<PAGE>
================================================================================
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 June 30, 2000
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 July 31, 2000 there were 17,448,605 shares of the Registrant's Common
Stock outstanding.
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<PAGE>
<TABLE>
<CAPTION>
NETOPIA, INC.
FORM 10-Q
TABLE OF CONTENTS PAGE
================================================================================================================
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements...................................... 2
Condensed consolidated balance sheets at June 30, 2000 and September 30, 1999.............. 2
Condensed consolidated statements of operations for the three and nine months ended
June 30, 2000 and 1999 .................................................................... 3
Condensed consolidated statements of cash flows for the nine months ended June 30,
2000 and 1999.............................................................................. 4
Notes to condensed consolidated financial statements....................................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................. 36
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K........................................................... 38
SIGNATURE................................................................................................. 38
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
--------------------------------------------------------------------------------
NETOPIA, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
<TABLE>
<CAPTION>
June 30, September 30,
2000 1999
------------- ---------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................................. $ 41,861 $ 61,381
Short-term investments................................................. 20,016 8,102
Trade accounts receivable less allowance for doubtful accounts and
returns of $934 and $796, respectively............................ 18,588 9,852
Royalties receivable................................................... -- 361
Note receivable........................................................ -- 966
Inventories, net....................................................... 7,075 3,681
Prepaid expenses and other current assets.............................. 3,193 1,397
----------- -----------
Total current assets........................................... 90,733 85,740
Royalties receivable....................................................... -- 377
Furniture, fixtures and equipment, net..................................... 3,907 2,403
Intangible assets, net..................................................... 33,986 2,362
Deposits and other assets.................................................. 3,255 5,087
----------- -----------
$ 131,881 $ 95,969
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................................... $ 8,927 $ 5,258
Accrued compensation................................................... 3,328 2,170
Accrued liabilities.................................................... 1,117 1,564
Deferred revenue....................................................... 1,939 1,343
Other current liabilities.............................................. 590 11
----------- -----------
Total current liabilities...................................... 15,901 10,346
Long-term liabilities...................................................... 376 544
----------- -----------
Total liabilities.............................................. 16,277 10,890
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;
17,330,250 and 15,519,198 shares issued and outstanding at
June 30, 2000 and September 30, 1999, respectively..................... 17 15
Additional paid-in capital............................................. 140,788 99,978
Accumulated deficit.................................................... (24,823) (14,942)
Accumulated other comprehensive income (loss).......................... (378) 28
----------- -----------
Total stockholders' equity..................................... 115,604 85,079
----------- -----------
$ 131,881 $ 95,969
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
NETOPIA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except for per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
June 30, June 30,
------------------------ ------------------------
2000 1999 2000 1999
------------ ---------- ------------ ----------
<S> <C> <C> <C> <C>
Revenues:
Internet equipment........................................ $ 22,134 $ 7,109 $ 48,633 $ 16,730
Web platform licenses and services....................... 6,381 5,111 17,970 13,948
--------- --------- ---------- ---------
28,515 12,220 66,603 30,678
Cost of revenues:
Internet equipment........................................ 15,461 4,502 33,949 10,600
Web platform licenses and services........................ 222 168 468 520
---------- ---------- ---------- ---------
15,683 4,670 34,417 11,120
---------- ---------- ---------- ---------
Gross profit............................................. 12,832 7,550 32,186 19,558
Operating expenses:
Research and development................................... 3,499 2,327 9,640 6,658
Selling and marketing ..................................... 6,886 5,058 18,805 14,647
General and administrative................................. 1,065 908 3,358 2,589
Acquired in-process research and development............... -- -- 8,658 4,205
Amortization of goodwill and other intangible assets....... 3,003 181 6,750 362
---------- ---------- ---------- ---------
Total operating expenses................................ 14,453 8,474 47,211 28,461
---------- ---------- ---------- ---------
Operating loss.......................................... (1,621) (924) (15,025) (8,903)
Other income, net............................................... 943 398 2,663 1,398
---------- ---------- ---------- ---------
Loss from continuing operations
before income taxes..................................... (678) (526) (12,362) (7,505)
Income tax provision............................................ -- -- -- --
---------- ---------- ---------- ---------
Loss from continuing operations........................... (678) (526) (12,362) (7,505)
Discontinued operations:
Income from discontinued operations, net of taxes............. 1,334 -- 2,481 --
---------- ---------- ---------- ---------
Net income (loss)......................................... $ 656 $ (526) $ (9,881) $ (7,505)
========== ========== ========== =========
Comprehensive income (loss):
Net income (loss).......................................... $ 656 $ (526) $ (9,881) $ (7,505)
Other comprehensive income (loss)........................... (659) 1,028 (406) 1,028
---------- ---------- ---------- ---------
Total comprehensive income (loss).......................... $ (3) $ 502 $ (10,287) $ (6,477)
========== ========== ========== =========
Per share data, continuing operations:
Basic and diluted loss per share........................... $ (0.04) $ (0.04) $ (0.74) $ (0.60)
========== ========== ========== =========
Common shares used in the per share calculations............ 17,239 12,907 16,612 12,560
========== ========== ========== =========
Per share data, net income (loss):
Basic income (loss) per share.............................. $ 0.04 $ (0.04) $ (0.59) $ (0.60)
========== ========== ========== =========
Diluted income (loss) per share............................ $ 0.04 $ (0.04) $ (0.59) $ (0.60)
========== ========== ========== =========
Common shares used in the basic per share calculations..... 17,239 12,907 16,612 12,560
========== ========== ========== =========
Common shares used in the diluted per share calculations... 17,239 12,907 16,612 12,560
========== ========== ========== =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
NETOPIA, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine months ended June 30,
---------------------------------
2000 1999
---------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................................... $ (9,881) $ (7,505)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization........................................... 8,623 2,219
Charge for in-process research and development.......................... 8,658 4,205
Changes in allowance for doubtful accounts and returns on
accounts receivable.................................................... 138 (8)
Changes in operating assets and liabilities:
Trade accounts receivable............................................ (8,874) (3,703)
Inventories.......................................................... (3,394) (1,440)
Prepaid expenses, and other current assets........................... (470) 178
Deposits and other assets............................................ 1,038 (353)
Accounts payable and accrued liabilities............................. 4,381 163
Deferred revenue..................................................... 496 441
Other liabilities.................................................... 510 (80)
----------- -----------
Net cash provided by (used in) operating activities............... 1,225 (5,883)
----------- -----------
Cash flows from investing activities:
Purchase of furniture, fixtures and equipment........................... (2,080) (1,285)
Capitalization of software development costs............................ (532) (377)
Acquisition of technology............................................... (11,642) (4,283)
Purchase of short-term investments...................................... (45,358) (14,723)
Purchase of long-term investment........................................ -- (1,000)
Proceeds from the sale and maturity of short-term investments........... 33,444 23,224
----------- -----------
Net cash provided by (used in) investing activities............... (26,168) 1,556
----------- -----------
Cash flows from financing activities:
Proceeds from the issuance of common stock, net......................... 5,423 3,007
----------- -----------
Net cash provided by financing activities......................... 5,423 3,007
----------- -----------
Net decrease in cash and cash equivalents.................................. (19,520) (1,320)
Cash and cash equivalents, beginning of period............................. 61,381 19,244
----------- -----------
Cash and cash equivalents, end of period................................... $ 41,861 $ 17,924
----------- -----------
Supplemental disclosures of noncash investing and financing activities:
Issuance of common stock and common stock options for acquisition of
intangible assets....................................................... $ 35,491 $ 2,811
----------- -----------
Issuance of common stock for consulting services........................ -- $ 116
----------- -----------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
NETOPIA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
(1) Basis of Presentation
---------------------
The unaudited condensed consolidated financial statements included in
this Form 10-Q reflect all adjustments, consisting only of normal recurring
adjustments which in our opinion are necessary to fairly present our
consolidated financial position, results of operations and cash flows for the
periods presented. These condensed consolidated financial statements should be
read in conjunction with our consolidated financial statements included in our
Annual Report on Form 10-K and other filings with the United States Securities
and Exchange Commission. The consolidated results of operations for the period
ended June 30, 2000 are not necessarily indicative of the results to be expected
for any subsequent quarter or for the entire fiscal year ending September 30,
2000.
(2) Recent Accounting Pronouncements
---------------------------------
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 (SFAS No. 133), Accounting for Derivative and Hedging
Activities. SFAS No. 133 establishes accounting and reporting standards for
derivative instruments (including derivative instruments embedded in other
contracts) and for hedging activities. SFAS No. 133, as amended by SFAS No. 137,
is effective for all fiscal quarters of fiscal years beginning after June 15,
2000. We will adopt SFAS 133 in our fiscal first quarter of 2001 and we do not
expect a material impact on our results of operations.
In December 1999, the SEC issued Staff Accounting Bulletin (SAB) 101,
Revenue Recognition in Financial Statements. SAB 101 provides guidance on
applying generally accepted accounting principles to revenue recognition issues
in financial statements. We will adopt SAB 101 in fiscal 2001 and we are
evaluating the effect, if any, that such adoption may have on our consolidated
results of operations and financial position.
In March 2000, the FASB issued Interpretation (FIN) No.44, Accounting
for Certain Transactions Involving Stock Compensation - an Interpretation of
Accounting Principles Board (APB) No. 25. APB No. 25 clarifies (a) the
definition of employee for purposes of applying APB No. 25; (b) the criteria for
determining whether a plan qualifies as a noncompensatory plan; (c) the
accounting consequences of various modifications to the terms of a previously
fixed stock option or award; and (d) the accounting for an exchange of stock
compensation awards in a business compensation. FIN No. 44 is effective July 31,
2000, but certain conclusions in this Interpretation cover specific events that
occur during the period after December 15, 1998 of January 12, 2000. The
adoption of the conclusions of FIN No. 44 covering events occuring during the
period after December 15, 1998 or January 12, 2000 did not have a material
effect on our consolidated financial position and results of operations. We do
not expect the adoption of the remaining conclusion will have a material effect
on our consolidated financial position or 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>
June 30, September 30,
2000 1999
---------------- ----------------
<S> <C> <C>
Raw materials and work in process........................ $ 3,480 $ 1,699
Finished goods........................................... 3,595 1,982
--------------- ---------------
$ 7,075 $ 3,681
=============== ===============
</TABLE>
(4) Furniture, Fixtures and Equipment, net (in thousands):
------------------------------------------------------
<TABLE>
<CAPTION>
June 30, September 30,
2000 1999
---------------- ----------------
<S> <C> <C>
Furniture, fixtures and equipment........................ $ 15,645 $ 13,565
Accumulated depreciation and amortization................ (11,738) (11,162)
--------------- ---------------
$ 3,907 $ 2,403
=============== ===============
</TABLE>
5
<PAGE>
(5) Net Income (Loss) Per Share
---------------------------
Basic net income (loss) per share (EPS) is based on the weighted
average number of shares of common stock outstanding during the period. Diluted
net income (loss) 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 options and warrants.
Computation of per share earnings (loss)
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months ended Nine months ended
June 30, June 30,
----------------------- ------------------------
2000 1999 2000 1999
---------- --------- --------- ----------
<S> <C> <C> <C> <C>
Computation Of Basic Net Income (Loss) Per Common
Share:
Net income (loss)................................. $ 656 $ (526) $ (9,881) $ (7,505)
========== ========= ========= ==========
Weighted average number of common stock
outstanding....................................... 17,239 12,907 16,612 12,560
========== ========= ========= ==========
Basic net income (loss) per common share........ $ 0.04 $ (0.04) $ (0.59) $ (0.60)
========== ========= ========= ==========
Computation Of Diluted Net Income (Loss) Per
Common Share:
Net income (loss)................................. $ 656 $ (526) $ (9,881) $ (7,505)
========== ========= ========= ==========
Weighted average number of common stock
outstanding.......................................
17,239 12,907 16,612 12,560
========== ========= ========= ==========
Number of common stock equivalents as a result
of stock options outstanding using the treasury
stock method...................................... -- -- -- --
---------- --------- --------- ----------
Shares used in per share calculation.............. 17,239 12,907 16,612 12,560
========== ========= ========= ==========
Diluted net income (loss) per common and common
equivalent share.................................. $ 0.04 $ (0.04) $ (0.59) $ (0.60)
========== ========= ========= ==========
</TABLE>
Potentially dilutive common shares have been excluded from the
computation of diluted EPS for the three months ended June 30, 1999 and for the
nine months ended June 30, 2000 and 1999 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. Potentially dilutive common shares which were excluded from the
computation of diluted EPS consisted of options to purchase common stock
totaling 4,110,245 shares for the three and nine months ended June 30, 2000,
options to purchase common shares totaling 3,960,851 for the three and nine
months ended June 30, 1999, and warrants to purchase common stock totaling
60,000 shares for the nine months ended June 30, 2000 and the three and nine
months ended June 30, 1999.
6
<PAGE>
(6) Acquisitions
------------
WebOrder
On March 23, 2000, we acquired all the outstanding common and preferred
stock of WebOrder, a California corporation, in a merger transaction in which
WebOrder merged into WO Merger Corporation, our wholly owned subsidiary formed
in connection with the transaction. WebOrder was a developer of e-commerce
infrastructure for small and medium size businesses. WebOrder's Smart Commerce
System offers e-commerce solutions to on-line businesses including the ability
to manage order processing, and the ability to maintain records of customer
transactions flowing through a merchant's E-Store.
We accounted for the transaction under the purchase method. The
aggregate purchase price of the transaction was approximately $20.7 million,
based on the consideration we paid at closing. The final purchase price is
dependent on potential earnout payments as discussed below. The aggregate
purchase price includes:
. $1.6 million in cash paid on the closing date of the transaction;
. 233,119 shares of our common stock issued on the closing date;
. A series of potential earnout payments paid in cash and common
stock after the closing date if certain revenue milestones are
achieved. These earnout opportunities will be added to and
included in the purchase price for accounting purposes when it is
deemed probable that the earnouts will be paid;
. The substitution of stock options to purchase our common stock in
replacement of the WebOrder options held by WebOrder's former
employees, who joined Netopia after the closing, valued at
approximately $2.1 million. We used the Black-Scholes method to
value the options issued using the following assumptions:
volatility of 101%, expected life of 5 years, interest rate of
5.7%, and no dividends; and
. Transaction costs of approximately $975,000 which include legal
fees, accounting fees, and fees for other related professional
services.
Approximately 15,695 shares of our common stock will be held in escrow
for one year after the closing to satisfy WebOrder's indemnification
obligations.
The excess purchase price over the net book value of the assets
acquired was approximately $20.1 million. The transaction resulted in goodwill
and other intangible assets of approximately $17.1 million, which is being
amortized over four and three years, respectively and a charge for acquired in-
process research and development of approximately $3.0 million. During the three
and nine months ended June 30, 2000, we amortized $1.1 million and $1.2 million
in goodwill and other intangible assets related to the acquisition of WebOrder.
Both cost and income approaches were used to appraise the value of the
business and projects acquired. Such methods take into consideration replacement
costs of assets acquired, the stage of completion of the projects 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 our fiscal
first quarter of 2001. These cash flows were discounted using a weighted average
discount rate of 42%. Based upon the expenses incurred and the development time
invested in the products prior to the acquisition and the estimated expenses and
development time to complete the products, we determined the products purchased
in aggregate, including products under development and completed products, to be
approximately 82% complete at the time of acquisition. We expect to complete the
in-process research and development during our fiscal fourth quarter of 2000 and
we estimate the costs to complete the in-process research and development to be
approximately $50,000.
7
<PAGE>
All of WebOrder's former full time employees became employees of
Netopia. WebOrder's founder and one other key shareholder/employee entered into
non-competition agreements in connection with the acquisition.
The following summary, prepared on an unaudited pro forma basis,
reflects the condensed consolidated statements of operations for the three
months ended June 30, 2000 and 1999 assuming WebOrder had been acquired as of
the beginning of the periods presented (in thousands, except per share data):
<TABLE>
<CAPTION>
June 30, June 30,
2000 1999
---------------- ----------------
<S> <C> <C>
Revenues..................................................... $ 28,515 $ 12,260
Net income (loss)............................................ $ 656 ($1,836)
Basic income (loss) per share................................ $ 0.04 ($0.14)
Diluted income (loss) per shared............................. $ 0.04 ($0.14)
Weighted-average shares used in the basic pro forma per
share computation............................................ 17,239 13,140
Weighted-average shares used in the diluted pro forma per
share computation............................................ 17,239 13,140
</TABLE>
The above pro forma net loss figures for the three months ended June
30, 2000 and 1999 exclude the charge for acquired in-process research and
development and have been adjusted to include the amortization of goodwill and
other intangibles related to the WebOrder acquisition for each period.
The following summary, prepared on an unaudited pro forma basis,
reflects the condensed consolidated statements of operations for the nine months
ended June 30, 2000 and 1999 assuming WebOrder had been acquired as of the
beginning of the periods presented (in thousands, except per share data):
<TABLE>
<CAPTION>
June 30, June 30,
2000 1999
---------------- ----------------
<S> <C> <C>
Revenues................................................... $ 66,872 $ 30,777
Net loss................................................... ($12,829) ($11,297)
Basic and diluted loss per share........................... ($0.76) ($0.88)
Weighted-average shares used in pro forma per
share computation.......................................... 16,845 12,793
</TABLE>
The above pro forma net loss figures for the nine months ended June 30,
2000 and 1999 exclude the charge for acquired in-process research and
development and have been adjusted to include the amortization of goodwill and
other intangibles related to the WebOrder acquisition for each period.
The pro forma results are not necessarily indicative of what would have
occurred if the acquisitions had been in effect for the periods presented. In
addition, they are not intended to be a projection of future results and do not
reflect any synergies that might be achieved from combined operations.
8
<PAGE>
StarNet Technologies
On October 13, 1999, we acquired StarNet Technologies, Inc., (StarNet),
a California corporation, in a merger transaction in which StarNet merged into
our newly formed, wholly owned, subsidiary. StarNet had been developing a voice
channel technology architecture that allows the transmission of voice lines over
a digital subscriber line along with the simultaneous transmission of standard
data packets. We intend to integrate StarNet's technology into our existing
Internet equipment development and begin offering voice and data integrated
access devices. Any delay in the completion of the development of the products
would cause us to incur additional unplanned development expenses as well as the
loss or deferral of customer purchases, either of which could seriously harm our
business.
We accounted for the transaction under the purchase method. The
aggregate consideration constituting the purchase price was approximately $27.5
million at closing (which included $1.0 million of potential earnout payments
discussed below), and may increase by up to an additional $4.9 million depending
on the actual amount of potential earnout payments. The aggregate consideration
included:
. $8.4 million in cash paid on the closing date of the transaction;
. 447,852 shares of our common stock issued on the closing date;
. A series of potential cash earnout payments aggregating up to
approximately $5.9 million at various times after the closing date
if certain technical and revenue milestones are achieved. These
earnout opportunities will be included in the purchase price for
accounting purposes when it is deemed probable that the earnout
will be paid. At the acquisition date, we had deemed probable and
recorded approximately $1.0 million in earnout payments. During
our fiscal third quarter of 2000, we determined that the
milestones for the $1.0 million potential earnout payment would
not be met and accordingly, reduced the purchase price and
amortization of goodwill relating to the purchase of StarNet by
such amount.
. The substitution of stock options to purchase our common stock in
replacement of the StarNet options held by StarNet's former
employee, who joined Netopia after the closing, valued at
approximately $1.4 million. We used the Black-Scholes method to
value the options issued using the following assumptions:
volatility of 101%, expected life of 4 years, interest rate of
4.9%; and no dividends; and
. Transaction costs of approximately $820,000 which include legal
fees, accounting fees, fees paid for an independent fairness
opinion, and fees for other services.
Approximately 30,673 shares of common stock were held in escrow for a
period of time after the closing to satisfy StarNet's indemnification
obligations under the definitive acquisition agreements. During our fiscal third
quarter of 2000, a portion of these shares were released from the escrow to
Netopia to satisfy Netopia's indemnification claims, and the remaining shares
were released from escrow to StarNet's former shareholders.
The acquisition has been accounted for as a purchase and resulted in
goodwill and other intangible assets of approximately $22.4 million at closing
which is being amortized over four and three years, respectively and a charge
for acquired in-process research and development of $5.7 million. During the
three and nine months ended June 30, 2000, we amortized $1.7 million and $4.9
million, respectively, in goodwill and other intangible assets related to the
purchase of StarNet.
We 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 projects 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 were
expected to occur during our
9
<PAGE>
fiscal fourth quarter of 2000. These cash flows were discounted using a weighted
average discount rate of 20%. Based upon the expenses incurred and the
development time invested in the products prior to the acquisition and the
estimated expenses and development time to complete the products, we determined
the products purchased in aggregate, including products under development and
completed products, to be approximately 73% complete at the time of acquisition.
We expect to complete the in-process research and development in our first
fiscal quarter of 2001 and we estimate the cost to complete the in-process
research and development to be approximately $2.0 million.
All of StarNet's former full time employees became employees of
Netopia. Each of StarNet's founders, and certain other key employees, entered
into non-competition agreements in connection with the acquisition.
The following summary, prepared on an unaudited pro forma basis,
reflects the condensed consolidated statements of operations for the three
months ended June 30, 2000 and 1999 assuming StarNet had been acquired as of the
beginning of the periods presented (in thousands, except per share data):
<TABLE>
<CAPTION>
June 30, June 30,
2000 1999
--------------- ----------------
<S> <C> <C>
Revenues.......................................................... $ 28,515 $ 12,709
Net income (loss)................................................. $ 656 ($2,336)
Basic income (loss) per share..................................... $ 0.04 ($0.17)
Diluted income (loss) per shared.................................. $ 0.04 ($0.17)
Weighted-average shares used in the basic pro forma per share
computation....................................................... 17,239 13,355
Weighted-average shares used in the diluted pro forma per share
computation....................................................... 17,239 13,355
</TABLE>
The above pro forma net loss figures for the three months ended June
30, 2000 and 1999 exclude the charge for acquired in-process research and
development and have been adjusted to include the amortization of goodwill and
other intangibles related to the StarNet acquisition for each period.
The following summary, prepared on an unaudited pro forma basis,
reflects the condensed consolidated statements of operations for the nine months
ended June 30, 2000 and 1999 assuming StarNet had been acquired as of the
beginning of the periods presented (in thousands, except per share data):
<TABLE>
<CAPTION>
June 30, June 30,
2000 1999
---------------- ----------------
<S> <C> <C>
Revenues................................................. $66,603 $31,513
Net loss................................................. ($10,203) ($10,258)
Basic and diluted loss per share......................... ($0.60) ($0.79)
Weighted-average shares used in pro forma per
share computation........................................ 17,060 13,008
</TABLE>
The above pro forma net loss figures for the nine months ended June 30,
2000 and 1999 exclude the charge for acquired in-process research and
development and have been adjusted to include the amortization of goodwill and
other intangibles related to the StarNet acquisition for each period.
The pro forma results are not necessarily indicative of what would have
occurred if the acquisitions had been in effect for the periods presented. In
addition, they are not intended to be a projection of future results and do not
reflect any synergies that might be achieved from combined operations.
10
<PAGE>
(7) Discontinued Operations
-----------------------
On August 5, 1998, we sold our 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 consideration we received, in aggregate, for
the sale of the LAN Division totaled $4.9 million and consisted of cash, a note
receivable, royalties receivable and a warrant to purchase up to 3% of the
equity of Farallon. The disposition of our LAN Division in August 1998 has been
accounted for as a discontinued operation in accordance with APB Opinion No. 30,
and prior period consolidated financial statements have been restated to reflect
the LAN Division's operations as a discontinued operation.
The note receivable was for $1.0 million which was payable on July 31,
2000, bearing interest at 8% per annum. Farallon paid the note and related
interest receivable in its entirety on May 9, 2000.
During our fiscal third quarter of 2000, Farallon bought out its
royalty obligation in its entirety for an amount in excess of the receivable on
our balance sheet. In addition, we exercised our warrant in Farallon that we
received as consideration for the sale and sold the shares received upon
exercise of the warrant. These transactions resulted in income of $1.3 million,
net of taxes, and are included in income from discontinued operations for the
three months ended June 30, 2000.
(8) Geographic, Segment and Significant Customer Information
--------------------------------------------------------
We adopted the provisions of SFAS No. 131, Disclosure about Segments of
an Enterprise and Related Information, during fiscal year 1999. SFAS No. 131
establishes standards for the reporting by public business enterprises of
information about operating segments, products and services, geographic areas,
and major customers. The methodology for determining what information is
reported is based on the organization of operating segments and the related
information that our Chief Operating Decision Maker (CODM) uses for operational
decisions and assessing financial performance. Our Chief Executive Officer (CEO)
is considered our CODM. For purposes of making operating decisions and assessing
financial performance, our CEO reviews financial information presented on a
consolidated basis accompanied by disaggregated information for revenues and
gross margins by product group as well as revenues by geographic region and by
customer. Currently, operating expenses or assets are not disaggregated by
product group for purposes of making operating decisions and assessing financial
performance.
We generate revenue from three groups of products and services.
Disaggregated financial information regarding our three operating segments for
the three months ended June 30, 2000 and 1999 is as follows:
<TABLE>
<CAPTION>
----------------------------------
Web Platform Licenses And Services
-------------- --------------- -------------- ------------------
Internet E-commerce Timbuktu
Equipment Products Products Total Products
-------------- --------------- -------------- ------------------
Three months ended June 30, 2000
---------------------------------
<S> <C> <C> <C> <C>
Revenues........................... $ 22,134 $ 2,410 $ 3,971 $ 28,515
Cost of revenues................... 15,461 104 118 15,683
-------------- --------------- -------------- ------------------
Gross profit....................... 6,673 2,306 3,853 12,832
Unallocated operating expenses 14,453
------------------
Operating loss................. (1,621)
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
----------------------------------
Web Platform Licenses And Services
-------------- --------------- -------------- ------------------
Internet E-commerce Timbuktu
Equipment Products Products Total Products
-------------- --------------- -------------- ------------------
Three months ended June 30, 1999
------------------------------------
<S> <C> <C> <C> <C>
Revenues........................... $ 7,109 $ 1,151 $ 3,960 $ 12,220
Cost of revenues................... 4,502 1 167 4,670
-------------- --------------- -------------- ------------------
Gross profit....................... 2,607 1,150 3,793 7,550
Unallocated operating expenses 8,474
------------------
Operating loss................. (924)
</TABLE>
Disaggregated financial information regarding our three operating
segments for the nine months ended June 30, 2000 and 1999 is as follows:
<TABLE>
<CAPTION>
----------------------------------
Web Platform Licenses And Services
-------------- --------------- -------------- ------------------
Internet E-commerce Timbuktu
Equipment Products Products Total Products
-------------- --------------- -------------- ------------------
Nine months ended June 30, 2000
------------------------------------
<S> <C> <C> <C> <C>
Revenues........................... $ 48,633 $ 6,595 $ 11,375 $ 66,603
Cost of revenues................... 33,949 116 352 34,417
-------------- --------------- -------------- ------------------
Gross profit....................... 14,684 6,479 11,023 32,186
Unallocated operating expenses 47,211
------------------
Operating loss................. (15,025)
</TABLE>
<TABLE>
<CAPTION>
----------------------------------
Web Platform Licenses And Services
-------------- --------------- -------------- ------------------
Internet E-commerce Timbuktu
Equipment Products Products Total Products
-------------- --------------- -------------- ------------------
Nine months ended June 30, 1999
------------------------------------
<S> <C> <C> <C> <C>
Revenues........................... $ 16,730 $ 2,486 $ 11,462 $ 30,678
Cost of revenues................... 10,600 10 510 11,120
-------------- --------------- -------------- ------------------
Gross profit....................... 6,130 2,476 10,952 19,558
Unallocated operating expenses 28,461
------------------
Operating loss................. (8,903)
</TABLE>
We sell our products and provide services worldwide through
telecommunication service providers, Internet service providers (ISPs),
independent distributors, value-added resellers and directly to end users. We
currently operate in five regions: United States, Europe, Asia/Pacific, Canada,
and Latin America. Revenues outside of the United States are primarily export
sales and have historically been denominated in United States dollars. Beginning
in our fiscal third quarter of 2000, international sales to members of the
European Union are being denominated in the Euro.
12
<PAGE>
Disaggregated financial information regarding our products and services
and revenues by geographic region is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
------------------------- -------------------------
2000 1999 2000 1999
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
United States...................................... $ 23,646 $ 9,021 $ 53,947 $ 21,559
Europe............................................. 4,197 2,518 10,605 7,352
Asia/Pacific....................................... 127 328 647 841
Canada............................................. 494 336 1,179 852
Latin America...................................... 51 17 225 74
------------ ------------ ----------- ------------
Total revenues............................... $ 28,515 $ 12,220 $ 66,603 $ 30,678
============ ============ =========== ============
</TABLE>
13
<PAGE>
We do not have material operating assets outside of the United States.
During the three months ended June 30, 2000:
. Covad Communications, a competitive local exchange carrier (CLEC),
accounted for 24% of our total revenues and 28% of our total
accounts receivable at June 30, 2000. All revenues derived from
this customer were related to sales of our Internet equipment; and
. Northpoint Communications, a CLEC, accounted for 10% of our total
revenues and 10% of our total accounts receivable. All revenues
derived from this customer were related to sales of our Internet
equipment.
No other customers during the three months ended June 30, 2000
accounted for 10% or more of our total revenues.
During the three months ended June 30, 1999, Ingram Micro, a worldwide
distributor of computer technology products and services, accounted for 10% of
our total revenues and 13% of our total accounts receivable. Of our total sales
to Ingram Micro, approximately 67% related to sales of our Internet equipment
and 33% related to sales of our web platform products.
During the nine months ended June 30, 2000:
. Covad Communications, a CLEC, accounted for 17% of our total
revenues and 28% of our total accounts receivable at June 30,
2000. All revenues derived from this customer were related to
sales of our Internet equipment; and
. Northpoint Communications, a CLEC, accounted for 12% of our total
revenues and 10% of our total accounts receivable at June 30,
2000. All revenues derived from this customer were related to
sales of our Internet equipment.
No other customers during the nine months ended June 30, 2000 accounted
for 10% or more of our total revenues.
During the nine months ended June 30, 1999, Ingram Micro, accounted for
10% of our total revenues and 13% of our total accounts receivable at June 30,
1999. Of our total sales to Ingram Micro, approximately 61% related to sales of
our Internet equipment and 39% related to sales of our Web platform products.
14
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations
-------------
Some of the information in this Form 10-Q contains forward-looking
statements that involve substantial risks and uncertainties. You can identify
these statements by forward-looking words such as "may," "will," "expect,"
"anticipate," "believe," "estimate" and "continue" or similar words. You should
read statements that contain these words carefully because they: (i) discuss our
expectations about our future performance; (ii) contain projections of our
future operating results or of our future financial condition; or (iii) state
other "forward-looking" information. We believe it is important to communicate
our expectations to our investors. There may be events in the future, however,
that we are not accurately able to predict or over which we have no control. The
risk factors listed in this Form 10-Q, as well as any cautionary language in
this Form 10-Q, provide examples of risks, uncertainties and events that may
cause our actual results to differ materially from the expectations we described
in our forward-looking statements. You should be aware that the occurrence of
any of the risks, uncertainties, or events described in this Form 10-Q could
seriously harm our business and that upon the occurrence of any of these events,
the trading price of our common stock could decline.
Overview
We develop, market and support Internet and electronic commerce
infrastructure for small and medium size businesses. Our digital subscriber line
(DSL) equipment and e-commerce Web platforms enable businesses to connect easily
and cost-effectively to the Internet, establish and enhance their Internet
presence, and conduct business and electronic commerce on the Web.
Our revenues are derived from the sale of hardware and software products.
Our hardware revenues primarily include sales of our DSL Internet routers as
well as sales of our integrated services digital network (ISDN) Internet
routers, ISDN integrated access devices (IADs), T1/frame relay Internet
routers and analog Internet routers. Our software revenues include license
revenues of our e-commerce Web platform and Timbuktu Pro software, recurring
revenues from our e-commerce Web platform, and fees for related services. We
recognize revenue from the sale of our hardware products upon shipment. We
recognize 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. We recognize maintenance and service
revenues over the period in which the services are provided. Certain of our
sales are made to customers under agreements permitting limited rights of return
for stock balancing or with protection for future price decreases. We record
revenue net of an estimated allowance for returns and price protection. Any
product returns or price decreases in the future that exceed our allowances may
seriously harm our business.
We sell our products and related maintenance, support and other services
through telecommunication service providers, Internet service providers (ISPs),
independent distributors, value-added resellers (VARs) and directly to end
users.
During the three months ended June 30, 2000:
. Our five largest customers, who each individually represented at least
5% of our total revenues, accounted for 54% of our total revenues; and
. Covad Communications, a competitive local exchange carrier (CLEC),
accounted for 24% of our total revenues. Northpoint Communications,
another CLEC, accounted for 10% of our total revenues. No other
customer during the three months ended June 30, 2000 accounted for 10%
or more of our total revenues.
15
<PAGE>
During the three months ended June 30, 1999:
. Our three largest customers, who each individually represented at
least 4% of our total revenues, accounted for 23% of our total
revenues; and
. Ingram Micro, a worldwide distributor of computer technology products
and services, accounted for 10% of our total revenues. No other
customers during the three months ended June 30, 1999 accounted for
10% or more of our total revenues.
During the nine months ended June 30, 2000:
. Our six largest customers, who each individually represented at least
5% of our total revenues, accounted for 51% of our total revenues; and
. Covad Communications, a CLEC, accounted for 17% of our total revenues.
Northpoint Communications, another CLEC, accounted for 12% of our
total revenues. No other customers during the nine months ended June
30, 2000 accounted for 10% or more of our total revenues.
During the nine months ended June 30, 1999:
. Our three largest customers, who each individually represented at
least 5% of our total revenues, accounted for 21% of our total
revenues; and
. Ingram Micro, a worldwide distributor of computer technology products
and services, accounted for 10% of our revenues. No other customers
during the nine months ended June 30, 1999 accounted for 10% or more
of our total revenues.
We do not have purchase contracts with any of our customers that obligate
them to continue to purchase our products. These customers could cease
purchasing our products at any time, which could seriously harm our business.
Historically, a significant portion of our revenues has been derived from
customers outside of the United States, and we expect this trend to continue.
For the three months ended June 30, 2000 and 1999, international revenues
accounted for 17% and 26% of our total revenues, respectively. For the nine
months ended June 30, 2000 and 1999, international revenues accounted for 19%
and 30% of our total revenues, respectively.
Our international revenues have historically been denominated in United
States dollars, and revenues generated by our international distributors have
historically been paid to us in United States dollars. Beginning in our fiscal
third quarter of 2000, international sales to customers located in countries
that are members of the European Union are being denominated in the Euro.
We provide end users of our products with a one-year limited warranty on
our Internet equipment and a 90-day limited warranty on single-user versions of
our Timbuktu Pro software. We permit end users to return our Internet equipment
and Timbuktu Pro for replacements or for refund of the full purchase price if
the products do not perform as warranted. Our e-commerce products are provided
on an "as is" basis, and we generally do not offer a warranty on these products.
End users of our Web platform are offered a free 30-day evaluation period to
evaluate the product prior to purchase and thereafter can discontinue their
service at any time at no cost. In the past, we have not encountered material
warranty claims. In the future, if warranty claims exceed our reserves for such
claims, our business would be seriously harmed. Additionally, we attempt to
further limit our liability to end users through disclaimers of special,
consequential and indirect damages and similar provisions. However, we cannot
assure you that such limitations of liability will be legally enforceable.
16
<PAGE>
Results of Operations for the Three Months Ended June 30, 2000 and 1999
The following table sets forth for the periods indicated, certain statement
of operations data expressed as a percentage of revenues.
<TABLE>
<CAPTION>
Three months ended
June 30,
----------------------------
2000 1999
------------- -------------
<S> <C> <C>
Revenues:
Internet equipment............................................. 77.6% 58.2%
Web platform licenses and services............................. 22.4% 41.8%
------------ -------------
100.0% 100.0%
Cost of revenues:
Internet equipment............................................. 54.2% 36.8%
Web platform licenses and services............................. 0.8% 1.4%
------------- -------------
55.8% 38.2%
------------- -------------
Gross profit................................................... 45.0% 61.8%
Operating expenses:
Research and development....................................... 12.3% 19.0%
Selling and marketing.......................................... 24.1% 41.4%
General and administrative..................................... 3.8% 7.5%
Acquired in-process research
and development............................................ -- --
Amortization of goodwill and other intangible assets........... 10.5% 1.5%
------------- -------------
Total operating expenses.................................... 50.7% 69.4%
------------- -------------
Operating loss.............................................. (5.7%) (7.6%)
Other income, net................................................. 3.3% 3.3%
------------- -------------
Loss from continuing operations
before income taxes......................................... (2.4%) (4.3%)
Income tax provision.............................................. -- --
------------- -------------
Loss from continuing operations................................ (2.4%) (4.3%)
Income from discontinued operations, net of taxes................. 4.7% --
------------- -------------
Net income (loss)........................................... 2.3% (4.3%)
============= =============
</TABLE>
Revenue. Our revenues increased 133.3% to $28.5 million in the three months
ended June 30, 2000 from $12.2 million in the three months ended June 30, 1999.
The increase in the three months ended June 30, 2000 was primarily due to
increased sales in North America of our digital subscriber line (DSL) Internet
equipment, most notably sales to CLECs such as Covad Communications, Northpoint
Communications, Jato Communications, and Rhythms Netconnctions who distribute
our products to end users.
These increases were partially offset by declining average selling prices
of our Internet equipment as a result of price competition and larger volume DSL
contracts.
17
<PAGE>
International revenues increased 53.1% to $4.9 million in the three months
ended June 30, 2000 from $3.2 million in the three months ended June 30, 1999.
International revenues increased primarily due to sales of our DSL Internet
equipment and ISDN integrated access devices (IADs) which were not available
during the three months ended June 30, 1999. International revenues accounted
for 16% and 26% of our total revenues for the three months ended June 30, 2000
and 1999, respectively. International revenues declined as a percentage of total
revenues primarily due to increasing sales of our DSL Internet equipment and Web
platform products 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.
Three months ended June 30,
--------------------------------
2000 1999
-----------------------------------------------------------------------
Europe............................. 15% 21%
Pacific Rim........................ -- 3
Canada and Other................... 2 2
--------------------------------
Subtotal international revenues.. 17 26
United States...................... 83 74
--------------------------------
Total revenues................. 100% 100%
================================
Although international revenues decreased as a percentage of total revenue
in the three months ended June 30, 2000, a substantial portion of our revenues
were derived from sales to international customers, and we expect sales to
international customers to increase in absolute dollars on an annual basis.
Gross Margin. Our total gross margin decreased to 45.0% in the three months
ended June 30, 2000 from 61.8% in the three months ended June 30, 1999. The
decrease was primarily due to:
. Increased sales of our Internet equipment, particularly our DSL
Internet routers, which have a lower gross margin than our Web
platform products;
. Increased costs of flash memory chips, capacitors and other components
used in our DSL Internet routers due to industry-wide shortages; and
. Declining average selling prices of our Internet equipment as a result
of price competition and larger volume DSL contracts.
These decreases were partially offset by:
. Increased sales of our e-commerce products which have a higher gross
margin than our Internet equipment; and
. Declining average costs of our Internet equipment.
In the past, our gross margin has varied significantly and will likely
vary significantly in the future. Our gross margins depend primarily on:
. The mix of hardware and software products sold;
. Pricing strategies;
. Standard cost changes;
. New versions of existing products; and
. External market factors, including, but not limited to, price
competition.
18
<PAGE>
Our Web platform products have a higher average gross margin than our
Internet equipment. Accordingly, to the extent we sell more Internet equipment
than Web platform products, our gross margins would be lower.
Research and Development. Our research and development expenses increased
50.4% to $3.5 million for the three months ended June 30, 2000 from $2.3 million
for the three months ended June 30, 1999. Research and development expenses
increased primarily due to increased headcount and employee related expenses,
increased development expenses related to our DSL Internet equipment as we
continue to expand our DSL product line and capabilities, and our acquisitions
of WebOrder in March 2000 and StarNet in October 1999 whose operations were not
included in our research and development expenses for the three months ended
June 30, 1999.
We expect to continue to devote substantial resources to product and
technological development. We expect research and development costs may increase
in absolute dollars for the remainder of fiscal 2000 and into fiscal 2001 as we
continue to expand the breadth and depth of our product offerings. We believe
our process for developing software is essentially completed concurrently with
the establishment of technological feasibility, and we have not capitalized any
internal software development costs to date. However, during the three months
ended June 30, 2000, we capitalized $168,000 of product development costs
incurred subsequent to the delivery of a working model, under a development
agreement with third parties.
Selling and Marketing. Our selling and marketing expenses increased 36.1%
to $6.9 million for the three months ended June 30, 2000 from $5.1 million for
the three months ended June 30, 1999. Selling and marketing expenses increased
primarily due to:
. Increased headcount and other employee related expenses to support the
increase in sales of our DSL and e-commerce products;
. Increased commission costs in line with higher revenue levels; and
. Increased travel and promotional costs related to developing and
supporting our sales and marketing channel.
These expenses were partially offset by reduced use of external
marketing professional services.
We believe that our selling and marketing expenses will increase in
absolute dollars for the remainder of fiscal year 2000 and into fiscal 2001 as a
result of:
. Our acquisitions of StarNet and WebOrder;
. Increased advertising and promotional campaigns related to our e-
commerce Web platform as well as our DSL Internet equipment; and
. Continued expansion of our sales staff domestically and
internationally.
General and Administrative. Our general and administrative expenses
increased 17.3% to $1.1 million for the three months ended June 30, 2000 from
$908,000 for the three months ended June 30, 1999. General and administrative
expenses increased primarily due to:
. Increased headcount and other employee related expenses;
. Increased use of third party contractors and temporary employee
services; and
. Increased occupancy costs related to our Alameda facility.
19
<PAGE>
Amortization of Goodwill and Other Intangible Assets. For the three months
ended June 30, 2000, amortization of goodwill and other intangible assets
represents the amortization of such amounts allocated to goodwill and other
intangible assets related to our acquisitions of Serus, netOctopus, StarNet and
WebOrder.
The amounts allocated to goodwill and other intangible assets in connection
with our acquisition of WebOrder was $17.1 million. We are amortizing the
goodwill and other intangible assets over four and three years, respectively.
For the three months ended June 30, 2000, we amortized $1.1 million in goodwill
and other intangible assets related to our acquisition of WebOrder. The amount
allocated to goodwill and other intangible assets in connection with our
acquisition of StarNet was $22.4 million. We are amortizing the goodwill and
other intangible assets over four and three years, respectively. For the three
months ended June 30, 2000, we amortized $1.7 million in goodwill and other
intangible assets related to our acquisition of StarNet. The amount allocated to
goodwill and other intangible assets in connection with our acquisition of Serus
was $2.1 million. We are amortizing the goodwill and other intangible assets
over four years. For the three months ended June 30, 2000 and 1999, we amortized
$134,000 and $133,000, respectively, in goodwill and other intangible assets
related to our acquisition of Serus. The amount allocated to goodwill and other
intangible assets in connection with our acquisition of netOctopus was $700,000.
We are amortizing the goodwill and other intangible assets over four years. For
the three months ended June 30, 2000 and 1999, we amortized $56,000 and $48,000,
respectively in goodwill and other intangible assets related to our acquisition
of netOctopus.
Other Income, Net. Other income, net, primarily represents interest we earn
on our cash, cash equivalents and short-term investments in addition to both
realized and unrealized gains and losses on foreign currency transactions. Other
income, net, increased 136.9% to $943,000 for the three months ended June 30,
2000 from $398,000 for the three months ended June 30, 1999. The increase was
due to the higher cash, cash equivalents and short-term investment balances on
hand primarily from the cash we raised through our secondary offering in August
1999.
Income Tax Provision. We did not record an income tax provision during the
three months ended June 30, 2000 or 1999 primarily due to continued substantial
uncertainty regarding our ability to realize our tax assets. We may begin
recording a provision for income taxes in our fiscal 2001 year. Based upon
available objective evidence, there has been sufficient uncertainty regarding
the realizability of our deferred tax assets to warrant a valuation allowance in
our financial statements. The factors considered included prior losses,
inconsistent profits, and lack of carryback potential to realize our deferred
tax assets. Based on our economic outlook for the remainder of fiscal year 2000,
and fiscal years 2001 and beyond, we believe the uncertainty regarding the
realizability of our deferred tax assets may diminish to the point where it is
more likely than not that our deferred tax assets will be realized. At such
point, we would also reverse all or a portion of our valuation allowance which
will result in a non-recurring income tax benefit.
Discontinued Operations. On August 5, 1998, we sold our Farallon Local Area
Networking (LAN) Division (the LAN Division). The consideration we received, in
aggregate, for the sale of the LAN Division totaled $4.9 million and consisted
of cash, a note receivable, royalties receivable and a warrant to purchase up to
3% of the equity of Farallon. Income from discontinued operations, net of taxes,
was $1.3 million for the three months ended June 30, 2000. Farallon bought out
its royalty obligation for an amount in excess of the receivable on our balance
sheet. In addition, we exercised and sold our warrant in Farallon that we
received as consideration for the sale in August 1998, and sold the shares
received upon exercise of the warrant. Each item generated income from
discontinued operations during our fiscal third quarter of 2000. (See Note 7 of
"Notes To Consolidated Financial Statements").
20
<PAGE>
Results of Operations for the Nine Months Ended June 30, 2000 and 1999
The following table sets forth for the periods indicated, certain statement
of operations data expressed as a percentage of revenues.
Nine months ended
June 30,
-----------------------
2000 1999
--------- ----------
Revenues:
Internet equipment........................... 73.0% 54.5%
Web platform licenses and services........... 27.0% 45.5%
--------- ----------
100.0% 100.0%
Cost of revenues:
Internet equipment........................... 51.0% 34.6%
Web platform licenses and services........... 0.7% 1.7%
--------- ----------
51.7% 36.2%
--------- ----------
Gross profit................................. 48.3% 63.8%
Operating expenses:
Research and development..................... 14.5% 21.7%
Selling and marketing........................ 28.2% 47.8%
General and administrative................... 5.1% 8.4%
Acquired in-process research
and development............................ 13.0% 13.7%
Amortization of goodwill and other intangible
assets..................................... 10.1% 1.2%
--------- ----------
Total operating expenses.............. 70.9% 92.8%
--------- ----------
Operating loss........................ (22.6%) (29.0%)
Other income, net............................... 4.0% 4.6%
--------- ----------
Loss from continuing operations
before income taxes................... (18.6%) (24.4%)
Income tax provision (benefit)................. -- --
--------- ----------
Loss from continuing operations.............. (18.6%) (24.4%)
Income from discontinued operations, net of
taxes................................. 3.7% --
--------- ----------
Net loss.............................. (14.8%) (24.4%)
========= ==========
Revenue. Our revenues increased 117.1% to $66.6 million in the nine months
ended June 30, 2000 from $30.7 million in the nine months ended June 30, 1999.
The increase in the nine months ended June 30, 2000 was primarily due to:
. Increased sales in North America of our digital subscriber line (DSL)
Internet equipment, most notably, sales to CLECs such as Covad
Communications, Northpoint Communications, Jato Communications, and
Rhythms Netconnections who distribute our products to end users.
. Increased license sales of our e-commerce products.
These increases were partially offset by decreased sales of our
integrated services digital network (ISDN) and analog Internet routers in North
America as demand for DSL products increased, and decreased sales of Timbuktu
Pro for the Macintosh products.
21
<PAGE>
International revenues increased 38.8% to $12.7 million in the nine months
ended June 30, 2000 from $9.1 million in the nine months ended June 30, 1999.
International revenues increased primarily due to sales of our DSL Internet
equipment which were not available during the nine months ended June 30, 1999,
the introduction of our ISDN integrated access devices (IADs), as well as
increased license sales of our e-commerce products. International revenues
accounted for 19% and 30% of our total revenues for the nine months ended June
30, 2000 and 1999, respectively. International revenues declined as a percentage
of total revenues primarily due to increasing sales of our DSL Internet
equipment and Web platform products 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.
Nine months ended June 30,
---------------------------------
2000 1999
--------------------------------------------------------------------------
Europe............................... 16% 24%
Pacific Rim.......................... 1 3
Canada and Other..................... 2 3
---------------------------------
Subtotal international revenues.... 19 30
United States........................ 81 70
Total revenues................... 100% 100%
=================================
Although international revenues as a percentage of total revenue decreased
in the nine months ended June 30, 2000, a substantial portion of our revenues
were derived from sales to international customers, and we expect sales to
international customers to increase in absolute dollars on an annual basis.
Gross Margin. Our total gross margin decreased to 48.3% in the nine months
ended June 30, 2000 from 63.8% in the nine months ended June 30, 1999. The
decrease was primarily due to:
. Increased sales of our Internet equipment, particularly our DSL
routers, which have a lower gross margin than our Web platform
products; and
. Increased costs of flash memory chips, capacitors and other components
used in our DSL routers.
These decreases were partially offset by:
. Increased volume license sales of our Web platform products; and
. Declining average costs of our Internet equipment.
In the past, our gross margin has varied significantly and will likely
vary significantly in the future.
Our gross margins depend primarily on:
. The mix of hardware and software products sold;
. Pricing strategies;
. Standard cost changes;
. New versions of existing products; and
. External market factors, including, but not limited to, price
competition.
22
<PAGE>
Our Web platform products have a higher average gross margin than our
Internet equipment. Accordingly, to the extent we sell more Internet equipment
than Web platform products, our total gross margins would be lower.
Research and Development. Our research and development expenses increased
44.8% to $9.6 million for the nine months ended June 30, 2000 from $6.7 million
for the nine months ended June 30, 1999. Research and development expenses
increased primarily due to increased headcount and employee related expenses,
increased development expenses related to our DSL Internet equipment, and our
acquisitions of Serus and netOctopus in December 1998, StarNet in October 1999,
and WebOrder in March 2000.
We expect to continue to devote substantial resources to product and
technological development. We expect research and development costs may increase
in absolute dollars for the remainder of fiscal 2000 and into fiscal 2001 as we
continue to expand the breadth and depth of our product offerings. We believe
our process for developing software is essentially completed concurrently with
the establishment of technological feasibility, and we have not capitalized any
internal software development costs to date. However, during the nine months
ended June 30, 2000, we capitalized $532,000 of product development costs
incurred subsequent to the delivery of a working model, under a development
agreement with third parties.
Selling and Marketing. Our selling and marketing expenses increased 28.4%
to $18.8 million for the nine months ended June 30, 2000 from $14.6 million for
the nine months ended June 30, 1999. Selling and marketing expenses increased
primarily due to:
. Increased headcount and other employee related expenses, including
commissions;
. Increased travel costs related to developing our sales and marketing
channels; and
. Increased participation in trade shows and promotional expenses
related to developing our sales and marketing channels.
These expenses were partially offset by reduced advertising placement
fees.
We believe that our selling and marketing expenses will increase in
absolute dollars for the remainder of fiscal year 2000 and into fiscal 2001 as a
result of:
. Our acquisitions of StarNet and WebOrder;
. Increased advertising and promotional campaigns related to our e-
commerce Web platform as well as our DSL Internet equipment; and
. Continued expansion of our sales staff domestically and
internationally.
General and Administrative. Our general and administrative expenses
increased 29.7% to $3.4 million for the nine months ended June 30, 2000 from
$2.6 million for the nine months ended June 30, 1999. General and administrative
expenses increased primarily due to:
. Increased employee related expenses;
. Increased use of third party contractors and temporary employee
services;
. Increased occupancy costs related to our Alameda facility; and
. An increase in bad debt expense in line with our increase in revenue.
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Acquired In-Process Research and Development. Based upon independent third
party valuation analysis of our acquisitions of WebOrder and StarNet, we
allocated one-time charges of approximately $3.0 million and $5.7 million,
respectively, of the purchase prices to acquired in-process research and
development for the nine months ended June 30, 2000. (See Note 6 of "Notes To
Condensed Consolidated Financial Statements").
We believe we followed recent guidance disseminated by the SEC in our
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 we did not properly value such assets and liabilities, we
may have to restate the charges to operations taken in connection with such
transactions.
Amortization of Goodwill and Other Intangible Assets. For the nine months
ended June 30, 2000, amortization of goodwill and other intangible assets
represents the amortization of such amounts allocated to goodwill and other
intangible assets related to our acquisitions of Serus, netOctopus, StarNet and
WebOrder.
The amounts allocated to goodwill and other intangible assets in connection
with our acquisition of WebOrder was $17.1 million. We are amortizing the
goodwill and other intangible assets over four and three years, respectively.
For the nine months ended June 30, 2000, we amortized $1.2 million in goodwill
and other intangible assets related to our acquisition of WebOrder. The amount
allocated to goodwill and other intangible assets in connection with our
acquisition of StarNet was $22.4 million. We are amortizing the goodwill and
other intangible assets over four and three years, respectively. For the nine
months ended June 30, 2000, we amortized $4.9 million in goodwill and other
intangible assets related to our acquisition of StarNet. The amount allocated to
goodwill and other intangible assets in connection with our acquisition of Serus
was $2.1 million. We are amortizing the goodwill and other intangible assets
over four years. For the nine months ended June 30, 2000 and 1999, we amortized
$400,000 and $266,000, respectively, in goodwill and other intangible assets
related to our acquisition of Serus. The amount allocated to goodwill and other
intangible assets in connection with our acquisition of netOctopus was $700,000.
We are amortizing the goodwill and other intangible assets over four years. For
the nine months ended June 30, 2000 and 1999, we amortized $169,000 and $96,000,
respectively, in goodwill and other intangible assets related to our acquisition
of netOctopus.
Other Income, Net. Other income, net, primarily represents interest we earn
on our cash, cash equivalents and short-term investments in addition to both
realized and unrealized gains and losses on foreign currency transactions. Other
income, net, increased 90.5% to $2.7 million for the nine months ended June 30,
2000 from $1.4 million for the nine months ended June 30, 1999. The increase was
due to the higher cash, cash equivalents and short-term investment balances on
hand primarily from the cash we raised through our secondary offering in August
1999.
Income Tax Provision. We did not record an income tax provision during the
nine months ended June 30, 2000 or 1999 primarily due to continued substantial
uncertainty regarding our ability to realize our tax assets. We may begin
recording a provision for income taxes in our fiscal 2001 year. Based upon
available objective evidence, there has been sufficient uncertainty regarding
the realizability of our deferred tax assets to warrant a valuation allowance in
our financial statements. The factors considered included prior losses,
inconsistent profits, and lack of carryback potential to realize our deferred
tax assets. Based on our economic outlook for the remainder of fiscal 2000, and
fiscal years 2001 and beyond, we believe the uncertainty regarding the
realizability of our deferred tax assets may diminish to the point where it is
more likely than not that our deferred tax assets will be realized. At such
point, we would also reverse all or a portion of our valuation allowance which
will result in a non-recurring income tax benefit.
Discontinued Operations. On August 5, 1998, we sold our Farallon Local Area
Networking (LAN) Division (the LAN Division). The consideration we received, in
aggregate, for the sale of the LAN Division totaled $4.9 million and consisted
of cash, a note receivable, royalties receivable and a warrant to purchase up to
5% of the equity of Farallon. Income from discontinued operations, net of taxes,
was $2.5 million for the nine months ended June 30, 2000. Farallon bought out
its royalty obligation for an amount
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in excess of the receivable on our balance sheet. In addition, we exercised and
sold our warrant in Farallon that we received as consideration for the sale in
August 1998. Each item generated income from discontinued operations during our
fiscal third quarter of 2000. In addition, income from discontinued operations
also represents the reversal of a liability we recorded for the excess space
created at our Alameda, California headquarters that we believed could not be
subleased to third parties at the time of sale. During the three months ended
December 31, 1999, we found alternative uses for this excess space. (See Note 7
of "Notes To Consolidated Financial Statements").
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Other Factors That You Need To Be Aware Of Which May Affect Our Future Operating
Results
We have a history of losses and negative cash flow. We may incur losses and
negative cash flow in the future.
Our failure to significantly increase our revenues would result in
continuing losses. We incurred losses from continuing operations of $678,000 and
$526,000 for the three months ended June 30, 2000 and 1999, respectively. Our
net income was $656,000 and our net loss was $526,000 for the three months ended
June 30, 2000 and 1999. Even if we do maintain profitability and positive cash
flow, we may not be able to sustain or increase profitability or cash flow on a
quarterly or annual basis.
We may incur negative cash flow in the future particularly to the extent we
complete any acquisition opportunities. As a result of continuing substantial
capital expenditures and product development, sales, marketing and
administrative expenses, we will need to generate significant revenues to
achieve positive cash flow.
Our quarterly operating results are likely to fluctuate because of many
factors and may cause our stock price to fluctuate.
Our revenues and operating results have varied in the past and are likely
to vary in the future from quarter to quarter. As a result, we believe that
period-to-period comparisons of our operating results are not necessarily
meaningful. Investors should not rely on the results of any one quarter or
series of quarters as an indication of our future performance.
It is likely that in some future quarter or quarters our operating results
will be below the expectations of securities analysts or investors. In such
event, the market price of our common stock may decline significantly.
These variations in our operating results will likely be caused by
factors related to the operation of our business, including:
. Variations in the timing and size of orders for our Internet equipment;
. Decreases or delays in purchases by significant customers, or loss of such
customers such as Covad Communications, Northpoint Communications, Rhythms
Netconnections, Ingram Micro and Jato Communications.
. Our ability to license, and the timing of licenses, of our business
products, particularly our e-commerce Web platform and Timbuktu Pro
products;
. The growth rate in the number of Web sites and E-Stores that are built
using our e-commerce products from which we derive revenues;
. The mix of products and services and the gross margins associated with such
products and services, including the impact of our increased sales of lower
margin Internet equipment as a percentage of our total revenues;
. The price and availability of chip sets, which we obtain from Conexant
Systems, for our DSL Internet equipment;
. The timing and size of expenses, including operating expenses and expenses
of developing new products and product enhancements; and
. Our ability to attract and retain key personnel.
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These variations may also be caused by factors related to the development
of the DSL market, the market for our Web platform products and the competition
we face in these markets, including:
. The timing and rate of deployment of DSL services by telecommunications
service providers;
. Anticipated price and promotion competition in the market for Internet
equipment and Web platform products;
. The level of market penetration of our Internet equipment and Web platform
products relative to those of our competitors;
. The timing and rate of deployment of alternative high-speed data
transmission technologies, such as cable modems and high-speed wireless
data transmission; and
. Anticipated increases in competition among producers of e-commerce
products, including the impact of products that are available from some of
our competitors at no cost.
These variations may also be caused by other factors affecting our
business, many of which are substantially outside of the control of our
management, including:
. Costs associated with future litigation, including litigation relating to
the use or ownership of intellectual property;
. Acquisition costs or other non-recurring charges in connection with the
acquisition of companies, products or technologies;
. Foreign currency and exchange rate fluctuations which may make our dollar-
denominated products more expensive in those foreign markets where we sell
our products in U.S. dollars or could expose us to currency rate
fluctuation risks to the extent we do not adequately hedge these foreign
currency sales; and
. General global economic conditions which could adversely affect sales to
our customers.
We may not be able to compete successfully against current and future
competitors.
We sell products and services in markets that are highly competitive. We
expect competition to intensify as current competitors expand their product and
service offerings and new competitors enter the market. Increased competition is
likely to result in price reductions, reduced gross margins and loss of market
share, any one of which could seriously harm our business. Competitors vary in
size, scope and breadth of the products and services offered.
In the DSL router market, we primarily encounter competition from 3Com,
Cayman Systems, Cisco Systems, Efficient Networks (FlowPoint), Ramp Networks and
several other companies. In addition to these competitors, there have been a
growing number of announcements by other companies that they intend to enter the
DSL router market. Further, some competitors offer low-cost or no-cost support
programs that are similar to our "Up & Running, Guaranteed!" program.
In the market for Web sites and electronic commerce platforms, we encounter
competition primarily from Homestead Technologies, IBM, Inc. Online, Site
Architects, NetObjects, Verio, Yahoo!Geocities, Website Pros, BigStep.com and
several other companies. In the market for our remote control and enterprise
software, we primarily encounter competition from Computer Associates, Intel,
Microcom (Compaq), Microsoft, Vector Networks, Stac Software, Symantec, Tivoli
Systems (IBM) and several other companies. We anticipate intense competition
from some of these companies because some of these competitors provide their
products to consumers at no cost. For example, Microsoft has available at no
cost a communications and collaboration software product that could limit the
market for Timbuktu Pro.
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Many of our current and potential competitors in all three product areas
have longer operating histories, significantly greater financial, technical,
marketing and other resources, significantly greater name recognition and a
larger base of customers than we do. In addition, many of our competitors have
well-established relationships with our current and potential customers and have
extensive knowledge of these industries. In the past, we have lost potential
customers to competitors in all three product areas for various reasons,
including lower prices and other incentives not matched by us. In addition,
current and potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products and services to address customer needs. Accordingly, new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. We also expect that competition will increase as a
result of industry consolidation.
We need to develop, introduce and market new and enhanced products in a timely
manner to remain competitive.
We compete in markets characterized by continuing technological
advancement, changes in customer requirements and evolving industry standards.
To compete successfully, we must design, develop, manufacture and sell new or
enhanced products that provide increasingly higher levels of performance,
reliability and compatibility. For example, we anticipate that voice over DSL
technology will become an important feature of future DSL router products. As a
result, we believe we will need to successfully develop, introduce and market
integrated access devices that will combine voice over DSL and data routing
functionality in our products. Additionally, we will need to continue to
integrate our DSL router technology with the architectures of leading central
office equipment providers in order to enhance the reliability, ease-of-use and
management functions of each of our DSL products. Currently, our router products
are fully integrated with Copper Mountain's CopperView management for CopperEdge
central office access concentrators and are interoperable with Lucent's Stinger,
Nokia's ATM/DSL D50 Speedlink and Paradyne's Hotwire GranDSLAM digital
subscriber line central office access concentrators. With the introduction of
our asymmetric digital subscriber line (ADSL) Internet routers, we will expand
our interoperability with Cisco, Alcatel, and Siemens central office access
concentrators. However, we may not be able to successfully develop, introduce,
enhance or market these or other products necessary to our future success. In
addition, any delay in developing, introducing or marketing these or other
products would seriously harm our business.
We may engage in acquisitions or divestitures that involve numerous risks,
including the use of cash and the diversion of management attention.
In the past, we have engaged in both acquisitions and divestitures. For
example, in August 1998, we sold our LAN Division, which developed and sold
local area network (LAN) products. We may continue to acquire companies,
technologies or products or to sell or discontinue some of our technologies or
products in future periods. In the past, our acquisitions and divestitures have
involved numerous risks, including the use of significant amounts of our cash,
diversion of the attention of our management from our core business, loss of our
key employees and significant expenses and write-offs. Incremental acquisition
related charges including in-process research and development and amortization
of goodwill and other intangibles or divestitures of profitable technologies or
products could adversely impact our profitability. For example, in December
1998, we acquired netOctopus and Serus, in October 1999, we acquired StarNet
Technologies, Inc. and in March 2000, we acquired WebOrder. The success of these
acquisitions depends upon our ability to timely and successfully develop,
manufacture and gain market acceptance for the products we acquired. If we
engage in additional acquisitions or divestitures in future periods, we may not
be able to address these risks and our business may be harmed.
We may experience declining gross margins due to price competition and an
increase in sales of lower margin Internet equipment as a percentage of our
total revenue.
We expect that sales of our Internet equipment may account for a larger
percentage of our total revenues in future periods. Because these products are
generally sold at lower gross margins than our Web platform products, this will
likely result in a decrease in our overall gross margins. Further, we expect
that the market for Internet equipment, in particular DSL products, will become
increasingly competitive and
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that we will be forced to lower the prices we charge for our Internet equipment
in the future. As the average selling price of our routers declines, our gross
margins related to such products, and in general, are likely to decline.
The loss of, or decline in, purchases by one or more of our key distributors or
customers would result in a significant decline in our revenues.
Our revenues will decline and we may incur losses if we lose one or more of
our significant customers or if our customers reduce or delay purchases of our
products. During the three months ended June 30, 2000, our top five customers
who each individually represented at least 5% of our total revenues accounted
for approximately 51% of our total revenues as a group, respectively. In this
period, sales to Covad Communications and Northpoint Communications represented
approximately 24% and 10% of our total revenues, respectively.
Our limited operating history in DSL Internet equipment makes it difficult to
evaluate our prospects.
Our DSL Internet equipment has a relatively short history. You should
consider our prospects in light of the difficulties we may encounter because
these products are at an early stage of development in a relatively new, rapidly
evolving and intensely competitive market. For example, we may not correctly
anticipate market requirements, including requirements for performance, price,
features and compatibility with other DSL equipment. We may not be able to
rapidly introduce innovative new products that meet these market requirements.
It is possible that the market for DSL Internet equipment will develop in a
manner that we do not anticipate. Our competitors have introduced DSL products,
some of which may compete effectively against our DSL products. Such
developments could render our DSL products obsolete.
Our revenues will not grow and we may incur losses if we cannot continue to
successfully introduce, market and sell our DSL Internet equipment.
A portion of our revenues from Internet equipment is derived from non-DSL
routers. We anticipate that in the future the market for such non-DSL products
will decrease and that sales of our non-DSL products will decline as a
percentage of our total revenues. Accordingly, our revenues will not grow if we
are unable to continue to introduce, market and sell our DSL Internet equipment.
Sales of our DSL Internet equipment will decline substantially if Copper
Mountain and Nokia DSL equipment is not widely deployed.
We are currently dependent on the central office equipment by
telecommunications service providers that are deploying DSL services.
Historically, substantially all of our sales of DSL routers have been for use
with DSL central office equipment manufactured by Copper Mountain, Nokia, Lucent
and Paradyne. With the introduction of our ADSL Internet routers, we will expand
our interoperability with Cisco, Alcatel, and Siemens central office access
concentrators. If Copper Mountain, Nokia, Lucent, Paradyne, Cisco, Alcatel, or
Siemens DSL equipment is not widely used in DSL deployments, our business will
be seriously harmed.
Substantial sales of our DSL Internet equipment will not occur unless
telecommunications service providers initiate substantial deployment of DSL
services.
The success of our DSL Internet equipment depends upon whether
telecommunications service providers deploy DSL technologies and upon the timing
of the deployment of such technologies. Factors that will impact such deployment
include:
. A prolonged approval process by service providers, including laboratory
tests, technical trials, marketing trials, initial commercial deployment
and full commercial deployment;
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. The development of a viable business model for DSL services, including the
capability to market, sell, install and maintain DSL services;
. Cost constraints, such as installation costs and space and power
requirements at the telecommunications service provider's central office;
. Lack of compatibility of DSL equipment that is supplied by different
manufacturers;
. Evolving industry standards for DSL technologies; and
. Government regulation.
If telecommunications service providers do not expand their deployment
of DSL services, or if additional telecommunications providers do not offer DSL
services on a timely basis, then our business, financial condition and results
of operations will be seriously harmed.
Other technologies for the high-speed Internet equipment market will compete
with DSL services.
DSL services are competing with a variety of different high-speed Internet
connectivity technologies, including cable modem, satellite and other wireless
technologies. Many of these technologies will compete effectively with DSL
services. If any technology competing with DSL technology is more reliable,
faster, less expensive, reaches more customers or has other advantages over DSL
technology, then the demand for our products and services and our revenues and
gross margins may decrease.
We depend upon the ability of emerging competitive telecommunications service
providers to compete effectively with traditional telephone companies in
providing DSL services.
The purchasers of our DSL Internet equipment are primarily emerging
competitive telecommunications service providers such as Covad Communications,
Northpoint Communications, Rhythms Netconnections, and Jato Communications. We
depend upon the ability of such competitive telecommunications service providers
to offer DSL services successfully and become sustainable businesses. These
competitive telecommunications service providers are competing with traditional
regional telephone companies. Traditional regional telephone companies may have
a number of competitive advantages over their new competitors, including greater
resources, name recognition and access to customers. Also, traditional regional
telephone companies may restrict, or attempt to restrict, the ability of
competitive telecommunications service providers to install DSL equipment at the
regional telephone companies' central offices.
We purchase the semiconductor chips for our DSL routers from a limited number of
suppliers.
All of our DSL routers rely on certain semiconductor chips that we purchase
from a limited number of suppliers. We do not have volume purchase contracts
with any of our suppliers and they could cease selling us these semiconductor
chips at any time. If we are unable to timely obtain a sufficient quantity of
these semiconductor chips from any of our suppliers, for any reason, sales of
our DSL routers could be delayed or halted. Further, we could also be forced to
redesign our DSL routers and qualify new suppliers of semiconductor chip sets.
The resulting stoppage or delay in selling our products, and the expense of
redesigning our DSL routers would seriously harm our reputation and business.
Substantially all of our circuit boards are manufactured by SMTC Corporation
(SMTC), a contract manufacturer.
Substantially all of our Internet equipment include circuit boards that are
manufactured by SMTC which recently acquired Hi-Tech Manufacturing, or HTM, our
former contract manufacturer. Additionally, certain of our DSL routers are
assembled and packaged by SMTC. If supplies of circuit boards or DSL
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routers from SMTC are interrupted for any reason, we will incur significant
losses until we can arrange for alternative sources. Any such interruption may
seriously harm our reputation and business.
We may be unable to obtain components for our Internet equipment from
independent contractors and specialized suppliers.
We do not manufacture any of the components used in our products and
perform only limited assembly on some products. All of our Internet equipment
rely on components that are supplied by independent contractors and specialized
suppliers. We generally do not have guaranteed supply arrangements with these
third-parties and they could cease selling components to us at any time.
Moreover, the ability of independent contractors and specialized suppliers to
provide us with sufficient router components also depends on our ability to
accurately forecast our future requirements. If we are unable to timely obtain a
sufficient quantity of components from independent contractors or specialized
suppliers for any reason, sales of our Internet equipment could be delayed or
halted. In addition, we may be required to pay premiums for components to other
vendors should our regular independent contractors and specialized suppliers be
unable to timely provide us with sufficient quantity of components. To the
extent we pay any premiums, our gross margins and operating results would be
harmed. Further, we could also be forced to redesign our Internet equipment and
qualify new suppliers of components. The resulting stoppage or delay in selling
our products and the expense of redesigning our Internet equipment would
seriously harm our reputation and business. In addition, we anticipate that it
will be necessary for us to establish relationships with additional component
suppliers in the future. If we are unsuccessful in establishing these
relationships, we may not be able to obtain sufficient components in some future
period.
Our revenues will not grow and we may incur losses if we cannot successfully
introduce, market and sell our Web platform.
A majority of revenues from our Web platform is derived from the sale of
Timbuktu Pro. We anticipate that in the future, the market for Timbuktu Pro will
grow more slowly than the market for our other Web platform products and
services. In addition, we rely on licensees of our Web platform to promote the
use of our Web platform for building Web sites and e-stores. The extent and
nature of the promotions by licensees of our Web platform are outside of our
control. If licensees of our Web platform do not successfully promote our Web
platform, we will not generate recurring revenues from royalties on Web sites
promoted by licensees of our Web platform.
The market for our Web platform may be limited by products and services that are
available at no cost.
Some companies are offering Web presence and enhancement products at no
cost. In some instances, we believe these companies are not charging for such
products and services because they are generating revenue from their Web sites
from other sources, such as advertising or subscription fees. If such free
products and services become widely used, the market for our Web platform
products will be limited.
To be successful, use of our Web platform must become widespread, and this will
require us to rapidly build our sales channel, which we may be unable to do.
Growth in revenues from our Web platform will be heavily dependent on
recurring fees from Web sites and e-stores created by licensees. Accordingly, to
be successful, our Web platform must become widely used. The sales cycle for
licensing our Web platform can be long. We will be required to build our
internal sales organization and customer support organization to increase the
number of licensees of our Web platform. Because the market for technical sales
and support personnel is intensely competitive, growing our sales and support
organization may be difficult. If we are unable to rapidly establish the
widespread use of our Web platform, it is possible that competing products could
become widely used, reducing the likelihood that we will generate significant
revenues from our Web platform.
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If hosting services for our Web platform perform poorly, our reputation will be
damaged and we could be sued.
We depend on our servers, networking hardware and software infrastructure,
and third-party service and maintenance of these items to provide reliable,
high-performance Web site hosting services for our customers. In addition, our
servers are located at third-party facilities. Failure or poor performance by
the third parties with which we contract to maintain our servers, hardware and
software, could lead to interruption or deterioration of our Web site hosting
services. Additionally, a slowdown or failure of our systems due to an increase
in the use of the Web sites we currently host, or due to damage or destruction
of our systems for any reason, could also lead to interruption or deterioration
of our Web site hosting services. If there is an interruption or a deterioration
of our Web site hosting services, our reputation would be seriously harmed and,
consequently, sales of our products and services would decrease. If such
circumstances do arise in some future period, in order to retain current
customers and attract new customers, we may have to provide our Web site hosting
services at a subsidized price or even at no cost. In addition, if our Web site
hosting services are interrupted, perform poorly, or are unreliable, we are at
risk of litigation from our customers.
We license a substantial portion of our Timbuktu Pro software to a limited
number of large customers and these licenses have a lengthy sales cycle.
A volume license of our Timbuktu Pro software involves a significant
commitment of financial resources by our customers. As a result, volume licenses
of our Timbuktu Pro software have a long sales cycle, and in the past, we have
only sold volume licenses of our Timbuktu Pro software to a small number of
large customers each quarter. Further, volume license sales of Timbuktu Pro are
typically closed in the final weeks of the quarter and the timing of these
licenses may cause our quarterly results to vary. We generally incur significant
expenses in sales and marketing prior to obtaining customer commitments for the
volume licenses of our Timbuktu Pro software. As a result, our inability to get
customer commitments or delays in such commitments due to the lengthy sales
cycles would reduce our revenues and cause our losses to increase.
A substantial portion of our revenues are derived from sales to international
customers.
A substantial portion of our revenues are derived from sales to
international customers. We expect sales to international customers to continue
to comprise a significant portion of our revenues. In the past, our
international sales have typically been denominated in United States dollars.
Beginning in the third quarter of fiscal 2000, sales to our European customers
who are members of the European Union are being denominated in the Euro. All
other international sales will continue to be denominated in United States
dollars. For our international sales that continue to be denominated in United
States dollars, fluctuations in currency exchange rates could cause our products
and services to become relatively more expensive to our foreign customers. This
could lead to decreased profitability of our products and services. In addition,
changes in the value of the Euro relative to the United States dollar, could
adversely affect our operating results, to the extent we do not hedge sales
denominated in the Euro.
We typically experience a seasonal reduction in revenues in the three months
ended September 30.
In the past, we have experienced a seasonal reduction in our revenues in
the three months ended September 30, primarily due to European vacation
schedules which typically result in reduced economic activity in Europe during
such periods. We anticipate that this trend will continue.
Our success depends on retaining our current key personnel and attracting
additional key personnel.
Our future performance depends on the continued service of our senior
management, product development and sales personnel, particularly Alan Lefkof,
our President and Chief Executive Officer. None of these persons, including Mr.
Lefkof, is bound by an employment agreement, and we do not carry key person life
insurance. The loss of the services of one or more of our key personnel could
seriously
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harm our business. Our future success depends on our continuing ability to
attract, hire, train and retain a substantial number of highly skilled
managerial, technical, sales, marketing and customer support personnel. In
addition, new hires frequently require extensive training before they achieve
desired levels of productivity. Competition for qualified personnel is intense,
and we may fail to retain our key employees or to attract or retain other highly
qualified personnel.
Our intellectual property may not be adequately protected, and our products may
infringe upon the intellectual property rights of third parties.
We depend on our ability to develop and maintain the proprietary aspects of
our technology. To protect our proprietary technology, we rely primarily on a
combination of contractual provisions, confidentiality procedures, trade
secrets, and patent, copyright and trademark law.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or obtain and use information that
we regard as proprietary. Policing unauthorized use of our products is
difficult, and there is no guarantee that the safeguards that we employ will
protect our intellectual property and other valuable competitive information.
For example, in selling our Timbuktu Pro software, we often rely on license
cards that are included in our products and are not signed by licensees.
Therefore, such licenses may be unenforceable under the laws of certain
jurisdictions. In addition, the laws of some foreign countries where our
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 our proprietary rights as fully as do the laws of the United States.
We rely upon certain software, firmware and hardware designs that we
license from third parties, including firmware that is integrated with our
internally developed firmware and used in our products to perform key functions.
We cannot be certain that these third-party licenses will continue to be
available to us on commercially reasonable terms. The loss of, or inability to
maintain, such licenses could result in shipment delays or reductions until
equivalent firmware is developed, identified, licensed and integrated which
would seriously harm our business.
Our customers may return our products to us for replacement or refund.
We provide end users of our products with a one-year limited warranty on
our Internet equipment and a 90-day limited warranty on single-user versions of
our Timbuktu Pro software. We permit end users to return our Internet equipment
and Timbuktu Pro for replacements or for refund of the full purchase price if
the products do not perform as warranted. Our e-commerce products are provided
on an "as is" basis, and we generally do not offer a warranty on this product.
End users of our Web sites and e-stores are offered a free 30-day evaluation
period to evaluate the product prior to purchase and thereafter can discontinue
their service at any time at no cost. In the past, we have not encountered
material warranty claims. In the future, if warranty claims exceed our reserves
for such claims, our business would be seriously harmed. Additionally, we
attempt to further limit our liability to end users through disclaimers of
special, consequential and indirect damages and similar provisions. However, we
cannot assure you that such limitations of liability will be legally
enforceable.
Our products are complex and may contain undetected or unresolved defects.
Our products are complex and may contain undetected or unresolved defects
when first introduced or as new versions are released. We cannot assure you
that, despite our testing, defects will not be found in new products or new
versions of products following commercial release. If our products do contain
undetected or unresolved defects, we may lose market share, experience delays in
or losses of market acceptance or be required to issue a product recall. In
addition, we would be at risk of product liability litigation for financial or
other damages to our customers because of defects in our products. Although we
attempt to limit our liability to end users through disclaimers of special,
consequential and
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indirect damages and similar provisions, we cannot assure you that such
limitations of liability will be legally enforceable.
Substantial sales of our common stock by our large stockholders could cause our
stock price to fall.
We have a limited number of stockholders that hold a large portion of our
common stock. To the extent our large stockholders sell substantial amounts of
our common stock in the public market, the market price of our common stock
could fall.
Our industry may become subject to changes in tariffs and regulations.
Our industry and industries that our business depends on may be affected by
changes in tariffs and regulations. For example, we depend on telecommunications
service providers for sales of our DSL Internet equipment, and companies in the
telecommunications industry must comply with numerous regulations and pay
numerous tariffs. If our industry or industries that we depend on become subject
to increases in tariffs and regulations that lead to corresponding increases in
the cost of doing our business or doing business with us, our revenues could
decline. For example, if a regulatory agency imposed restrictions on DSL service
that were not also imposed on other forms of high-speed Internet access, our
business could be harmed.
Our California facilities are located near major earthquake fault lines.
Our California facilities are located near major earthquake fault lines. If
there is a major earthquake in the region, our business could be seriously
harmed.
We may find it difficult to raise needed capital in the future, which could
significantly harm our business.
We may require substantial capital to finance our future growth and fund
our ongoing research and development activities beyond fiscal 2000. Our capital
requirements will depend on many factors, including:
. Acceptance of and demand for our products;
. The number and timing of acquisitions;
. The costs of developing new products;
. The costs associated with our expansion; and
. The extent to which we invest in new technology and research and development
projects.
If we issue additional stock or other instruments to raise capital, the
percentage ownership in Netopia of existing stockholders would be reduced.
Additional financing may not be available when needed and, if such financing is
available, it may not be available on terms favorable to us.
Our stock price may be volatile, which may result in substantial losses for our
stockholders.
The market price of our common stock may fluctuate significantly in
response to the following factors, some of which are beyond our control:
. Variations in our quarterly operating results;
. Changes in securities analysts' estimates of our financial performance;
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. Changes in market valuations of similar companies;
. Announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
. Losses of major customers or the failure to complete significant licensing
transactions;
. Additions or departures of key personnel; and
. Fluctuations in the stock market price and volume, which are particularly
common among highly volatile securities of companies in our industry.
We are at risk of securities class action litigation due to the expected
volatility of our stock price.
In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. We may in the future be a target of similar litigation. Securities
litigation could result in substantial costs and divert management's attention
and resources.
A third party may have difficulty acquiring us, even if doing so would be
beneficial to our stockholders.
Provisions of our Amended and Restated Certificate of Incorporation, our
Bylaws and Delaware law could make it difficult for a third party to acquire us,
even if doing so would be beneficial to our stockholders.
Liquidity and Capital Resources
We have funded our operations to date primarily through the private sale of
equity securities and the public offerings of our common stock. As of June 30,
2000, we had cash, cash equivalents and short-term investments representing 47%
of total assets.
Our operating activities provided $1.2 million of cash for the nine months
ended June 30, 2000 and used $5.9 million for the nine months ended June 30,
1999. The cash provided by operations in the nine months ended June 30, 2000 was
primarily due to cash generated from our regular operating activities as well as
an increase in accounts payable and accrued liabilities, partially offset by
increases in accounts receivable and inventories. The cash used by operations in
the nine months ended June 30, 1999 was primarily due to supporting our regular
operating activities as well as an increase in accounts receivable and
inventories.
Cash used in investing activities for the nine months ended June 30, 2000
was primarily due to:
. Purchases of short-term investments; and
. Our acquisitions of technology, including the acquisition of WebOrder
and StarNet.
These amounts were partially offset by proceeds realized from the sale and
maturity of short-term investments.
Cash provided by investing activities for the nine months ended June 30,
1999 was primarily due to proceeds from the sale of short-term investments
partially offset by:
. Purchases of short-term investments;
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. Our acquisitions of technolgy, including our acquisitions of Serus and
netOctopus; and
. Purchases of capital equipment.
Cash provided by our financing activities for the nine months ended June
30, 2000 and 1999 was primarily related to the exercise of employee stock
options and activities related to our Employee Stock Purchase Plan.
We believe that our existing cash, cash equivalents and short-term
investments will be adequate to meet our cash needs for working capital, capital
expenditures and earnouts related to our acquisitions for at least the next
twelve months. We may require substantial capital to finance our future growth
and fund our ongoing research and development activities during the remainder of
fiscal 2000 and thereafter. If we issue additional stock to raise capital, the
percentage ownership in Netopia of existing stockholders would be reduced.
Additional financing may not be available when needed and, if such financing is
available, it may not be available on terms favorable to us.
From time to time, in the ordinary course of business, we may evaluate
potential acquisitions of businesses, products and technologies. Accordingly, a
portion of our 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. In the past, our acquisitions and divestitures have
involved numerous risks, including the use of significant amounts of our cash,
diversion of the attention of our management from our core business, loss of our
key employees and significant expenses and write-offs. For example, in December
1998, we acquired netOctopus and Serus, in October 1999, we acquired StarNet
and, in March 2000, we acquired WebOrder. The success of these acquisitions
depends upon our ability to timely and successfully develop, manufacture and
gain market acceptance for the products we acquired. If we engage in additional
acquisitions or divestitures in future periods, we may not be able to address
these risks and our business may be harmed.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments for
speculative or trading purposes. We place our investments in instruments that
meet high credit quality standards, as specified in our investment policy. This
policy also limits the amount of credit exposure to any one issue, issuer and
type of instrument. We do not expect any material loss with respect to our
investment portfolio.
The table below presents the carrying value and related weighted-average
interest rates for our investment portfolio. The carrying value approximates
fair value at June 30, 2000. All of our investments mature in twelve months or
less.
<TABLE>
<CAPTION>
Carrying Average
Principal (notional) amounts in United States dollars: Amount Interest Rate
----------------------------------------------------------------------------------------------------
<S> <C> <C>
(in thousands)
Cash equivalents - fixed rate............................. $ 39,657 6.40%
Short-term investments - fixed rate....................... 19,802 6.43%
-------------
$ 59,459
=============
</TABLE>
Beginning in our fiscal third quarter of 2000, sales to European countries
which are members of the European Union are being denominated in the Euro. In
order to reduce our exposure resulting from currency fluctuations, we have
entered into currency exchange forward contracts. These contracts guarantee a
predetermined exchange rate at the time the contract is purchased.
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As of June 30, 2000, we had two outstanding currency exchange forward
contracts totaling approximately $960,000. The contracts are denominated in the
Euro and expire on July 31, 2000 and August 31, 2000, respectively.
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PART II. OTHER INFORMATION
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
June 30, 2000.
SIGNATURE
--------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 14, 2000 NETOPIA, INC.
(Registrant)
By: /s/ James A. Clark
James A. Clark
Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal
Financial Officer
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