is often subject to delays associated with long
approval processes that typically accompany significant capital
expenditures. For these and other reasons, the sales cycle associated
with the license of the Internet/Intranet software products is often lengthy
and subject to a number of significant delays over which the Company
has little or no control. There can be no assurance that the Company
will not experience these and additional delays in the future on Internet
/Intranet software or other products.
The Company's Netopia products are often distributed through
partnerships with ISPs. These partnerships often involve lengthy testing
and certification studies as well as detailed agreements. As a result,
partnerships with ISPs to distribute Netopia products involve a significant
commitment of management attention and resources by prospective
partners. Accordingly, the Company's business development process
for these distribution channels is often subject to delays associated
with long approval processes that typically accompany significant
partnership development and capital expenditures. For these and
other reasons, the business development process associated with the
partnerships are often lengthy and subject to a number of significant
delays over which the Company has little or no control. There can be
no assurance that the Company will not experience these and additional
delays in the future on partnership development.
Risks Associated with Potential Acquisition. The Company may
acquire or invest in companies, technologies or products that complement
the Company's business or its product offerings. Any acquisitions may
result in potentially dilutive issuance of equity securities, the incurrence
of debt, the write-off of software development costs or the amortization
of expenses related to goodwill and other intangible assets, any of which
could have a material adverse effect on the Company's business,
financial condition and results of operations. Acquisitions would
involve numerous additional risks including difficulties in the
assimilation of operation, services, products and personnel of any
acquired company. In addition 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 of any acquired concern. There can be no assurance that
the Company would be successful in overcoming these or any
significant risks encountered in connection with any such acquisition.
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 domestic telecommunications
carriers. In foreign countries, such products are subject to a wide
variety of governmental review and certification requirements. While
certain foreign countries and the European Economic Community
regulate the importation and certification of the Company's products,
most foreign customers typically require that the Company's products
receive certification from their country's primary telecommunication
carriers. Any future inability to obtain on a timely basis or retain domestic
certification or foreign regulatory approvals could have a material adverse
effect on the Company's business, operating results and financial condition.
Dependence on Key Personnel. The Company's business and
prospects depend to a significant degree upon the continuing contributions
of its key management, sales, marketing, product development and
administrative personnel. The Company does not have employment contracts
with its key personnel and does not maintain any key person life insurance
policies. The loss of key management or technical personnel could materially
and adversely affect the Company's business, operating results and financial
condition. The Company believes that its prospects depend in large part
upon its ability to attract and retain highly-skilled engineering, managerial,
sales and marketing, and administrative personnel. Competition for such
personnel is intense, and there can be no assurance that the Company will
be successful in attracting and retaining such personnel. Failure to attract
and retain key personnel could have a material adverse effect on the
Company's business, operating results and financial condition.
As of April 30, 1997 the Company employed 238 persons,
including 58 in sales and marketing, 65 in research and development,
35 in customer service and support, 46 in manufacturing operations,
and 34 in general and administrative functions. Of the 65 research and
development employees 56 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.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through
cash flow from operations, the private sale of equity securities and the
Initial Public Offering ("IPO") of the Company's Common Stock.
Since inception, the Company has raised $19.4 million from the
private sale of equity securities and approximately $24.8 million
of cash, net of offering expenses, from the Company's IPO
completed in June, 1996. As of March 31, 1997, the Company
had cash, cash equivalents and short-term investments of $40.4
million (representing 67.6% of total assets) and had working capital
of $50.1 million.
The Company generated cash from operating activities of $3.1
million for the six months ended March 31, 1997. The cash generated
from operations was primarily due to the collection of accounts
receivable of $3.8 million and reduction in inventories, partially
offset by reductions of accounts payable of $1.3 million and
decreased accrued expenses and other liabilities. Inventory
decreased 13.1% from $6.3 million as of September 30, 1996
to $5.5 million as of March 31, 1997. Netopia and Fast Ethernet
products represented 11.9% and 22.7% of total gross inventory as
of September 30, 1996, respectively, and represented 13.1% and
18.8% of total gross inventory as of March 31, 1997, respectively.
The Company's investing activities have consisted primarily
of purchases of short-term investments and capital equipment.
Expenditures for capital equipment totaled $554,000 for the six months
ended March 31, 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 at least the next
12 months. Thereafter, if cash generated from operations is
insufficient to satisfy the Company's liquidity requirements,
the Company may seek to sell additional equity or convertible
debt securities or obtain additional credit facilities. The sale of
additional equity or convertible debt securities could result in
additional dilution to the Company's stockholders. A portion
of the Company's cash may be used to acquire or invest in
complementary businesses or products or to obtain the right to
use complementary technologies. From time to time, in the ordinary
course of business, the Company evaluates potential acquisitions
of such businesses, products or technologies. The Company has no
agreements or commitments, and is not currently engaged in any
negotiations with respect to any such transaction.
Item 4. Submission of Matters to a Vote of Security Holders
The Company's annual meeting of shareholders was held on
February 14, 1997. According to the certified list of stockholders
which was presented at the meeting, there were 11,134,651 shares
of common stock of the Company outstanding and eligible to vote
at the meeting. 9,485,474 shares of common stock, representing
85.2% of the total votes eligible to be cast, were present at the
meeting, in person or by proxy, constituting a majority and more
than a quorum of the outstanding shares entitled to vote. The
following actions were taken at this meeting:
A. Election of Directors
<TABLE>
<CAPTION>
Affirmative Negative Withheld Broker
Votes Votes Votes Non-votes
<S> <C> <C> <C> <C>
Reese M. Jones 9,462,177 23,297
Alan B. Lefkof 9,343,055 142,419
Bandel L. Carno 9,462,777 22,697
David F. Marquardt 9,462,777 22,697
James R. Swartz 9,462,777 22,697
B. Amendment to
the 1996 Stock
Option Plan 8,116,139 626,152 19,335 723,848
C. Amendment
to the Employee
Stock Purchase
Plan 8,116,139 626,152 19,335 723,848
D. Ratification
of KPMG Peat
Marwick L.L.P.
as auditors. 9,470,084 5,155 10,235
</TABLE>
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
March 31, 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: May 14, 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
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-START> OCT-01-1996
<PERIOD-END> MAR-31-1997
<CASH> 17001
<SECURITIES> 23397
<RECEIVABLES> 7396
<ALLOWANCES> 1228
<INVENTORY> 5467
<CURRENT-ASSETS> 56448
<PP&E> 12547
<DEPRECIATION> 9951
<TOTAL-ASSETS> 59804
<CURRENT-LIABILITIES> 6358
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 53434
<TOTAL-LIABILITY-AND-EQUITY> 59804
<SALES> 26143
<TOTAL-REVENUES> 26143
<CGS> 13726
<TOTAL-COSTS> 13726
<OTHER-EXPENSES> 13790
<LOSS-PROVISION> 1228
<INTEREST-EXPENSE> (797)
<INCOME-PRETAX> (576)
<INCOME-TAX> (201)
<INCOME-CONTINUING> (375)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (375)
<EPS-PRIMARY> (0.03)
<EPS-DILUTED> (0.03)
</TABLE>
EXHIBIT 11.1
STATEMENT OF COMPUTATION OF PER SHARE RESULTS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Six Months
Ended March 31, Ended March 31,
<S> <C> <C> <C> <C>
1996 1997 1996 1997
Net income (loss) $ 2,576 $ (493) $ 2,875 $ (375)
Weighted average number of
common stock outstanding 9,286 11,350 9,269 11,239
Number of common stock
equivalents as a result of stock
options outstanding using the
treasury stock method 839 --- 839 ---
Number of common stock issued
and stock options granted in
accordance with Staff Accounting
Bulletin No. 83 369 --- 369 ---
Shares used in per share
calculation 10,494 11,350 10,477 11,239
Net income (loss) per share $ 0.25 $(0.04) $ 0.27 $(0.03)
</TABLE>
