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, 1999
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
Netopia, Inc.
(Exact name of registrant as specified in its charter)
Delaware 94-3033136
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) 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 |X|check 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 April 30, 1999 there were 12,784,174 shares of the Registrant's
Common Stock outstanding.
<PAGE>
NETOPIA, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements........................ 2
Condensed consolidated balance sheets at March 31, 1999 and September
30, 1998........................................................... 2
Condensed consolidated statements of operations for the three and six
months ended March 31, 1999 and 1998............................... 3
Condensed consolidated statements of cash flows for the six months
ended March 31, 1999 and 1998...................................... 4
Notes to condensed consolidated financial statements............... 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................. 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk......... 30
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders................ 30
Item 6. Exhibits and Reports on Form 8-K................................... 31
SIGNATURE................................................................... 32
1
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
<TABLE>
<CAPTION>
NETOPIA, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except for share and per share amounts)
(unaudited)
March 31, September 30,
1999 1998
----------------- -----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................................. $ 16,706 $ 19,244
Short-term investments................................................. 15,246 22,851
Trade accounts receivable less allowance for doubtful accounts and
returns of $629 and $617, respectively............................ 8,253 4,358
Royalties receivable................................................... 410 410
Inventories, net....................................................... 1,527 1,591
Prepaid expenses and other current assets.............................. 901 929
----------------- -----------------
Total current assets........................................... 43,043 49,383
Note receivable............................................................ 978 900
Royalties receivable....................................................... 1,372 1,372
Furniture, fixtures and equipment, net..................................... 2,163 2,068
Intangible assets.......................................................... 2,725 --
Deposits and other assets.................................................. 2,220 2,569
================= =================
$ 52,501 $ 56,292
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................................... $ 5,080 $ 5,440
Accrued compensation................................................... 1,730 1,217
Accrued liabilities.................................................... 2,013 3,468
Deferred revenue....................................................... 1,183 807
Other current liabilities.............................................. 104 299
----------------- -----------------
Total current liabilities...................................... 10,110 11,231
Long-term liabilities...................................................... 371 260
----------------- -----------------
Total liabilities.............................................. 10,481 11,491
Commitments and contingencies
Stockholders' equity:
Preferred stock:
$0.001 par value, 5,000,000 shares authorized, none issued
or outstanding.................................................... -- --
Common stock:
$0.001 par value, 25,000,000 shares authorized; 12,641,439 and
11,953,908 shares issued and outstanding at March 31, 1999 and
September 30, 1998, respectively................................... 13 12
Additional paid-in capital............................................. 56,068 51,871
Retained deficit....................................................... (14,061) (7,082)
----------------- -----------------
Total stockholders' equity..................................... 42,020 44,801
----------------- -----------------
$ 52,501 $ 56,292
================= =================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
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<TABLE>
<CAPTION>
NETOPIA, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except for per share amounts)
(unaudited)
Three months ended Six months ended
March 31, March 31,
----------------------------- ----------------------------
1999 1998 1999 1998
-------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues............................................. $ 10,535 $ 6,252 $ 18,458 $ 11,715
Cost of revenues..................................... 3,644 1,858 6,450 3,579
-------------- -------------- ------------- -------------
Gross profit..................................... 6,891 4,394 12,008 8,136
Operating expenses:
Research and development......................... 2,346 1,711 4,331 3,602
Selling and marketing ........................... 4,828 3,113 9,589 6,639
General and administrative....................... 899 805 1,681 1,596
Acquired in-process research
and development............................. -- -- 4,205 --
Amortization of goodwill......................... 181 -- 181 --
-------------- -------------- ------------- -------------
Total operating expenses...................... 8,254 5,629 19,987 11,837
-------------- -------------- ------------- -------------
Operating loss................................ (1,363) (1,235) (7,979) (3,701)
Other income, net..................................... 430 564 1,000 1,137
-------------- -------------- ------------- -------------
Loss from continuing operations
before income taxes........................... (933) (671) (6,979) (2,564)
Income tax benefit.................................... -- (241) -- (915)
-------------- -------------- ------------- -------------
Loss from continuing operations.................. (933) (430) (6,979) (1,649)
Discontinued operations, net of taxes................ -- 87 -- 251
-------------- -------------- ------------- -------------
Net loss..................................... $ (933) $ (343) $ (6,979) $ (1,398)
============== ============== ============= =============
Per share data, continuing operations:
Basic and diluted loss per share................. $ (0.07) $ (0.04) $ (0.56) $ (0.14)
============== ============== ============= =============
Shares used in the per share calculations........ 12,613 11,623 12,386 11,567
============== ============== ============= =============
Per share data, discontinued operations:
Basic income per share........................... $ -- $ 0.01 $ -- $ 0.02
============== ============== ============= =============
Diluted income per share......................... $ -- $ 0.01 $ -- $ 0.02
============== ============== ============= =============
Common shares used in the calculations of basic
income per share............................... -- 11,623 -- 11,567
============== ============== ============= =============
Common and common equivalent shares used in the
calculations of diluted income per share....... -- 12,409 -- 12,619
============== ============== ============= =============
Per share data, net loss:
Basic and diluted net loss per share............. $ (0.07) $ (0.03) $ (0.56) $ (0.12)
============== ============== ============= =============
Shares used in the per share calculations........ 12,613 11,623 12,386 11,567
============== ============== ============= =============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
NETOPIA, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six months ended March 31,
--------------------------------------
1999 1998
----------------- -----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................................... $ (6,979) $ (1,398)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization........................................... 1,393 736
Amortization of deferred compensation................................... -- 9
Charge for acquired in-process research and development................. 4,205 --
Changes in operating assets and liabilities:
Trade accounts receivable............................................ (3,895) 1,079
Inventories.......................................................... 64 (334)
Prepaid expenses, deposits and other current assets.................. 16 (27)
Accounts payable and accrued liabilities............................. (1,302) (1,324)
Deferred revenue..................................................... 346 (68)
Other liabilities.................................................... (54) 361
----------------- -----------------
Net cash used in operating activities............................. (6,206) (966)
----------------- -----------------
Cash flows from investing activities:
Purchase of furniture, fixtures and equipment........................... (736) (489)
Acquisition of technology............................................... (4,299) --
Capitalization of software development costs............................ (288) (241)
Purchase of short-term investments...................................... (12,666) (24,262)
Proceeds from the sale and maturity of short-term investments........... 20,271 27,004
----------------- -----------------
Net cash provided by investing activities......................... 2,282 2,012
----------------- -----------------
Cash flows from financing activities:
Proceeds from the issuance of common stock.............................. 1,386 380
----------------- -----------------
Net cash provided by financing activities......................... 1,386 380
----------------- -----------------
Net increase (decrease) in cash and cash equivalents....................... (2,538) 1,426
Cash and cash equivalents, beginning of period............................. 19,244 14,444
----------------- -----------------
Cash and cash equivalents, end of period................................... $ 16,706 $ 15,870
================= =================
Supplemental disclosures of noncash investing and
financing activities:
Issuance of common stock for acquisition of intangible assets........... $ 2,811 $ --
================= =================
Issuance of common stock for consulting services........................ $ 92 $ --
================= =================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
NETOPIA, 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, 1999 are not necessarily indicative of
the results to be expected for any subsequent quarter or for the entire fiscal
year ending September 30, 1999.
(2) Recent Accounting Pronouncements
During the first quarter of fiscal 1999, the Company adopted Statement
of Position ("SOP") No. 97-2, Software Revenue Recognition ("SOP 97-2"). The
provisions of SOP 97-2 have been applied to transactions entered into beginning
October 1, 1998. SOP 97-2 generally requires revenue earned on software
arrangements involving multiple elements such as software products, upgrades,
enhancements, postcontract customer support, installation and training to be
allocated to each element based on the relative fair values of the elements. The
fair value of an element must be based on evidence which is specific to the
vendor. The revenue allocated to software products, including specified upgrades
or enhancements generally is recognized upon delivery of the products. The
revenue allocated to post contract customer support generally is recognized
ratably over the term of the support, and revenue allocated to service elements
generally is recognized as the services are performed. If evidence of the fair
value for all elements of the arrangement does not exist, all revenue from the
arrangement is deferred until such evidence exists or until all elements are
delivered. The adoption of SOP 97-2 did not have a material impact on the
Company's consolidated results of operations.
In December 1998, the American Institute of Certified Public
Accountants ("AICPA") Accounting Standards Executive Committee ("AcSEC") issued
SOP 98-9 which amends paragraphs 11 and 12 of SOP 97-2 to require recognition of
revenue using the "residual method" when (i) there is vendor-specific objective
evidence of the fair values of all undelivered elements in a multiple-element
arrangement that is not accounted for using long-term contract accounting, (ii)
vendor-specific objective evidence of fair value does not exist for one or more
of the delivered elements in the arrangement, and (iii) all revenue-recognition
criteria in SOP 97-2 other than the requirement for vendor-specific objective
evidence of the fair value of each delivered element of the arrangement are
satisfied. Under the residual method, the arrangement fee is recognized as
follows; (a) the total fair value of the undelivered elements, as indicated by
vendor-specific objective evidence, is deferred and subsequently recognized in
accordance with the relevant sections of SOP 97-2, and (b) the difference
between the total arrangement fee and the amount deferred for the undelivered
elements is recognized as revenue related to the delivered elements. SOP 98-9
was adopted by the Company effective January 1, 1999. The adoption of SOP 98-9
did not have a material impact on the Company's consolidated results of
operations.
Effective October 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income. SFAS No.
130 establishes standards for the reporting and disclosure of comprehensive
income and its components which will be presented in association with a
company's financial statements. Comprehensive income is defined as the change in
a business enterprise's equity during the period arising from transactions,
events or circumstances relating to non-owner sources, such as foreign currency
translation adjustments and unrealized gains or losses on available-for-sale
securities. There were no material differences between net loss and
comprehensive income (loss) during the three and six months ended March 31, 1999
and 1998.
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information. SFAS No. 131 establishes annual and interim reporting standards
relating to the disclosure of an enterprise's business segments, products,
services, geographic areas and major customers. Adoption of this standard is not
expected to have a material effect on the Company's consolidated financial
position or results of operations.
5
<PAGE>
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions are
met, a derivative may be specifically designated and accounted for as (a) a firm
commitment, (b) a hedge of the exposure to variable cash flows of a forecasted
transaction, or (c) a hedge of the foreign currency exposure of a net investment
in a foreign operation, an unrecognized firm commitment, an available-for-sale
security, or a foreign-currency-denominated forecasted transaction. For a
derivative not designated as a hedging instrument, changes in the fair value of
the derivative are recognized in earnings in the period of change. This
statement will be effective for all annual and interim periods for fiscal years
beginning after June 15, 1999. The Company does not expect the adoption of SFAS
No. 133 will have a material effect on the financial position or results of
operations of the Company.
In March, 1998, the AICPA issued SOP 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires that
certain costs related to the development or purchase of internal-use software be
capitalized and amortized over the estimated useful life of the software. SOP
98-1 is effective for financial statements issued for fiscal years beginning
after December 15, 1998. The Company does not expect the adoption of SOP 98-1
will have a material impact on its results of operations.
(3) Inventories
Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out ("FIFO") method. Net inventories consisted
of the following (in thousands):
<TABLE>
<CAPTION>
March 31, September 30,
1999 1998
---------------- ----------------
<S> <C> <C>
Raw materials and work in process.......................................... $ 674 $ 1,080
Finished goods............................................................. 853 511
================ ================
$ 1,527 $ 1,591
================ ================
</TABLE>
(4) Furniture, Fixtures and Equipment, net (in thousands):
<TABLE>
<CAPTION>
March 31, September 30,
1999 1998
---------------- ----------------
<S> <C> <C>
Furniture, fixtures and equipment.......................................... $ 12,676 $ 11,940
Accumulated depreciation and amortization.................................. (10,513) (9,872)
---------------- ----------------
$ 2,163 $ 2,068
================ ================
</TABLE>
(5) Earnings Per Share
SFAS No. 128, Earnings Per Share, established standards for the
computation, presentation and disclosure of earnings per share ("EPS") and also
requires dual presentation of basic EPS and diluted EPS for entities with
complex capital structures. Basic earnings per share is based on the weighted
average number of shares of common stock outstanding during the period. Diluted
earnings per share is based on the weighted average number of shares of common
stock outstanding during the period and dilutive common equivalent shares from
options and warrants outstanding during the period. No common equivalent shares
are included for loss periods as they would be anti-dilutive. Dilutive common
equivalent shares consist of stock options and stock warrants.
6
<PAGE>
Potential common shares have been excluded from the net loss
computation of diluted EPS for the three and six months ended March 31, 1999 and
1998 since their effect on EPS is antidilutive due to the losses incurred in
each period. Consequently, the number of shares in the computations of basic and
diluted EPS is the same for each period. Potential common shares excluded from
the computations of diluted EPS consist of options to purchase common stock
which totaled 4,010,813 shares and 3,007,306 shares for the three and six months
ended March 31, 1999 and 1998, respectively.
<TABLE>
<CAPTION>
Three months ended Six months ended
March 31, March 31,
------------------------ -----------------------
1999 1998 1999 1998
------------ ----------- ----------- -----------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Computation of basic net loss per share:
Net loss..................................................... $ (933) $ (343) $ (6,979) $(1,398)
============ =========== =========== ===========
Weighted average number of common shares outstanding......... 12,613 11,623 12,386 11,567
============ =========== =========== ===========
Basic net loss per share.................................. $ (0.07) $ (0.03) $ (0.56) $ (0.12)
============ =========== =========== ===========
Computation of diluted net loss per share:
Net loss..................................................... $ (933) $ (343) $ (6,979) $(1,398)
============ =========== =========== ===========
Weighted average number of common shares outstanding......... 12,613 11,623 12,386 11,567
Number of dilutive common stock equivalents.................. -- -- -- --
------------ ----------- ----------- -----------
Shares used in per share calculation......................... 12,613 11,623 12,386 11,567
============ =========== =========== ===========
Diluted net loss per share................................ $ (0.07) $ (0.03) $ (0.56) $ (0.12)
============ =========== =========== ===========
</TABLE>
(6) Acquisitions
On December 17, 1998, the Company closed a transaction to purchase
substantially all of the assets and assume certain liabilities and the existing
operations of Serus LLC ("Serus"), a Utah limited liability company. Serus is
developing a java-based web site editing software product which would allow web
site owners to modify and edit the appearance of their web site through their
web browser with minimal knowledge of Hypertext Markup Language ("HTML"). Upon
completion of the development of such products, Netopia intends to market the
products both independently and along with its Netopia Virtual Office web site
platform to allow users more flexibility in customizing their web sites. In
accordance with the Serus Asset Purchase Agreement, Netopia acquired
substantially all of the assets and assumed certain liabilities of Serus and its
existing operations which included in-process research and development. The
maximum aggregate purchase price of the Serus transaction is approximately $7.0
million including (i) $3.0 million of cash paid on the closing date of the
transaction, (ii) 409,556 shares of the Company's Common Stock issued on the
closing date, and (iii) a $1.0 million earnout opportunity based upon certain
criteria as set forth in the Serus Purchase Agreement. The excess purchase price
over the net book value acquired was $6.0 million, of which, based upon the
Company's estimates prepared in conjunction with a third party valuation
consultant, $3.9 million was allocated to acquired in-process research and
development and $2.1 million was allocated to intangible assets. The amounts
allocated to intangible assets include assembled workforces of $100,000 and
goodwill of $2.0 million. The Company used the income approach to appraise the
value of the business and projects acquired. Such method takes into
consideration the stage of completion of the project and estimates related to
expected future revenues, expenses and cash flows which are then discounted back
to present day amounts. Based upon these estimates, material net cash flows from
the acquired business are expected to occur during the calendar year 2001. These
cash flows were discounted using a discount rate of 44.0%. Based upon the
expenses incurred and the development time invested in the product prior to the
acquisition and the estimated expenses and development time to complete the
product, the Company determined the product to be approximately 85% complete at
the time of acquisition. The Company expects to complete development of the
product in the summer of 1999 and to incur approximately $400,000 of development
expenses from the date of acquisition to completion of development. The $1.0
million earnout opportunity in (iii) above shall be accounted for when it is
deemed probable that the earnout will be earned. The Company will amortize the
goodwill related to the Serus transaction quarterly over the next four (4)
years. During the six months ended March 31, 1999, goodwill amortization related
to the Serus transaction was $133,000. Any delay in the completion of the
development of the product would cause the Company to incur additional unplanned
development expenses as well as the loss of or deferral of customer purchases
either of which would have a material adverse effect on the Company's business,
operating results and financial condition.
7
<PAGE>
On December 31, 1998, the Company closed a transaction to purchase from
Network Associates substantially all of the assets and assume certain
liabilities related to the netOctopus systems management software
("netOctopus"). The netOctopus software is a suite of administration tools under
development that allows for simultaneous system support of multiple users across
MacOS computer networks. Upon completion of the development of the Windows
versions of the netOctopus software products, Netopia intends to market the
products both independently and along with its Timbuktu Pro enterprise software.
In accordance with the netOctopus Purchase Agreement, Netopia acquired
substantially all of the assets and assumed certain liabilities related to the
netOctopus software and its existing operations which included in-process
research and development. The maximum aggregate purchase price of the netOctopus
transaction was $1.1 million of cash paid on the closing date of the
transaction. In addition, there is a $300,000 earnout opportunity based upon
certain criteria as set forth in the netOctopus Purchase Agreement. The excess
purchase price over the net book value acquired was $1.1 million, of which,
based upon the Company's estimates prepared in conjunction with a third party
valuation consultant, $400,000 was allocated to acquired in-process research and
development and $700,000 was allocated to intangible assets. The amounts
allocated to intangible assets include assembled workforces of $60,000,
developed technology of $540,000 and goodwill of $100,000. The Company used the
income approach to appraise the value of the business and projects acquired.
Such method takes into consideration the stage of completion of the project and
estimates related to expected future revenues, expenses and cash flows which are
then discounted back to present day amounts. Based upon these estimates,
material net cash flows from the acquired business are expected to occur during
the calendar year 2000. These cash flows were discounted using a discount rate
of 25.0%. Based upon the expenses incurred and the development time invested in
the product prior to the acquisition and the estimated expenses and development
time to complete the product, the Company determined the product to be
approximately 70% complete at the time of acquisition. The Company expects to
complete development of the product during the Company's third fiscal quarter of
fiscal 1999 and to incur approximately $75,000 of development expenses from the
date of acquisition to completion of development. The $300,000 earnout
opportunity above shall be accounted for when it is deemed probable that the
earnout will be earned. The Company will amortize the goodwill related to the
netOctopus transaction quarterly over the next four (4) years. During the six
months ended March 31, 1999, goodwill amortization related to the netOctopus
transaction was $48,000. Any delay in the completion of the development of the
product would cause the Company to incur additional unplanned development
expenses as well as the loss of or deferral of customer purchases either of
which would have a material adverse effect on the Company's business, operating
results and financial condition.
(7) Discontinued Operations
On August 5, 1998, the Company sold its Farallon Local Area Networking
("LAN") Division (the "LAN Division") including the LAN Division's products,
accounts receivable, inventory, property and equipment, intellectual property
and other related assets to Farallon Communications, Inc. ("Farallon"), formerly
known as Farallon Networking Corporation, a Delaware corporation and an
affiliate of Gores Technology Group ("Gores").
The disposition of the LAN Division has been accounted for as a
discontinued operation in accordance with Accounting Principles Board ("APB")
Opinion No. 30, and prior period consolidated financial statements have been
restated to reflect the LAN Division's operations as a discontinued operation.
Revenue from discontinued operations was $5.1 million and $10.1 million for the
three and six months ended March 31, 1998, repectively. The income from
discontinued operations of $87,000 and $251,000 for the three and six months
ended March 31, 1998, respectively, represents operating income, net of taxes,
of the discontinued operation. At September 30, 1998, the Company had $2.5
million in accrued liabilities which represented transaction expenses and costs
incurred and accrued as a result of the sale of the LAN Division. Such expenses
are directly attributable to the sale transaction and are primarily related to
reserves taken against the lease of the Company's Alameda, California
headquarters, investment advisory, legal and accounting fees and certain
expenses related to employees of the LAN Division. Such accrual consisted of
$1.7 million of facility costs, approximately $300,000 in employee-related costs
and other costs consisting primarily of services fees of approximately $500,000.
At March 31, 1999, the balance in accrued liabilities related to the sale of the
LAN Division was $1.7 million consisting of $1.4 million of facility costs and
approximately $300,000 related to purchase price adjustments. Pursuant to the
Agreement of Purchase and Sale of Assets by and between the Company and
Farallon, the purchase price of the LAN Division is subject to a purchase price
8
<PAGE>
adjustment. Such adjustment is based upon the difference between the unaudited
balance sheet of the LAN Division as of the effective date of the sale and the
estimated book value of the LAN Division at March 31, 1998.
(8) Subsequent Events
In April 1999, the Company purchased $999,988 of Series D-1 preferred
stock of Northpoint Communications Group, Inc. ("Northpoint"). Upon the initial
public offering ("IPO") of the common stock of Northpoint, which occured on May
5, 1999, the Company's Series D-1 preferred stock converted into 55,555 shares
of Class B common stock. As a Series D-1 purchaser, the Company has agreed not
to transfer any Series D-1 preferred stock or Class B common stock to any
non-affiliated third party until March 2000. The Company has also agreed not to
acquire more than 10% of Northpoint's voting stock without Northpoint's consent
until March 2002. In addition, as a Series D-1 purchaser, the Company has agreed
to vote any voting securities it holds as recommended by Northpoint's board of
directors, except with respect to votes pursuant to the protective provisions in
Northpoint's certificate of incorporation.
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 Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, including statements regarding the
Company's expectations, beliefs, intentions, strategies, proceeds, expenses,
charges, accruals, losses and reserves 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 statements. 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
Factors That May Affect Future 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, 1999 and 1998
Revenues. The Company's revenues are derived from the sale of hardware
and software products and include license revenues for its Netopia Virtual
Office ("NVO") web site software platform and Timbuktu Pro enterprise software,
sales of its Netopia Internet router products and fees for related services. The
Company recognizes revenue from sales of its hardware products upon shipment of
the product. The Company recognizes revenues from licenses of computer software
provided that a firm purchase order has been received, the software and related
documentation have been shipped, collection of the resulting receivable is
deemed probable, and no other significant vendor obligations exist. Maintenance
and service revenues are recognized over the period in which services are
provided. Certain of the Company's sales are made to customers under agreements
permitting limited rights of return for stock balancing or with protection for
future price decreases. Revenue is recorded net of an estimated allowance for
returns and price protection. Any product returns or price decreases in the
future that exceed the Company's allowances may materially adversely affect the
Company's business, operating results and financial condition.
Revenues increased 68.5% to $10.5 million in the three months ended
March 31, 1999 from $6.3 million in the three months ended March 31, 1998. The
increase was primarily due to increased sales of the Company's Netopia Internet
router products, NVO web site platform and Timbuktu Pro enterprise software.
Netopia Internet router products revenue increased primarily due to
sales of the Netopia Digital Subscriber Line ("DSL") Internet routers
domestically, which were not available during the three months ended March 31,
1998, and increased sales of Netopia Integrated Service Digital Network ("ISDN")
Internet routers internationally primarily as a result of the Company's
relationship with France Telecom's Internet service, WANadoo, and Telecom
Italia's Internet service, Telecom Italia Net ("TIN"). These increases were
partially offset by continued price competition related to the Netopia Internet
routers. The Company expects that its Internet router products may experience
9
<PAGE>
increasing price competition from both domestic and foreign manufacturers of
similar products as well as competition from alternative technologies. Any such
increased price and/or technology competition could materially adversely affect
the Company's business, operating results and financial condition.
NVO web site platform revenue increased primarily due to licensing of
the server platform. The sale of the NVO web site platform is dependent upon the
Company's ability to leverage this software platform to generate revenue streams
from the licensing of the technology to future customers and partners and
monthly subscription based accounts. This product has existed for only a limited
period of time, and, as a result, is relatively unproven. There can be no
assurance that the Company will be able to retain its subscribers or that it
will be able to attract new subscribers or licensees. The failure to do so would
materially adversely affect the Company's business, operating results and
financial condition.
Timbuktu Pro enterprise software revenue increased primarily due to
increased volume license sales of the Windows version of Timbuktu Pro and volume
license sales of the netOctopus systems management software ("netOctopus,"
acquired from Network Associates in December 1998). This increase was partially
offset by decreased sales of the MacOS version of Timbuktu Pro enterprise
software. The Company expects revenue from the MacOS version of Timbuktu Pro to
continue to decline in absolute dollars and as a percent of revenue.
International revenues accounted for 29% and 33% of the Company's total
revenues for the three months ended March 31, 1999 and 1998, respectively.
International revenues declined as a percentage of total revenues primarily due
to increasing sales of Netopia DSL Internet routers and the NVO web site
platform in the United States. The following table provides a breakdown of
revenue by region expressed as a percentage of total revenues for the periods
presented:
<TABLE>
<CAPTION>
Three months ended March 31,
--------------------------------------
1999 1998
----------------- -----------------
<S> <C> <C>
Europe..................................................................... 24% 25%
Pacific Rim................................................................ 2 6
Other...................................................................... 3 2
----------------- -----------------
Subtotal international revenues.......................................... 29 33
United States.............................................................. 71 67
================= =================
Total revenues......................................................... 100% 100%
================= =================
</TABLE>
Although international revenues decreased as a percent of total
revenues, international revenues increased 49.6% to $3.1 million in the three
months ended March 31, 1999 from $2.1 million in the three months ended March
31, 1998. International revenues increased primarily due to increased sales of
the Company's Netopia ISDN Internet routers as a result of the Company's
relationships with WANadoo and TIN, and was partially offset by decreased sales
of the MacOS version of Timbuktu Pro enterprise software.
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, the introduction of the Euro as a standardized European
currency and general 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 the introduction of the Euro
or other movements in currency exchange rates will not have a material adverse
effect on the Company's revenues in the future.
The Company expects that international revenues will continue to
represent a significant portion of its total revenues. However, the Company also
expects seasonality will cause international revenues, in the near-term, to
decrease as a percent of total revenue as the European market enters its
traditional summer slowdown. 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. However, there can be no assurance
that the Company will be able to maintain or increase international market
10
<PAGE>
demand for its products. To the extent that the Company is unable to maintain or
increase international demand for its products, 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 operations are subject to inherent risks,
including, but not limited to, the impact of current and potential future
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, seasonality 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 such as the People's Republic of China, may not
protect the Company's products or intellectual property rights to the same
extent as do the laws of the United States and thus may 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 sells its products and related maintenance, support and
other services through distributors, Internet Service Providers ("ISPs"), Value
Added Resellers ("VARs"), Competitive Local Exchange Carriers ("CLECs"),
directly by the Company to corporate accounts and over the Internet. The
Company's revenues from distributors accounted for 43% and 45% of the Company's
total revenues for the three months ended March 31, 1999 and 1998, respectively.
The Company's three largest customers, in aggregate, accounted for 24% and 25%
of the Company's total revenues for the three months ended March 31, 1999 and
1998, respectively. During the three months ended March 31, 1999 and 1998,
revenue from Ingram Micro, a worldwide distributor of computer technology
products and services, accounted for 11% and 12% of the Company's total
revenues, respectively. No other customers have accounted for 10% or more of the
Company's total revenues during the three months ended March 31, 1999 and 1998.
The distribution of 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 current distributors 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 which operate on a purchase order basis. Due to the August 1998
sale of the Company's former Farallon Local Area Networking ("LAN") Division
(the "LAN Division"), which historically sold significant volumes of product
through the Company's distributors, the Company was required to update its
agreements with its distributors to reflect the distribution of the Company's
current products. Currently, the Company has updated its distribution agreements
with its significant distributors such as Ingram Micro, Tech Data and Merisel.
There can be no assurance that the Company's current distributors will continue
to market the Company's products or that the Company's channel expense levels
will not increase. The loss of, or a significant reduction in revenue from any
one of the Company's distributors could have a material adverse effect on the
Company's business, operating results and financial condition. The Company's
distributors generally offer products of several different companies, including
products that are competitive with the Company's products. There can be no
assurance that future sales by the Company's distributors will continue at
current levels, that the Company will be able to retain its current distributors
in the future on terms which are acceptable to the Company, that the Company's
current distributors will choose to or be able to market the Company's products
effectively, that economic conditions or industry demand will not adversely
affect these or other distributors, that these distributors will not devote
greater resources to marketing products of other companies or that internal
staffing changes or other changes at the Company's distributors will not disrupt
historical purchasing or payment patterns. Accordingly, the loss of, or a
significant reduction in revenue from, any 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 would materially
and adversely affect the Company's business, operating results and financial
condition. The Company also provides end users with a ninety (90) day limited
11
<PAGE>
warranty on its Timbuktu Pro and netOctopus software products and a one (1) year
limited warranty on its Internet router products, and permits end users to
return the product for replacement or its full purchase price if the product
does not perform as warranted. The NVO web site platform is provided on an "as
is" basis; therefore, the Company does not generally offer a warranty on its NVO
web site platform. End users are offered a free thirty (30) day evaluation
period to use and evaluate the service prior to purchase and thereafter can
discontinue their subscription at any time. 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.
The Company's Timbuktu Pro and netOctopus 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 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 Company's 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/or
additional delays in the future on the sales of its software or other products.
The Company's Netopia Internet router products and NVO web site
platform are often distributed through partnerships with ISPs, VARs and
telecommunications carriers. These partnerships often involve lengthy testing
and certification studies, detailed agreements and financial commitments from
the prospective partner. As a result, partnerships with ISPs, VARs and/or
telecommunications carriers to distribute the Company's 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 is often lengthy and historically has
been subject to a number of significant delays over which the Company has little
or no control. Additionally, credit risks related to the financial viability of
newly organized ISPs or VARs are often more significant than for other partners.
There can be no assurance that the Company will not experience these and/or
additional delays or financial risks in the future related to partnership
development.
The Company's business model for NVO is dependent upon the Company's
ability to leverage this web site platform to generate revenue streams from
monthly subscription-based accounts and the licensing of the technology to
future customers and partners. The licensing of NVO often involves a significant
commitment of management attention and resources by prospective customers.
Accordingly, the Company's sales process for NVO is often subject to delays
associated with long approval processes that typically accompany significant
expenditures. The potential profitability of the business model is unproven,
and, to be successful, the Company must, among other things, develop and market
solutions that achieve broad market acceptance by its subscribers, partners and
Internet users. This model has existed for only a limited period of time and, as
a result, is relatively unproven. There can be no assurance that the Company
will be able to retain its current subscribers or that it will be able to
attract new subscribers or licensees. Accordingly, no assurance can be given
that the Company's business model for NVO will be successful or that it can
generate revenue growth or significant profits.
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.
Gross Margin. The Company's total gross margin decreased to 65.4% in
the three months ended March 31, 1999 from 70.3% in the three months ended March
31, 1998. The decrease is primarily due to the increased sales of the Company's
Netopia Internet router products, which have a lower gross margin than the
Company's software products, as well as declining average selling prices as a
result of price competition, partially offset by an increased proportion of
volume and server license sales of the Company's software products. 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
12
<PAGE>
the Company, pricing strategies, royalties paid to third parties, standard cost
changes, new versions of existing products and external market factors,
including, but not limited to, price competition. The Company's Timbuktu Pro and
NVO software products have a higher average gross margin than the Company's
Netopia Internet router products. Accordingly, to the extent the product mix for
any particular quarter includes a substantial proportion of lower margin
products, there would be a material adverse effect on the Company's business,
operating results and financial condition.
Research and Development. Research and development expenses increased
37.1% to $2.3 million for the three months ended March 31, 1999 from $1.7
million for the three months ended March 31, 1998. Research and development
expenses increased primarily due to increased employee and development related
expenses as a result of the Company's acquisitions in December 1998 of Serus LLC
("Serus") and netOctopus as well as increased development expenses related to
the Company's Internet router products. Research and development expenses
represented 22.3% and 27.4% of total revenues for the three months ended March
31, 1999 and 1998, respectively. The Company believes that it will continue to
devote substantial resources to product and technological development and that
research and development costs will increase in absolute dollars in fiscal 1999.
Historically, the Company has believed its process for developing software is
essentially completed concurrently with the establishment of technological
feasibility, and no internal software costs have been capitalized to date.
During the three months ended March 31, 1999, $288,000 of product development
costs were capitalized.
Selling and Marketing. Selling and marketing expenses increased 55.1%
to $4.8 million for the three months ended March 31, 1999 from $3.1 million for
the three months ended March 31, 1998. Selling and marketing expenses increased
primarily due to increased advertising, promotional and channel development
expenses related to NVO and DSL Internet routers, increased headcount and other
employee related expenses as a result of the Company's acquisitions in December
1998 of Serus and netOctopus. Selling and marketing expenses represented 45.8%
and 49.8% of total revenues for the three months ended March 31, 1999 and 1998,
respectively. The Company believes that selling and marketing expenses may
increase in absolute dollars in fiscal 1999 as a result of increased advertising
and promotion campaigns related to the launch of an e-commerce enabled version
of NVO and the initial launch of the product acquired from Serus as well as
expansion of its Timbuktu Pro and NVO telesales staff.
General and Administrative. General and administrative expenses
increased 11.7% to $899,000 for the three months ended March 31, 1999 from
$805,000 for the three months ended March 31, 1998. General and administrative
expenses increased primarily due to increased employee related expenses and
increased expenses related to the solicitation of proxies for the Company's
annual stockholder meeting. General and administrative expenses represented 8.5%
and 12.9% of total revenues for the three months ended March 31, 1999 and 1998,
respectively.
Amortization of Goodwill. Amortization of goodwill represents the
amortization of such amounts allocated to intangible assets related to the
Company's acquisitions of Serus and netOctopus, both of which were completed in
December 1998. The amount allocated to intangible assets related to the Serus
transaction was $2.1 million, and the amount allocated to intangible assets
related to the netOctopus transaction was $700,000. The Company is amortizing
the intangible assets related to these transactions over four (4) years.
Other Income, Net. Other income, net, primarily represents interest
earned by the Company on its cash, cash equivalents and short-term investments.
Other income decreased 23.8% to $430,000 for the three months ended March 31,
1999 from $564,000 for the three months ended March 31, 1998. The decrease is
primarily due to decreased cash and short-term investment balances as a result
of the cash used for the Company's acquisitions of Serus and netOctopus and
operating activities. The Company expects that interest income may decrease in
absolute dollars and as a percentage of revenues primarily due to the cash used
for operating activities.
Income Tax Benefit. The Company did not record an income tax benefit
during the three months ended March 31, 1999 primarily due to continued
substantial uncertainty regarding the Company's ability to realize its tax
assets. The tax benefit recorded in the three months ended March 31, 1998 was
primarily related to the Company's net operating loss in such period. The
effective tax rate was 36% for the three months ended March 31, 1998. This rate
differed from the statutory rate primarily due to state income taxes, investment
income from tax advantaged investments, and the utilization of research and
experimentation tax credits.
13
<PAGE>
Discontinued Operations. In the fourth quarter of fiscal 1998, the
Company sold its LAN Division through which it had developed and sold LAN
products primarily for Apple computers. The sale of the LAN Division has been
accounted for as a discontinued operation and prior period consolidated
financial statements have been restated to reflect the discontinuation of the
LAN Division. Income from discontinued operations of $87,000 during the three
months ended March 31, 1998 represents the operating income, net of taxes of the
discontinued operations. The LAN Division's operations, products and the market
in which it competed were no longer considered core to the Company's business
strategy. As a result, the Company sold the LAN Division's products, accounts
receivable, inventory, property and equipment, intellectual property and other
related assets, to Farallon Communications, Inc. ("Farallon"), formerly known as
Farallon Networking Corporation, a Delaware corporation and an affiliate of
Gores Technology Group ("Gores"). Farallon also assumed certain accounts payable
and other liabilities of the LAN Division. In connection with such sale, the
Company received consideration aggregating $4.9 million, including (i) $2.0
million of cash, (ii) royalties on Farallon's revenues for a period of five
years to the extent that Farallon achieves revenues from the sale of its LAN
products of at least $15.0 million per year, (iii) a two year $1.0 million
promissory note from Farallon, guaranteed by Gores, and (iv) a warrant to
purchase up to 5% of the equity of Farallon. There can be no assurance that the
business of Farallon will be sufficiently successful to allow the Company to
realize the value of the receivables, note and warrant described in (ii), (iii)
and (iv) above. See "Other Risks Associated with the Sale of the LAN Division."
Six Months Ended March 31, 1999 and 1998
Revenue. Revenues increased 57.6% to $18.5 million in the six months
ended March 31, 1999 from $11.7 million in the six months ended March 31, 1998.
The increase was primarily due to increased sales of the Company's Netopia
Internet router products, NVO web site platform and Timbuktu Pro enterprise
software.
Netopia Internet router products revenue increased primarily due to
sales of the Netopia DSL Internet routers domestically, which were not available
during the six months ended March 31, 1998, and increased sales of the Netopia
ISDN Internet router internationally primarily as a result of the Company's
relationship with WANadoo and TIN. These increases were partially offset by
continued price competition related to the Netopia Internet routers. The Company
expects that its Internet router products may experience increasing price
competition from both domestic and foreign manufacturers of similar products as
well as competition from alternative technologies. Any such increased price
and/or technology competition could materially adversely affect the Company's
business, operating results and financial condition.
NVO web site platform revenue increased primarily due to licensing of
the server platform. The sale of NVO web site software is dependent upon the
Company's ability to leverage this software platform to generate revenue streams
from the licensing of the technology to future customers and partners and
monthly subscription based accounts. This product has existed for only a limited
period of time, and, as a result, is relatively unproven. There can be no
assurance that the Company will be able to retain its subscribers or that it
will be able to attract new subscribers or licensees. The failure to do so would
materially adversely affect the Company's business, operating results and
financial condition.
Timbuktu Pro enterprise software revenue increased primarily due to
increased volume license sales of the Windows version of Timbuktu Pro and volume
license sales of netOctopus systems management software (acquired from Network
Associates' in December 1998). This increase was partially offset by decreased
sales of the MacOS version of Timbuktu Pro enterprise software. The Company
expects revenue from the MacOS version of Timbuktu Pro to continue to decline in
absolute dollars and as a percent of revenue.
International revenues accounted for 32% and 34% of the Company's total
revenues for the six months ended March 31, 1999 and 1998, respectively.
International revenues declined as a percentage of total revenues primarily due
to increasing sales of the Netopia DSL Internet router and the NVO web site
platform in the United States. The following table provides a breakdown of
revenue by region expressed as a percentage of total revenues for the periods
presented:
14
<PAGE>
<TABLE>
<CAPTION>
Six months ended March 31,
--------------------------------------
1999 1998
----------------- -----------------
<S> <C> <C>
Europe..................................................................... 26% 25%
Pacific Rim................................................................ 3 6
Other...................................................................... 3 3
----------------- -----------------
Subtotal international revenues.......................................... 32 34
United States.............................................................. 68 66
================= =================
Total revenues......................................................... 100% 100%
================= =================
</TABLE>
Although international revenues decreased as a percent of total
revenues, international revenue increased 50.9% to $5.9 million in the six
months ended March 31, 1999 from $3.9 million in the six months ended March 31,
1998. International revenue increased primarily due to increased sales of the
Company's Netopia Internet routers, particularly the Netopia ISDN Internet
router as a result of the Company's relationships with WANadoo and TIN, and was
partially offset by decreased sales of the MacOS version of Timbuktu Pro
enterprise software.
The Company's revenues from distributors accounted for 43% and 46% of
the Company's total revenues for the six months ended March 31, 1999 and 1998,
respectively. The Company's three largest customers, in aggregate, accounted for
23% and 22% of the Company's total revenues for the six months ended March 31,
1999 and 1998, respectively. During the six months ended March 31, 1999 and
1998, revenue from Ingram Micro, a worldwide distributor of computer technology
products and services, accounted for 10% and 12% of the Company's total
revenues, respectively. No other customers have accounted for 10% or more of the
Company's total revenues during the six months ended March 31, 1999 and 1998.
Gross Margin. The Company's total gross margin decreased to 65.1% in
the six months ended March 31, 1999 from 69.4% in the six months ended March 31,
1998. The decrease is primarily due to the increased sales of the Company's
Netopia Internet router products, which have a lower gross margin than the
Company's software products, as well as declining average selling prices as a
result of price competition, partially offset by an increased proportion of
volume and server license sales of the Company's software products. 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, pricing strategies, royalties paid to third parties, standard cost
changes, new versions of existing products and external market factors,
including, but not limited to, price competition. The Company's Timbuktu Pro and
NVO software products have a higher average gross margin than the Company's
Netopia Internet router products. Accordingly, to the extent the product mix for
any particular quarter includes a substantial proportion of lower margin
products, there would be a material adverse effect on the Company's business,
operating results and financial condition.
Research and Development. Research and development expenses increased
20.2% to $4.3 million for the six months ended March 31, 1999 from $3.6 million
for the six months ended March 31, 1998. Research and development expenses
increased primarily due to increased employee and development related expenses
as a result of the Company's acquisitions of Serus and netOctopus in December
1998 as well as increased development expenses related to the Company's Internet
router products. This increase was partially offset by reduced software
localization expenses. Research and development expenses represented 23.5% and
30.7% of total revenues for the six months ended March 31, 1999 and 1998,
respectively. The Company believes that it will continue to devote substantial
resources to product and technological development and that research and
development costs will increase in absolute dollars in fiscal 1999.
Historically, the Company has believed its process for developing software is
essentially completed concurrently with the establishment of technological
feasibility, and no internal software costs have been capitalized to date.
During the six months ended March 31, 1999, $288,000 of product development
costs were capitalized.
Selling and Marketing. Selling and marketing expenses increased 44.4%
to $9.6 million for the six months ended March 31, 1999 from $6.6 million for
the six months ended March 31, 1998. Selling and marketing expenses increased
primarily due to increased advertising, promotional and channel development
expenses related to NVO and DSL Internet routers, increased headcount and other
employee related expenses as a result of the Company's acquisitions in December
15
<PAGE>
1998 of Serus and netOctopus. Selling and marketing expenses represented 52.0%
and 56.7% of total revenues for the six months ended March 31, 1999 and 1998,
respectively. The Company believes that selling and marketing expenses may
increase in absolute dollars in fiscal 1999 as a result of increased advertising
and promotion campaigns related to the launch of an e-commerce enabled version
of NVO and the first commercial launch of the product acquired from Serus as
well as expansion of its Timbuktu Pro and NVO telesales staff.
General and Administrative. General and administrative expenses
increased 5.3% to $1.7 million for the six months ended March 31, 1999 from $1.6
million for the six months ended March 31, 1998. General and administrative
expenses increased primarily due to increased employee related expenses. General
and administrative expenses represented 9.1% and 13.6% of total revenues for the
six months ended March 31, 1999 and 1998, respectively.
Acquired In-Process Research and Development. On December 17, 1998, the
Company closed a transaction to purchase substantially all of the assets and
assume certain liabilities and the existing operations of Serus, a Utah limited
liability company. Serus is developing a java-based web site editing software
product which would allow web site owners to modify and edit the appearance of
their web site through their web browser with minimal knowledge of Hypertext
Markup Language ("HTML"). Upon completion of the development of such products,
Netopia intends to market the products both independently and along with its NVO
web site platform to allow users more flexibility in customizing their web
sites. In accordance with the Serus Asset Purchase Agreement, Netopia acquired
substantially all of the assets and assumed certain liabilities of Serus and its
existing operations which included in-process research and development. The
maximum aggregate purchase price of the Serus transaction is approximately $7.0
million including (i) $3.0 million of cash paid on the closing date of the
transaction, (ii) 409,556 shares of the Company's Common Stock issued on the
closing date, and (iii) a $1.0 million earnout opportunity based upon certain
criteria as set forth in the Serus Purchase Agreement. The excess purchase price
over the net book value acquired was $6.0 million, of which, based upon the
Company's estimates prepared in conjunction with a third party valuation
consultant, $3.9 million was allocated to acquired in-process research and
development and $2.1 million was allocated to intangible assets. The amounts
allocated to intangible assets include assembled workforces of $100,000 and
goodwill of $2.0 million. The Company used the income approach to appraise the
value of the business and projects acquired. Such method takes into
consideration the stage of completion of the project and estimates related to
expected future revenues, expenses and cash flows which are then discounted back
to present day amounts. Based upon these estimates, material net cash flows from
the acquired business are expected to occur during the calendar year 2001. These
cash flows were discounted using a discount rate of 44.0%. Based upon the
expenses incurred and the development time invested in the product prior to the
acquisition and the estimated expenses and development time to complete the
product, the Company determined the product to be approximately 85% complete at
the time of acquisition. The Company expects to complete development of the
product in the summer of 1999 and to incur approximately $400,000 of development
expenses from the date of acquisition to completion of development. The $1.0
million earnout opportunity in (iii) above shall be accounted for when it is
deemed probable that the earnout will be earned. The Company will amortize the
goodwill related to the Serus transaction quarterly over the next four (4)
years. During the six months ended March 31, 1999, goodwill amortization related
to the Serus transaction was $133,000. Any delay in the completion of the
development of the product would cause the Company to incur additional unplanned
development expenses as well as the loss of or deferral of customer purchases
either of which would have a material adverse effect on the Company's business,
operating and financial condition.
On December 31, 1998, the Company closed a transaction to purchase from
Network Associates' substantially all of the assets and assume certain
liabilities related to the netOctopus systems management software. The
netOctopus software is a suite of administration tools under development that
allows for simultaneous system support of multiple users across MacOS computer
networks. Upon completion of the development of the Windows versions of the
netOctopus software products, Netopia intends to market the products both
independently and along with its Timbuktu Pro enterprise software. In accordance
with the netOctopus Purchase Agreement, Netopia acquired substantially all of
the assets and assumed certain liabilities related to the netOctopus software
and its existing operations which included in-process research and development.
The maximum aggregate purchase price of the netOctopus transaction was $1.1
million of cash paid on the closing date of the transaction. In addition, there
is a $300,000 earnout opportunity based upon certain criteria as set forth in
the netOctopus Purchase Agreement. The excess purchase price over the net book
value acquired was $1.1 million, of which, based upon the Company's estimates
16
<PAGE>
prepared in conjunction with a third party valuation consultant, $400,000 was
allocated to acquired in-process research and development and $700,000 was
allocated to intangible assets. The amounts allocated to intangible assets
include assembled workforces of $60,000, developed technology of $540,000 and
goodwill of $100,000. The Company used the income approach to appraise the value
of the business and projects acquired. Such method takes into consideration the
stage of completion of the project and estimates related to expected future
revenues, expenses and cash flows which are then discounted back to present day
amounts. Based upon these estimates, material net cash flows from the acquired
business are expected to occur during the calendar year 2000. These cash flows
were discounted using a discount rate of 25.0%. Based upon the expenses incurred
and the development time invested in the product prior to the acquisition and
the estimated expenses and development time to complete the product, the Company
determined the product to be approximately 70% complete at the time of
acquisition. The Company expects to complete development of the product during
the Company's third fiscal quarter and to incur approximately $75,000 of
development expenses from the date of acquisition to completion of development.
The $300,000 earnout opportunity above shall be accounted for when it is deemed
probable that the earnout will be earned. The Company will amortize the goodwill
related to the netOctopus transaction quarterly over the next four (4) years.
During the six months ended March 31, 1999, goodwill amortization related to the
netOctopus transaction was $48,000. Any delay in the completion of the
development of the product would cause the Company to incur additional unplanned
development expenses as well as the loss of or deferral of customer purchases,
either of which would have a material adverse effect on the Company's business,
operating and financial condition.
The Company believes it followed recent guidance disseminated by the
SEC in its valuation of the assets acquired and liabilities assumed and, in
particular, in the valuation of in-process research and development. However, in
the event that it is determined that the Company did not properly value such
assets and liabilities, the Company may have to re-state the charges to
operations taken in connection with such transactions.
In the course of integrating Serus and netOctopus into the operations
of the Company, it is possible that facts or circumstances may be discovered
that were not known nor apparent prior to the time that the Company executed the
Serus and netOctopus Purchase Agreements, respectively, or non-disclosed during
the financial and technical due diligence reviews of Serus and/or netOctopus.
There can be no assurance that difficulties will not be encountered in
integrating the operations of Serus and netOctopus, or that the specific
benefits expected from the integration of Serus and netOctopus will be achieved.
The acquisitions of Serus and netOctopus also involve a number of other risks,
including technical risks related to the completion of on-going development
efforts; assimilation of new operations and personnel; the diversion of
resources from Netopia's existing business; integration of their respective
equipment, product and service offerings, networks and technologies, financial
and information systems and brand names; coordination of geographically
separated facilities and work forces; management challenges associated with the
integration of the companies; coordination of their respective engineering,
selling, marketing and service efforts, assimilation of new management
personnel; and maintenance of standards, controls, procedures and policies. The
process of integrating the Serus and netOctopus operations, including their
personnel, could cause interruption of, or loss in momentum in the activities of
Netopia's business and operations, including those of the businesses acquired.
Amortization of Goodwill. Amortization of goodwill represents the
amortization of such amounts allocated to intangible assets related to the
Company's acquisitions of Serus and netOctopus, both of which were completed in
December 1998. The amount allocated to intangible assets related to the Serus
transaction was $2.1 million and the amount allocated to intangible assets
related to the netOctopus transaction was $700,000. The Company is amortizing
the intangible assets related to these transactions over four (4) years.
Other Income, Net. Other income, net, primarily represents interest
earned by the Company on its cash, cash equivalents and short-term investments.
Other income decreased 12.0% to $1.0 million for the six months ended March 31,
1999 from $1.1 million for the six months ended March 31, 1998. The decrease is
primarily due to the cash used for the Company's acquisitions of Serus and
netOctopus and operating activities. The Company expects its interest income to
decrease in absolute dollars and as a percentage of revenues primarily due to
the cash used for operating activities.
Income Tax Benefit. The Company did not record an income tax benefit
during the six months ended March 31, 1999 primarily due to continued
substantial uncertainty regarding the Company's ability to realize its tax
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assets. The tax benefit recorded in the six months ended March 31, 1998 was
primarily related to the Company's net operating loss in such period. The
effective tax rate was 36% for the six months ended March 31, 1998. This rate
differed from the statutory rate primarily due to state income taxes, investment
income from tax advantaged investments, and the utilization of research and
experimentation tax credits.
Discontinued Operations. In the fourth quarter of fiscal 1998, the
Company sold its LAN Division through which it had developed and sold LAN
products primarily for Apple computers. The sale of the LAN Division has been
accounted for as a discontinued operation and prior period consolidated
financial statements have been restated to reflect the discontinuation of the
LAN Division. Income from discontinued operations of $251,000 during the six
months ended March 31, 1998 represents the operating income, net of taxes of the
discontinued operations. The LAN Division's operations, products and the market
in which it competed were no longer considered core to the Company's business
strategy. As a result, the Company sold the LAN Division's products, accounts
receivable, inventory, property and equipment, intellectual property and other
related assets, to Farallon, formerly known as Farallon Networking Corporation,
a Delaware corporation and an affiliate of Gores. Farallon also assumed certain
accounts payable and other liabilities of the LAN Division. In connection with
such sale, the Company received consideration aggregating $4.9 million,
including (i) $2.0 million of cash, (ii) royalties on Farallon's revenues for a
period of five years to the extent that Farallon achieves revenues from the sale
of its LAN products of at least $15.0 million per year, (iii) a two year $1.0
million promissory note from Farallon, guaranteed by Gores, and (iv) a warrant
to purchase up to 5% of the equity of Farallon. There can be no assurance that
the business of Farallon will be sufficiently successful to allow the Company to
realize the value of the receivables, note and warrant described in (ii), (iii)
and (iv) above. See "Other Risks Associated with the Sale of the LAN Division."
Other Factors That May Affect Future Operating Results
The Company operates in a rapidly changing environment that involves a
number of risks, many of which are beyond the Company's control. The following
discussion highlights some of these risks. The Company's actual results could
differ materially from those discussed herein. Factors that could cause or
contribute to such differences include, but are not limited to, those discussed
in this section and elsewhere in this Report, and the risks discussed in the
Company's other United States Securities and Exchange Commission filings.
Fluctuations in Quarterly Results; Future Operating Results Uncertain.
The Company's quarterly operating results have varied significantly in the past
and are likely to vary significantly in the future. As a result of the sale of
the LAN Division, the Company's future operating results are dependent upon the
market acceptance of its Netopia Internet router products, the NVO web site
platform and Timbuktu Pro enterprise software products (the "Internet/Intranet
products") and enhancements thereto. To the extent that revenue from the sale of
the Company's Internet/Intranet products does not increase, the Company's
business, operating results and financial condition would be materially and
adversely affected. Historically, the Company's continuing operations have not
achieved profitability and there can be no assurance that the Company will
achieve profitability in the future. The Company's operating results depend on
factors such as increased use of the Internet, changes in networking and
communications technologies, price and product competition developments and
changes in the Internet market, demand for the Company's products, retention and
growth of the Company's NVO subscriber base, product enhancements and new
product announcements by the Company and its competitors, market acceptance of
new products of the Company or its competitors, the size and timing of customer
orders and purchasing cycles, customer order deferrals in anticipation of
enhancements to the Company's or competitors' products, customer order deferrals
for budgetary or other reasons, manufacturing delays, disruptions in sources of
supply, product life cycles, product quality problems, changes in the level of
operating expenses, the timing of research and development expenditures and the
level of the Company's international revenues. The Company's results also depend
on the demand for vendor products related to the Company's products such as
Windows or Apple personal computers and operating systems, among others, and
customer order deferrals in anticipation of new product offerings by these
vendors. The Company's gross margins and operating results depend on factors
such as raw material costs, write-offs of obsolete inventory, 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 as well as
the structure of planned NVO partnerships which may be reported as either higher
margin royalty arrangements or lower margin operations subject to royalty,
amortization or other costs. Additionally, the Company's operating results
depend on general factors such as personnel changes, changes in the Company's
strategy, fluctuations in foreign currency exchange rates, general economic
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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 operating history in the Internet market and the dynamic
market environment in which the Company competes make the prediction of future
operating results difficult, if not impossible. Sales orders are typically
shipped shortly after receipt and, consequently, order backlog at the beginning
of any quarter has in the past represented only a small portion of that
quarter's revenues. Accordingly, the Company's net revenues in any quarter are
substantially dependent on orders booked and shipped during that quarter.
Historically, the Company has often shipped and recognized a significant portion
of its revenues in the last weeks, or even days, of a quarter. As a result, the
magnitude of quarterly fluctuations may not become evident until late in, or
after the close of a particular quarter. The Company typically experiences
significant volumes of shipments at the end of the quarter which may be exposed
to delays caused by shipping halts or other factors beyond the Company's
control. In addition, the Company recognizes revenue on products sold through
distributors, ISPs and VARs upon shipment to the distributor, ISP and VAR.
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 and the summer slowdown in most European
markets. 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 or if the Company implements marketing programs
designed to capture additional market share 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 indicators 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.
Year 2000 Readiness Disclosure. The Year 2000 issue is the result of
computer programs being written using two digits rather than four to define the
application year. Any of the Company's programs or products that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. In addition, the year 2000 is a leap year, which may also
lead to incorrect calculations, functions or systems failure. As a result,
within approximately nine months, computer systems and software used by many
companies may need to be upgraded to comply with such Year 2000 requirements. In
October 1996, the Company began a "Millennium Project" to determine if any
actions needed to be taken regarding date-related effects to: (i) the Company's
software or hardware products; (ii) the Company's internal operating and desktop
computer systems and non-information technology systems; and (iii) the readiness
of the Company's third party vendors and business partners.
Through testing, the Company has determined that its Netopia Internet
router products; its NVO web site platform (the Netopia Site Server version 2.3
and later and all client software versions 2.2.4 and later); and its Windows,
MacOS and Enterprise versions of Timbuktu Pro (versions 1.5 and later), are Year
2000 Compliant. Upon completion of the development of the products acquired as a
result the Serus and netOctopus acquisitions, the Company expects these products
to meet Year 2000 readiness requirements. Although the majority of the Company's
products are Year 2000 compliant, the Company believes that the purchasing
patterns of customers and potential customers may be affected by Year 2000
issues as companies expend significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase products such as those offered by the
Company, which could have a material adverse effect on the Company's business,
operating results and financial condition. In addition, even if the Company's
products are Year 2000 compliant, other systems or software used by the
Company's customers may not be Year 2000 compliant. The failure of such
non-compliant third-party software or systems could affect the perceived
performance of the Company's products, which could have a material adverse
effect on the Company's business, operating results and financial condition.
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The Company's internal systems include information technology systems
such as financial, order entry, inventory, shipping and customer database
computer systems, desktop computer systems and non-information technology
systems such as telephones and facilities. The Company has conducted a
comprehensive review of its internal information technology systems such as
financial, order entry, inventory, shipping and customer database computer
systems to determine if any actions need to be taken regarding Year 2000
date-related effects. These underlying systems are based on a relational
database language which identifies dates based on four (4) digit numbers rather
than two (2) digit numbers and therefore the Company has determined that the
Year 2000 issue will not pose significant operational problems for these
computer systems. The Company has initiated a comprehensive inventory and
evaluation of all desktop systems and expects to complete this process and
upgrade such non-compliant desktop systems to Year 2000 compliant systems by
June 1999. The additional costs of remediation are not expected to be material
to the Company's financial condition or results of operations. However, if
implementation of replacement systems is delayed or if significant new
non-compliance issues are identified, the Company's business, financial
condition and results of operations could be materially adversely affected.
The Company is in the process of identifying and prioritizing critical
third party vendors, strategic partners and suppliers of non-information related
products and services concerning their plans and progress in addressing the Year
2000 problem. The Company is also working with key suppliers of products and
services to determine that their operations and products are Year 2000 compliant
or to monitor their progress toward Year 2000 compliance, as appropriate.
To date, the Company has not incurred material expenses related to its
Year 2000 compliance effort other than the investment of employee time and
resources. The Company has currently identified certain facilities related items
that the Company estimates will cost approximately $60,000 to upgrade to Year
2000 compliance. While the Company has dedicated and will continue to dedicate a
substantial amount of time and internal resources towards attaining Year 2000
compliance, there can be no assurance that the Company's Year 2000 compliance
program will be completed on a timely basis. In addition, there can be no
assurance that there will not be an interruption of operations or other
limitations of system functionality or that the Company will not incur
substantial costs to avoid such limitations. Any failure to effectively monitor,
implement or improve the Company's operational, financial, management and
technical support systems could have a material adverse effect on the Company's
business, financial condition and results of operations. Furthermore, the
Company believes that the purchasing patterns of customers and potential
customers may be affected by Year 2000 issues as companies expend significant
resources to correct or patch their current software systems for Year 2000
compliance. These expenditures may result in reduced funds available to purchase
software products such as those offered by the Company, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, even if the Company's products are Year 2000
compliant, other systems or software used by the Company's customers may not be
Year 2000 compliant. The failure of such non-compliant third-party software or
systems could affect the perceived performance of the Company's products, which
could have a material adverse effect on the Company's business, financial
condition and results of operations. The most likely worst case scenarios would
include hardware failure and the failure of infrastructure services provided by
government agencies and other third parties (e.g., electricity, telephone
service, water transport, internet services, etc.). In such worst case scenario
the Company would lose customers and revenue which would have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company is in the process of developing its contingency planning at this
time and is scheduled to have these plans in place by September 1999. The
Company expects its contingency plans to include, among other things, manual
"work-arounds" for software and hardware failures, as well as substitution of
systems, if necessary.
Competition. Netopia believes that the principal competitive factors in
its markets are: (1) product feature, function and reliability, (2) customer
service and support, (3) price and performance, (4) ease of use, (5) brand name
recognition (6) strategic alliances, (7) size and scope of distribution
channels, (8) timeliness of new product introductions, (9) breadth of product
line and (10) size and loyalty of customer base. While the Company believes, in
general, that it currently competes favorably with regard to these factors there
can be no assurance that the Company will be able to compete successfully in the
future, the failure of which would have a material adverse effect on the
Company's business, operating results and financial condition.
The markets for the Company's products, services and subscribers are
intensely competitive, highly fragmented and characterized by rapidly changing
technology, evolving industry standards, price competition and frequent new
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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 equipment,
manufacturers of Internet presence and web site software and developers of
remote control and collaboration software. In the Internet access equipment
market, the Company competes primarily with Ascend, Lucent, Cisco, 3Com, Ramp
Networks, Flowpoint (a division of Cabletron) and several other companies. In
the Internet presence and web site software market, the Company competes with
IBM, Inc. Online, The Globe, AOL, Yahoo!, SiteMatic, HotOffice, Homestead, Hiway
(a division of Verio), Zyworld and several other companies. In the remote
control and enterprise software markets, the Company competes primarily with
Symantec, Microsoft, Tivoli (IBM), Lotus (IBM), Stac Electronics, Microcom
(Compaq), Computer Associates, Contigo, PlaceWare 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. Other companies in the personal computer or
Internet industry may seek to expand their product offerings by designing and
selling products using competitive technology that could render the Company's
products obsolete or have a material adverse effect on the Company's sales. For
example, Microsoft has available for free, via download on the Internet,
communications and collaboration software compatible with the Microsoft Internet
Explorer and has publicly stated that they are committed to integrating Internet
technology into existing products at no additional cost to customers. 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 NVO software. Accordingly,
there can be no assurance that the Company can continue to market its enterprise
and web site software, and the failure to do so 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 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. The markets in which the Company currently competes are subject
to intense price competition, and the Company expects additional price and
product competition as other established and emerging companies enter these
markets and new products and technologies are introduced. Consolidations in the
computer and communication industries 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 the loss of market share, further price reductions and
reduced gross margins, 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.
Dependence on Internet/Intranet Products. The Company's business is
dependent upon continued growth in the sale of its products. The rapid growth in
the use of the Internet and Intranets for communication and commerce is a recent
phenomenon. There can be no assurance that such communication or commerce over
the Internet will continue to grow or become an accepted method of communication
and commerce. Additionally, 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 infrastructure of the Internet will continue to be able
to support the demands placed upon it by such potential growth, or that it 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 revenue growth rates, the Company does not believe prior percentage
growth rates should be relied upon as being indicative of future operating
results. The Company's limited operating history as an Internet company and the
dynamic market environment in which the Company operates makes the prediction of
future operating results difficult, if not impossible. There can be no assurance
that the Company will increase sales of its products, or that the Company's
existing distribution channels are appropriate for the sale of its products.
Accordingly, the failure of the Company's products to gain market acceptance or
to achieve significant sales would materially and adversely affect the Company's
business, operating results and financial condition.
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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, that they will not develop and/or market their own
competitive technology, or that they will not be acquired and thereby reassess
their relationship with the Company.
The Company has relationships with several CLECs for the development
and sale of the Company's DSL Internet routers. Currently, these CLECs
predominantly use copper telephone lines controlled by the incumbent local
exchange carriers ("ILECs") to provide DSL connections to customers. These CLECs
also depend on the ILECs for collocation of equipment and for a substantial
portion of the transmission facilities used to connect the CLECs equipment in
ILEC central offices to the CLECs Metro Service Centers. In addition, CLECs
depend on the ILECs to test and maintain the quality of the copper lines that
are used for providing DSL service. Additionally, CLECs have not established a
history of obtaining access to collocation and transmission facilities from
ILECs in large volumes. In many cases, CLECs may be unable to obtain access to
collocation and transmission facilities from the ILECs, or to gain access at
acceptable rates, terms and conditions, including timeliness. CLECs have
experienced, and will likely continue to experience in the future, lengthy
periods between the request for and the actual provision of the collocation
space and telephone lines. The inability of the CLECs to obtain adequate and
timely access to collocation space or transmission facilities on acceptable
terms and conditions from ILECs could hinder the distribution of DSL service
offered by these CLECs which would have a material adverse effect on the
Company's business, operating results and financial condition. Additionally, if
the CLECs deployment of broadband communication technologies, such as DSL,
experiences increasingly rapid demand, the CLEC infrastructure may not be able
to adequately address such demand and could cause delays in deployment of such
technologies which would have a material adverse effect on the Company's
business, operating results and financial condition.
Because CLECs compete with ILECs in the DSL communications market,
ILECs may be reluctant to cooperate with the CLECs. The ILECs may experience, or
claim to experience, a shortage of collocation space or transmission capacity.
If this occurs, CLECs may not have alternate means of connecting their DSL
equipment with the copper lines or connecting their equipment in central offices
to Metro Service Centers. CLECs have experienced rejections of collocation
applications on the grounds that no space is available. CLECs may receive
additional rejections in the future. The number of other CLECs that request
collocation space will also affect the availability of collocation space and
transmission capacity. If the CLECs which the Company has partnered with are
unable to obtain physical collocation space or transmission capacity from the
targeted ILECs, these CLECs may face delays, additional costs or the inability
to provide services in certain locations. In many cases where the CLECs
application for physical collocation is rejected, the CLECs expect to have the
option of adjacent location where the CLECs equipment is installed in a building
that is very close to the ILECs central office, or virtual collocation where the
ILEC manages and operates the CLECs equipment. While CLECs have used adjacent
and virtual collocation in their network, these alternatives reduce the CLECs
control over their equipment, and therefore may reduce the level of quality and
service. Delays in obtaining access to collocation space and telephone lines or
the rejection of applications for CLEC collocation could result in delays in,
and increased expenses associated with, the rollout of DSL services, which in
turn could have a material and adverse effect on the Company's business,
operating results and financial condition.
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. In addition, the availability of many of these components
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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 the Company's 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 distributors, ISPs and VARs. However, there can be no
assurance that the Company will be able to establish such alliances or that such
alliances will result in increased revenues.
New Product Development and Rapid Technological Change. The Internet
market 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 Internet Routers currently operate over ISDN, Fractional T1/T1
(domestically), Fractional E1/E1 (international), Frame Relay, SDSL, ISDN DSL
("IDSL"), Ethernet and 56K analog telecommunication services. As other
communications technologies such as Asynchronous Transfer Mode ("ATM"),
Asymmetric Digital Subscriber Line ("ADSL"), various other versions of DSL,
packetized voice and communication over cable or wireless networks are developed
or gain market acceptance, the Company will be required to enhance its Internet
Router 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 the
telecommunications technologies currently supported do not achieve widespread
customer acceptance as a result of the adoption of alternative technologies or
as a result of de-emphasis of ISDN, Fractional T1/T1, Fractional E1/E1, Frame
Relay, SDSL, IDSL, Ethernet or 56K technologies by telecommunications service
providers, the Company's business, operating results and financial condition
would 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.
The Company believes that its future business and operating results
depend in part on its ability to continue to enhance existing products, develop
new products and improve the price and performance of its products in a timely
manner. The Company continuously evaluates the emerging needs, developing
standards and emerging technologies of its target markets to identify new market
or product opportunities. Netopia is focusing its development efforts on its
Internet Routers through high-speed digital telecommunication services,
including, DSL, packetized voice and various security technologies and software
enhancements to its NVO web site platform and Timbuktu Pro products, further
international localization of its products and cost-reducing design
improvements. In addition, the Company has relied and will continue to rely on
external development resources, such as OEM suppliers, for the development of
certain of its products and related components. The Company may in the future
acquire products or technologies to complement current research and development
23
<PAGE>
efforts. Research and development expenses were $2.3 million and $1.7 million
for the three months ended March 31, 1999 and 1998, respectively, and $4.3
million and $3.6 million for the six months ended March 31, 1999 and 1998,
respectively.
As of April 30, 1999, Netopia's research and development staff
consisted of 67 employees. 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.
Proprietary Rights and Technology. The Company's ability to compete is
dependent in part on its proprietary rights and technology. The Company relies
primarily on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect its
proprietary rights. The Company generally enters into confidentiality or license
agreements with its employees, resellers, distributors, customers and potential
customers and limits access to the distribution of its software, hardware
designs, documentation and other proprietary information. However, in some
instances, the Company may find it necessary to release its source code to
certain parties; for example, the Company entered into a product development
agreement pursuant to which it released certain source code to a third party in
the People's Republic of China. 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 three issued United States patents.
There can be no assurance that the Company's patents will not be invalidated,
circumvented or challenged, that the rights granted thereunder will provide
competitive advantages to the Company or that any of the Company's pending or
future patent applications, whether or not being currently challenged by
applicable governmental patent examiners, will be issued with the scope of the
claims sought by the Company, if at all. Furthermore, there can be no assurance
that others will not develop technologies that are similar or superior to the
Company's technology or design around the patents owned by the Company. Despite
the Company's efforts to protect its proprietary rights, unauthorized parties
may attempt to copy aspects of the Company's products or to obtain and use
information that the Company regards as proprietary. Policing unauthorized use
of the Company's products is difficult, and while the Company is unable to
determine the extent to which piracy of its software products exists, software
piracy is expected to be a persistent problem. In selling its software products,
the Company often relies on "shrink wrap" licenses that are not signed by
licensees and, therefore, it is possible that such licenses may be unenforceable
under the laws of certain jurisdictions. In addition, the laws of some foreign
countries where the Company's products are or may be manufactured or sold,
particularly developing countries including various countries in Asia, such as
the People's Republic of China, 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.
Other Risks Associated with the Sale of the LAN Division. In connection
with the sale of the LAN Division, the Company received consideration
aggregating $4.9 million, including (i) $2.0 million of cash, (ii) royalties on
Farallon's revenues for a period of five years to the extent that Farallon
achieves revenues from the sale of its LAN products of at least $15.0 million
per year, (iii) a two year $1.0 million promissory note from Farallon,
guaranteed by Gores, and (iv) a warrant to purchase up to 5% of the equity of
Farallon.
Pursuant to the Agreement of Purchase and Sale of Assets, dated August
5, 1998 (the "Farallon Purchase Agreement"), by and between the Registrant and
Farallon, the purchase price of the LAN Division is subject to a purchase price
adjustment. Such adjustment is based upon the difference between the unaudited
balance sheet of the LAN Division as of the effective date of sale (the "Draft
Balance Sheet") and the estimated book value of the LAN Division at March 31,
1998. On the effective date of sale, the Company estimated this difference and
accordingly recorded the liability on the Company's Balance Sheet as of
September 30, 1998. The Company has recently received correspondence from
24
<PAGE>
Farallon disputing such difference. The Company currently expects to proceed to
arbitration as provided in the Farallon Purchase Agreement to resolve any
purchase price adjustment disagreement. Any adjustment to the purchase price of
the LAN Division in excess of the amount accrued for could have an adverse
effect on the Company's business, operating results and financial condition.
The Company's successful realization of assets related to the sale of
the LAN Division, such as the royalty and note receivable, is dependent upon the
successful operation of Farallon by its management team and by Gores. For
example, if Farallon is unable to achieve revenues from LAN products of at least
$15.0 million per year, the Company will lose its right to a portion of
Farallon's revenue which could have a material adverse affect upon the Company's
business, operating results and financial condition. Farallon's use of its bank
credit facility or incurrance of other debt related financing may require
Netopia to take a subordinate position to such debt. Such subordinate position,
if required, could potentially decrease the likelihood of Netopia receiving
payments on its future receivables from Farallon which would allow Farallon's
other debt holders to be repaid on their loans before Farallon would make any
payments to Netopia on it's Farallon related receivables. Failure to receive
such payments for these or any other reasons would have a material adverse
effect on the Company's business, operating results and financial condition.
Additionally, the Company made certain representations and warranties about the
assets and liabilities transferred to Farallon in the Farallon Purchase
Agreement which the Company believes were materially accurate but which could
become the topic of future negotiation or dispute. While the Company believes
such representations were accurate, the Company could be liable for up to $2
million for any damages to Farallon resulting from any breach or breaches of any
such representation and warranties. These or other aspects of the transaction
would have a material adverse affect upon the Company's business, operating
results and financial condition.
Management of Changing Business. 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 modify its manufacturing capabilities.
The Company may experience an 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. In
addition, certain aspects of the Company's Internet/Intranet business require
volume sales to achieve profitability. If the Company is unable to achieve such
volumes, offset the loss of revenue or to manage the transition effectively, the
Company's business, operating results and financial condition will be materially
and adversely affected.
Risks Associated with Potential Acquisitions or Divestitures. The
Company may acquire or invest in companies, technologies or products that
complement the Company's business or its product offerings. In addition, the
Company continues to evaluate the performance of all its products and product
lines and may sell or discontinue current technologies, products or product
lines. Any acquisitions or divestitures may result in the use of cash,
potentially dilutive issuance of equity securities, the write-off of software
development costs or other assets, incurrance of severance liabilities, the
amortization of expenses related to goodwill and other intangible assets and/or
the incurrance of debt, any of which could have a material adverse effect on the
Company's business, financial condition, cash flows and results of operations.
Acquisitions or divestitures would involve numerous additional risks including
difficulties in the assimilation or separation of operations, services, products
and personnel, the diversion of management's attention from other business
concerns, the disruption of the Company's business, the entry into markets in
which the Company has little or no direct prior experience, the potential loss
of key employees and the potential loss of key distributor or supplier
relationships. In addition, potential acquisition candidates targeted by the
Company may not have audited financial statements, detailed financial
information or any degree of internal controls. There can be no assurance that
an audit subsequent to any successful completion of an acquisition will not
reveal matters of significance, including with respect to revenues, expenses,
liabilities, contingent or otherwise, and intellectual property. There can be no
assurance that the Company would be successful in overcoming these or any other
significant risks encountered and the failure to do so could have a material
adverse effect upon the Company's business, operating results and financial
condition.
Risk of Capacity Constraints; System Failures. The performance of the
Company's servers, networking hardware and software infrastructure used for the
hosting services offered by the Company for NVO is critical to the Company's
business and reputation and its ability to attract customers, web users, new
25
<PAGE>
subscribers and partners. Any system failure that causes an interruption in
service or a decrease in responsiveness of the Company's hosting service could
result in less traffic to the Company's hosted web sites and, if sustained or
repeated, could impair the Company's reputation and the attractiveness of its
brand name. The Company maintains redundant systems for all critical operational
areas. The Company offers 10Mb of disk space to each NVO web site hosted on the
Company's servers and additional disk space provided in 10Mb increments. Disk
storage is configured to survive drive failures without risk of data loss using
RAID striping and mirroring as well as tape backup. Although the Company has
taken steps to minimize the risk of data loss there can be no assurance that
data would not be lost in the event of a catastrophic drive failure.
The Company is currently operating under a month-to-month web-hosting
agreement with Exodus Communications, Inc. ("Exodus") for the hosting of NVO web
sites. Pursuant to the agreement, Exodus provides and manages power and
environmentals for the Company's networking and server equipment. Exodus also
provides site connectivity to the Internet via multiple DS-3 and OC-3 links on a
24 hour-a-day, seven-days-per week basis. Under the terms of the agreement,
Exodus does not, however, guarantee that the Company's Internet access will be
uninterrupted, error-free or completely secure. The Company has decided to
terminate its use of the Exodus web-hosting services and has entered into a
similar web-hosting agreement to host its NVO web sites from a similar third
party web-hosting vendor (the "Vendor"). The Company currently anticipates that
it will transition its NVO web sites to the new Vendor in July 1999. Any
extended disruption in the Internet access provided by Exodus or the Company's
new Vendor or any extended failure of the Company's server and networking
systems to handle current or higher volumes of traffic or any extended
disruption of Internet access during the transition to the Company's new Vendor
could have a material adverse effect on the Company's business, operating
results and financial condition.
An increase in the use of the Company's hosted NVO web sites could
strain the capacity of its systems, which could lead to slower response time or
system failures. Slowdowns or system failures adversely affect the speed and
responsiveness of the Company's hosted web sites and would diminish the
experience for the Company's subscribers and visitors. The ability of the
Company to provide effective Internet connections or of its systems to manage
substantially larger numbers of customers at higher transmission speeds is as
yet unknown, and, as a result, the Company faces risks related to its ability to
scale up to its expected customer levels while maintaining superior performance.
If usage of bandwidth increases, Netopia will need to purchase additional
servers and networking equipment and rely more heavily on its equipment and on
Exodus and the future Vendor and their services to maintain adequate data
transmission speeds, the availability of which may be limited or the cost of
which may be significant.
The successful delivery of the Company's services is also dependent in
substantial part upon the ability of Exodus and the future Vendor and the
Company to protect Netopia's servers and network infrastructure against damage
from human error, fire, flood, power loss, telecommunications failure, sabotage,
intentional acts of vandalism and similar events. In addition, substantially all
of the Company's servers and network infrastructure are located in Northern
California, an area particularly susceptible to earthquakes, which also could
cause system outages or failures if one should occur. Despite precautions taken
by, and planned to be taken by, the Company and Exodus and the future Vendor,
the occurrence of other natural disasters or other unanticipated problems at
their respective facilities could result in interruption in the services
provided by the Company or significant damage to the Company's equipment.
Despite the implementation of network security measures by the Company, its
servers are vulnerable to computer viruses, break-ins, and similar disruptions
from unauthorized tampering. The occurrence of any of these events could result
in interruptions, delays or cessations in service, which could have a material
adverse effect on the Company's business, operating results and financial
condition. In addition, the Company's reputation and the Netopia brand name
could be materially and adversely affected.
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
26
<PAGE>
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 (the "FCC")
regulations. The Company's telecommunications products also must be certified by
certain domestic telecommunications carriers. In many foreign countries, such
products are subject to a wide variety of governmental review and certification
requirements. While the European Economic Community and certain other foreign
countries 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 retain, or obtain on a timely basis, domestic or foreign
regulatory approvals and certifications, including safety and
telecommunications, could have a material adverse effect on the Company's
business, operating results and financial condition.
Due to the increasing popularity and use of the Internet, a number of
legislative and regulatory proposals are under consideration by federal, state,
local and foreign governmental organizations, and it is possible that a number
of laws or regulations may be adopted with respect to the Internet relating to
such issues as user privacy, user screening to prevent inappropriate uses of the
Internet by, for example, minors or convicted criminals, taxation, infringement,
pricing, content regulation, quality of products and services and intellectual
property ownership and infringement. The adoption of any such laws or
regulations may decrease the growth in the use of the Internet, which could in
turn decrease the demand for the Company's products, increase the Company's cost
of doing business, or otherwise have a material adverse effect on the Company's
business, results of operations and financial condition. Moreover, the
applicability to the Internet of existing laws governing issues such as property
ownership, copyright, trademark, trade secret, obscenity, libel and personal
privacy is uncertain and developing. Any new legislation or regulation, or
application or interpretation of existing laws, could have a material adverse
effect on the Company's business, operating results and financial condition. For
example, although it was held unconstitutional, the Telecommunications Act of
1996 prohibited the transmission over the Internet of certain types of
information and content. Other nations, including Germany and China, have taken
actions to restrict the free flow of material on the World Wide Web (the "web")
deemed to be objectionable. In addition, although substantial portions of the
Communications Decency Act (the "CDA") were held to be unconstitutional, there
can be no assurance that similar legislation will not be enacted in the future,
and it is possible that such legislation could expose the Company to substantial
liability. Legislation like the CDA could also dampen the growth in use of the
web generally and decrease the acceptance of the web as a communications and
commercial medium, and could, thereby, have a material adverse effect on the
Company's business, operating results and financial condition. It is also
possible that the use of "cookies" to track demographic information and users
may become subject to laws limiting or prohibiting their use. A "cookie" is a
bit of information keyed to a specific server, file pathway or directory
location that is stored on a user's hard drive, possibly without the user's
knowledge. A user is generally able to remove cookies. Germany, for example, has
imposed laws limiting the use of cookies, and a number of Internet commentators,
advocates and governmental bodies in the United States and other countries have
urged the passage of laws limiting or abolishing the use of cookies. Limitations
on the Company's potential use of cookies could limit the effectiveness of the
Company's tracking user data, which could have a material adverse effect on the
Company's business, operating results and financial condition. In addition, a
number of legislative proposals have been made at the federal, state and local
level that would impose additional taxes on the sale of goods and services over
the Internet and certain states have taken measures to tax Internet-related
activities. Moreover, it is likely that, once such moratorium is lifted, some
type of federal and/or state taxes will be imposed upon Internet commerce, and
there can be no assurance that such legislation or other attempts at regulating
commerce over the Internet will not substantially impair the growth of commerce
on the Internet and, as a result, adversely affect the Company's opportunity to
derive financial benefit from such activities. In addition to the foregoing
areas of recent legislative activities, several telecommunications carriers are
currently seeking to have telecommunications over the web regulated by the FCC
in the same manner as other telecommunications services. For example, America's
Carriers Telecommunications Association has filed a petition with the FCC for
this purpose. In addition, because the growing popularity and use of the web
have burdened the existing telecommunications infrastructure and many areas with
high web use have begun to experience interruptions in phone service, local
telephone carriers have petitioned the FCC to regulate ISPs in a manner similar
to long-distance telephone carriers and to impose access fees on the ISPs. If
either of these petitions is granted, or the relief sought therein is otherwise
granted, the costs of communicating on the web could increase substantially,
potentially slowing growth in use of the web, which could in turn decrease
demand for the Company's services or increase the Company's cost of doing
business.
27
<PAGE>
Due to the global nature of the web, it is possible that, although
transmissions by the Company over the Internet originate primarily in the State
of California, the governments of other states and foreign countries might
attempt to regulate the Company's transmissions or prosecute the Company for
violations of their laws. There can be no assurance that violations of local
laws will not be alleged or charged by state or foreign governments, that the
Company might not unintentionally violate such laws or that such laws will not
be modified, or new laws enacted, in the future. Any of the foregoing
developments could have a material adverse effect on the Company's business,
operating results and financial condition.
In addition, as the Company's services are available over the Internet
in multiple states and foreign countries, such jurisdictions may claim that the
Company is required to qualify to do business as a foreign corporation in each
such state or foreign country. The failure by the Company to qualify as a
foreign corporation in a jurisdiction where it is required to do so could
subject the Company to taxes and penalties and could result in the inability of
the Company to enforce contracts in such jurisdictions. Any such new legislation
or regulation, the application of laws and regulations from jurisdictions whose
laws do not currently apply to the Company's business, or the application of
existing laws and regulations to the Internet and other online services could
have a material adverse effect on the Company's business, operating results and
financial condition.
Liability for Information Retrieved From the Web. Because materials may
be downloaded by subscribers and other users of the Company's NVO web sites and
subsequently distributed to others, there is a potential that claims will be
made against the Company for defamation, negligence, copyright or trademark
infringement, personal injury or other theories based on the nature, content,
publication and distribution of such materials. Such claims have been brought,
and sometimes successfully pressed, in the past. In addition, the increased
attention focused upon liability issues as a result of these lawsuits and
legislative proposals could impact the overall growth of Internet use. The
Company could also be exposed to liability with respect to the offering of
third-party content that may be accessible through content and materials that
may be posted by subscribers on their personal web sites or chat sessions. Such
claims might include, among others, that by directly or indirectly hosting the
personal web sites of third parties, the Company is liable for copyright or
trademark infringement or other wrongful actions by such third parties through
such web sites. The Company also offers e-mail services, which expose the
Company to potential risk, such as liabilities or claims resulting from
unsolicited e-mail (spamming), lost or misdirected messages, illegal or
fraudulent use of e-mail or interruptions or delays in e-mail service. Even to
the extent that such claims do not result in liability to the Company, the
Company could incur significant costs in investigating and defending against
such claims. The imposition on the Company of potential liability for
information carried on or disseminated through its systems could require the
Company to implement measures to reduce its exposure to such liability, which
may require the expenditure of substantial resources and limit the
attractiveness of the Company's services to its subscribers which would have a
material adverse effect on the Company's business, operating results and
financial condition.
Dependence on Apple. The Company believes that approximately 20% to 25%
of its revenues are derived from customers purchasing products for the Apple
MacOS environment. Accordingly, the Company is dependent on the market for MacOS
computers and the development and sale of new Apple computers, particularly
sales of such computers into business environments. 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.
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 without merit or are immaterial, there
can be no assurance that third parties will not assert infringement or other
claims in the future with respect to the Company's current or future products or
activities. The Company expects that it will increasingly be subject to
infringement claims as the number of products and competitors in the Company's
industry segments grow and the functionality of products in different industry
segments overlap. Any such claims, with or without merit, could be time
consuming to defend, result in costly litigation, divert management's attention
and resources, cause product shipment delays or require the Company to enter
into additional 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.
28
<PAGE>
From time to time, the Company may be involved in litigation or
administrative claims arising out of its operations in the normal course of
business. In the event of a successful claim against the Company, the Company's
business, operating results and financial condition would be materially and
adversely affected.
California Headquarters; Subleased Facilities. 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 Northern 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. As a result of the sale of the LAN Division and per the Separation
Agreement by and between Netopia and Farallon dated August 5, 1998, Netopia is
to assign the lease of its warehouse facility to Farallon. The assignment of
such lease is expected to occur in fiscal 1999. After the lease is assigned to
Farallon, the Company will continue to utilize a portion of the warehouse space
under a sublease with Farallon. The term of the sublease will begin on the
effective date of the lease assignment and terminate on December 31, 2002. Upon
completion of the sublease, Farallon will become responsible for the payment of
applicable rent and utilities related to the warehouse facility. Under
Farallon's management the warehouse facility could be exposed to closure or
interrupted utility services which would not be controllable by the Company and
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, announcements of product
distribution agreements, introduction of new products by the Company or its
competitors, developments with respect to patents, copyrights or proprietary
rights, conditions and trends in the Internet and other technology industries,
changes in or failure by the Company to meet securities analysts' expectations,
large volume sales of the Company's Common Stock and activities related to
acquisitions or divestitures, semi-professional and amateur day traders,
postings on Internet message and chat boards, 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 Internet 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. The Company
currently anticipates that it will retain all future earnings, if any, for use
in its business and does not anticipate paying any cash dividends on its Common
Stock in the foreseeable future. The closing price per share of the Company's
Common Stock as reported on the Nasdaq Stock Market on May 14, 1999 was $25.875.
Liquidity and Capital Resources
The Company has funded its operations to date primarily through the
private sale of equity securities and the Initial Public Offering (the "IPO") of
the Company's Common Stock. Since inception, the Company has raised $19.4
million from the private sale of equity securities and approximately $24.8
million, net of offering expenses, from the Company's IPO completed in June
1996. As of March 31, 1999, the Company had cash, cash equivalents and
short-term investments representing 61% of total assets.
The Company's operating activities used cash of $6.3 million and
$966,000 for the six months ended March 31, 1999 and 1998, respectively. The
cash used by operations in the six months ended March 31, 1999 was primarily due
to supporting the Company's operating activities as well as the increase in
accounts receivable and the reduction of accounts payable and accrued
liabilities related to the sale of the LAN Division. The cash used by operations
in the six months ended March 31, 1998 was primarily due to the net loss of $1.4
million and a decrease of $1.3 million in accounts payable and accrued
liabilities, partially offset by the reduction of accounts receivable of $1.1
million.
Cash provided by investing activities in the six months ended March 31,
1999 was primarily due to proceeds from the sale and maturity of short-term
investments partially offset by the purchases of such investments as well as the
acquisitions of Serus and netOctopus and purchases of capital equipment. The
cash provided by investing activities in the six months ended March 31, 1998 was
primarily related to the sale and maturity of short-term investments partially
29
<PAGE>
offset by the purchase of such investments and purchases of capital equipment.
Expenditures for capital equipment were $736,000 and $489,000 for the six months
ended March 31, 1999 and 1998, respectively. The Company's financing activities
in the six months ended March 31, 1999 and 1998 were primarily related to the
exercise of stock options and activities related to the Company's Employee Stock
Purchase Plan.
Although the Company believes that its existing cash balance will
decrease moderately during the remainder of fiscal 1999 as a result strategic
equity investments and operating activities, the Company believes that its
existing cash, cash equivalents and short-term investments will be adequate to
meet its cash needs for working capital, capital expenditures and earnouts
related to its acquisitions for at least the next 12 months. 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. However, there can be no assurance that
such additional equity or convertible debt financing or additional credit
facilities will be available on terms acceptable to the Company, if at all. The
sale of additional equity or convertible debt securities could result in
additional dilution to the Company's stockholders. From time to time, in the
ordinary course of business, the Company evaluates potential acquisitions of
businesses, products and technologies. Accordingly, a portion of the Company's
cash may be used to acquire or invest in complementary businesses or products,
to obtain the right to use complementary technologies, to obtain additional
presence on the Internet or to support additional advertising and promotional
campaigns.
Item 3. Qualitative and Quantitative Disclosures About Market Risk
The Company's exposure to market risk for changes in interest rates
relates primarily to its investment portfolio. The Company does not use
derivative financial instruments for speculative or trading purposes. The
Company places its investments in instruments that meet high credit quality
standards, as specified in the Company's investment policy. The policy also
limits the amount of credit exposure to any one issue, issuer and type of
instrument. The Company does not expect any material loss with respect to it
investment portfolio.
The table below presents the carrying value and related weighted
average interest rates for the Company's investment portfolio. The carrying
value approximates fair value at March 31, 1999. All the Company's investments
mature in twelve months or less.
<TABLE>
<CAPTION>
Carrying Average
Principal (notional) amounts in United States dollars: Amount Interest Rate
------------------ ------------------
(in thousands)
<S> <C> <C>
Cash equivalents - fixed rate................................. $ 13,946 4.62%
Short-term investments - fixed rate........................... 5.66%
14,985
------------------
$ 28,931
==================
</TABLE>
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
On February 18, 1999, the Annual Meeting of Stockholders of Netopia,
Inc. was held in Alameda, California.
An election of directors was held, with the following individuals being
elected to the Board of Directors of the Company:
<TABLE>
<CAPTION>
Votes For: Votes Withheld:
------------------ --------------------
<S> <C> <C>
Reese M. Jones................................................ 11,200,375 377,308
Alan B. Lefkof................................................ 11,199,414 378,269
David F. Marquardt............................................ 11,200,547 377,136
James R. Swartz............................................... 11,200,547 377,136
</TABLE>
30
<PAGE>
Other matters voted upon at the meeting and the number of affirmative
and negative votes cast with respect to each such matter were as follows:
1. To approve amendments to the Company's 1996 Stock Option Plan,
including a 500,000 share increase to the number of shares available
under the 1996 Stock Option Plan. (5,796,412 votes in favor, 938,681
votes opposed, 435,180 votes abstaining and 4,407,410 broker
non-votes).
2. To approve an amendment to the Company's Employee Stock Purchase Plan
to increase the number of shares of the Company's Common Stock
available for issuance by 150,000 shares. (6,309,170 votes in favor,
439,516 votes opposed, 421,587 votes abstaining and 4,407,410 broker
non-votes).
3. To ratify the appointment of KPMG LLP as independent auditors of the
Company. (11,069,978 votes in favor, 69,585 votes opposed and 438,120
votes abstaining).
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
There were no reports filed on Form 8-K during the three months ended
March 31, 1999.
31
<PAGE>
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 17, 1998 NETOPIA, INC.
(Registrant)
By: /s/ James A. Clark
James A. Clark
Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal
Financial Officer)
32
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 16,706
<SECURITIES> 15,246
<RECEIVABLES> 11,013
<ALLOWANCES> 629
<INVENTORY> 1,527
<CURRENT-ASSETS> 43,043
<PP&E> 2,163
<DEPRECIATION> 10,513
<TOTAL-ASSETS> 52,501
<CURRENT-LIABILITIES> 10,110
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 42,007
<TOTAL-LIABILITY-AND-EQUITY> 52,501
<SALES> 10,535
<TOTAL-REVENUES> 10,535
<CGS> 3,644
<TOTAL-COSTS> 3,644
<OTHER-EXPENSES> 8,254
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (430)
<INCOME-PRETAX> (933)
<INCOME-TAX> 0
<INCOME-CONTINUING> (933)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (933)
<EPS-PRIMARY> (0.07)
<EPS-DILUTED> (0.07)
</TABLE>
