- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 December 31, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 0-28450
Netopia, Inc.
(Exact name of registrant as specified in its charter)
Delaware 94-3033136
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2470 Mariner Square Loop
Alameda, California 94501
(Address of principal executive offices, including Zip Code)
---------------------------
(510) 814-5100
(Registrant's telephone number, including area code)
Indicate by |X|check whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No
----- ----
As of January 31, 2000 there were 16,376,408 shares of the
Registrant's Common Stock outstanding.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
NETOPIA, INC.
FORM 10-Q
TABLE OF CONTENTS PAGE
- --------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements.................. 2
Condensed consolidated balance sheets at
December 31, 1999 and September 30, 1999..................... 2
Condensed consolidated statements of operations for
the three months ended December 31, 1999 and 1998............ 3
Condensed consolidated statements of cash flows
for the three months ended December 31, 1999 and 1998........ 4
Notes to condensed consolidated financial statements......... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................... 10
Item 3. Quantitative and Qualitative Disclosures About
Market Risk.................................................. 26
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.................... 27
Item 6. Exhibits and Reports on Form 8-K............................. 27
SIGNATURE ............................................................. 29
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
- --------------------------------------------------------------------------------
NETOPIA, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except for share and per share amounts)
(unaudited)
<TABLE>
<CAPTION>
December 31, September 30,
1999 1999
--------------------------------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents.............................................. $ 26,141 $ 61,381
Short-term investments................................................. 32,764 8,102
Trade accounts receivable less allowance for doubtful accounts and
returns of $931 and $796, respectively............................ 12,654 9,852
Royalties receivable................................................... 537 361
Note receivable........................................................ 980 966
Inventories, net....................................................... 4,818 3,681
Prepaid expenses and other current assets.............................. 1,956 1,397
----------------- -----------------
Total current assets........................................... 79,850 85,740
Royalties receivable....................................................... -- 377
Furniture, fixtures and equipment, net..................................... 2,669 2,403
Intangible assets, net..................................................... 23,163 2,362
Deposits and other assets.................................................. 4,653 5,087
----------------- -----------------
$ 110,335 $ 95,969
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................................... $ 6,250 $ 5,258
Accrued compensation................................................... 2,511 2,170
Accrued liabilities.................................................... 1,572 1,564
Deferred revenue....................................................... 1,759 1,343
Other current liabilities.............................................. 6 11
----------------- -----------------
Total current liabilities...................................... 12,098 10,346
Long-term liabilities...................................................... 453 544
----------------- -----------------
Total liabilities.............................................. 12,551 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;
16,281,460 and 15,519,198 shares issued and outstanding at
December 31, 1999 and September 30, 1999, respectively................. 16 15
Additional paid-in capital............................................. 118,839 99,978
Accumulated deficit.................................................... (21,404) (14,942)
Accumulated other comprehensive income................................. 333 28
----------------- -----------------
Total stockholders' equity..................................... 97,784 85,079
----------------- -----------------
$ 110,335 $ 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
December 31,
-----------------------------------
1999 1998
-----------------------------------
<S> <C> <C>
Revenues:
Internet equipment....................................................... $ 10,839 $ 4,151
Web platform licenses and services....................................... 5,453 3,772
-------------- -------------
16,292 7,923
Cost of revenues:
Internet equipment....................................................... 7,609 2,646
Web platform licenses and services....................................... 122 160
-------------- -------------
7,731 2,806
-------------- -------------
Gross profit.................................................................. 8,561 5,117
Operating expenses:
Research and development................................................. 2,998 1,985
Selling and marketing.................................................... 5,647 4,761
General and administrative............................................... 976 782
Acquired in-process research and development............................. 5,668 4,205
Amortization of goodwill and other intangible assets..................... 1,709 --
-------------- -------------
Total operating expenses................................................. 16,998 11,733
-------------- -------------
Operating loss.................................................... (8,437) (6,616)
Other income, net............................................................. 828 570
-------------- -------------
Loss from continuing operations before income taxes............... (7,609) (6,046)
Income tax provision (benefit)................................................. -- --
-------------- -------------
Loss from continuing operations................................... (7,609) (6,046)
Discontinued operations:
Income from discontinued operations, net of taxes...................... 1,147 --
-------------- -------------
Net loss.......................................................... $ (6,462) $ (6,046)
============== ==============
Comprehensive loss:
Net loss................................................................. $ (6,462) $ (6,046)
Other comprehensive income............................................... 305 --
Total comprehensive loss.......................................... $ (6,157) $ (6,046)
============== ==============
Per share data, continuing operations:
Basic and diluted loss per share.......................................... $ (0.47) $ (0.50)
============== ==============
Common shares used in the per share calculations.......................... 16,047 12,159
============== ==============
Per share data, net loss:
Basic and diluted net loss per share...................................... $ (0.40) $ (0.50)
============== ==============
Common shares used in the per share calculations.......................... 16,047 12,159
============== ==============
======================================================================================================================
</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>
Three months ended
December 31,
-----------------------------------
1999 1998
-----------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................................... $ (6,462) $ (6,046)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization........................................... 1,887 604
Charge for in-process research and development.......................... 5,668 4,205
Changes in allowance for doubtful accounts and returns on
accounts receivable.................................................. 135 (2)
Changes in operating assets and liabilities:
Trade accounts receivable............................................ (2,938) (1,193)
Inventories.......................................................... (1,138) 190
Prepaid expenses, and other current assets........................... 96 222
Deposits and other assets............................................ 54 --
Accounts payable and accrued liabilities............................. 990 (1,551)
Deferred revenue..................................................... 348 82
Other liabilities.................................................... 323 (26)
------------- -------------
Net cash used in operating activities............................. (1,037) (3,515)
------------- -------------
Cash flows from investing activities:
Purchase of furniture, fixtures and equipment........................... (116) (173)
Capitalization of software development costs............................ (111) --
Acquisition of technology............................................... (10,855) (4,161)
Purchase of short-term investments...................................... (25,635) (6,885)
Proceeds from the sale and maturity of short-term investments........... 974 11,343
------------- -------------
Net cash provided by (used in) investing activities............... (35,743) 124
------------- -------------
Cash flows from financing activities:
Proceeds from the issuance of common stock, net......................... 1,540 594
------------- -------------
Net cash provided by financing activities......................... 1,540 594
------------- -------------
Net decrease in cash and cash equivalents.................................. (35,240) (2,797)
Cash and cash equivalents, beginning of period............................. 61,381 19,244
------------- -------------
Cash and cash equivalents, end of period................................... $ 26,141 $ 16,447
============= =============
Supplemental disclosures of noncash investing and financing activities:
Issuance of common stock and common stock options for acquisition of
intangible assets....................................................... $ 17,322 $ 2,811
============= =============
=====================================================================================================================
</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 December 31, 1999 are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire fiscal year ending
September 30, 2000.
(2) Recent Accounting Pronouncements
In March 1998, AcSec issued SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. SOP 98-1 requires that certain
costs related to the development or purchase of internal-use software be
capitalized and amortized over the estimated useful life of the software. We
adopted SOP 98-1 on October 1, 1999, which did not have a material impact on our
results of operations.
In June 1998, the FASB issued 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. To date, we have not entered into any derivative financial instruments or
hedging activities.
(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>
December 31 September 30,
1999 1999
---------------- ----------------
<S> <C> <C>
Raw materials and work in process........................ $ 2,313 $ 1,699
Finished goods........................................... 2,505 1,982
---------------- ----------------
$ 4,818 $ 3,681
================ ================
(4) Furniture, Fixtures and Equipment, net (in thousands):
------------------------------------------------------
December 31, September 30,
1999 1999
---------------- ----------------
Furniture, fixtures and equipment........................ $ 13,679 $ 13,565
Accumulated depreciation and amortization................ (11,010) (11,162)
---------------- ----------------
$ 2,669 $ 2,403
================ ================
</TABLE>
5
<PAGE>
(5) Earnings Per Share
Basic net loss per share (EPS) is based on the weighted average number of
shares of common stock outstanding during the period. Diluted net 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.
Potentially dilutive common shares have been excluded from the computation
of diluted EPS for the three months ended December 31, 1999 and 1998 since their
effect on EPS is antidilutive due to the losses incurred in each period.
Consequently, the number of shares in the computations of basic and diluted EPS
is the same for each period. Potentially dilutive common shares which were
excluded from the computation of diluted EPS consisted of options to purchase
common stock totaling 3,803,516 for the three months ended December 31, 1999,
3,474,527 for the three months ended December 31, 1998 and warrants to purchase
common stock totaling 60,000 for the three months ended December 31, 1999 and
1998.
(6) Acquisitions
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 has 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 the 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:
o $8.4 million in cash paid on the closing date of the transaction;
o 447,852 shares of our common stock issued on the closing date;
o 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;
o 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
o 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 are being held in escrow for a
period of time after the closing to satisfy StarNet's indemnification
obligations under the definitive acquisition agreements.
6
<PAGE>
The acquisition has been accounted for as a purchase and resulted in
goodwill and other intangible assets of approximately $22.4 million which is
being amortized over four and three years, respectively and a charge for
acquired in-process research and development of $5.7 million.
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 are expected
to occur during our 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 the summer of calendar 2000 and we estimate the cost to complete
the in-process research and development to be approximately $1.8 million.
The funds used to pay the cash portion of the purchase price were derived
from our existing working capital.
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 statement of operations for the three months ended
December 31, 1999 and 1998 assuming StarNet had been acquired as of the
beginning of the periods presented (in thousands, except per share data):
December 31 December 31,
1999 1998
---------- ---------
Revenues...................................... $16,292 $8,219
Net loss...................................... ($6,802) ($8,154)
Basic and diluted loss per share.............. ($0.42) ($0.42)
Weighted-average shares used in pro forma
per share computation......................... 16,110 12,607
The above pro forma net loss figure for the three months ended December 31,
1999 includes the charge for acquired in-process research and development.
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.
(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 5% of the
equity of Farallon.
7
<PAGE>
The note receivable is for $1.0 million payable on July 31, 2000, bearing
interest at 8% per annum. The value of the note has been discounted to reflect a
rate of 15%, the assumed fair market rate of interest for a similar financial
instrument.
The royalties receivable are based upon Farallon's total annual revenues
over each of the next five fiscal years ending on July 31, 2003. At December 31,
1999 there was a balance of $537,000 recorded as royalties receivable due from
Farallon. Farallon's total revenues in each annual period must reach at least
$15.0 million for a royalty to be paid to us.
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. Income from discontinued
operations, net of taxes was $1.1 million for the three months ended December
31, 1999. This income 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. During the three months ended December
31, 1999, we found alternative uses for this excess space.
(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 financial performance assessments. 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
performance.
We generate revenue from three groups of products and services.
Disaggregated financial information regarding our three operating segments for
the three months ended December 31, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
WEB PLATFORM LICENSES
---------------------
INTERNET WEB SITE TIMBUKTU TOTAL PRODUCTS
EQUIPMENT PRODUCTS PRODUCTS
1999
<S> <C> <C> <C> <C>
Revenues........................... $ 10,839 $ 1,832 $ 3,621 $ 16,292
Cost of revenues................... 7,609 6 116 7,731
----------- ---------- ---------- -----------
Gross profit....................... 3,230 1,826 3,505 8,561
Unallocated operating expenses 16,998
-----------
Operating loss................. (8,437)
Other income, net.................. 828
-----------
Loss before income taxes....... (7,609)
Income tax provision (benefit)..... --
-----------
Loss from continuing
operations.................... $ (7,609)
===========
- -----------------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
WEB PLATFORM LICENSES
---------------------
INTERNET WEB SITE TIMBUKTU TOTAL
EQUIPMENT PRODUCTS PRODUCTS PRODUCTS
1998
<S> <C> <C> <C> <C>
Revenues........................... $ 4,151 $ 542 $ 3,230 $ 7,923
Cost of revenues................... 2,646 5 155 2,806
---------- ---------- ---------- ----------
Gross profit....................... 1,505 537 3,075 5,117
Unallocated operating expenses 11,733
----------
Operating loss................. (6,616)
Other income, net.................. 570
----------
Loss before income taxes....... (6,046)
Income tax provision (benefit)..... --
----------
Loss from continuing
operations.................... $ (6,046)
==========
</TABLE>
We sell our products and provide services worldwide through a direct sales
force, independent distributors, and value-added resellers. 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 denominated in
United States dollars. Disaggregated financial information regarding our
products and services and revenues by geographic region is as follows (in
thousands):
Three Months Ended
December 31,
-------------------------
1999 1998
------------ ------------
United States....................................... $12,282 $5,079
Europe.............................................. 3,260 2,317
Asia/Pacific........................................ 299 243
Canada.............................................. 359 238
Latin America....................................... 92 46
------------ ------------
Total revenues............................. $16,292 $7,923
============ ============
We do not have material operating assets outside of the United States.
During the three months ended December 31, 1999, Northpoint Communications,
a competitive local exchange carrier (CLEC), accounted for 12% of our total
revenues and 11% of our total accounts receivable. All revenues derived from
this customer were related to sales of our internet equipment. No other customer
during the three months ended December 31, 1999 accounted for 10% or more of our
total revenues. One other customer accounted for 10% of our total accounts
receivable for the three months ended December 31, 1999. No customers during the
three months ended December 31, 1998 accounted for 10% or more of our total
revenues or total accounts receivable.
9
<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 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 provide Internet and electronic commerce infrastructure that enables
small and medium size businesses to easily and cost-effectively connect to the
Internet, establish and enhance their presence, and conduct business and
electronic commerce on the Web. We offer digital subscriber line (DSL) and other
high-speed, multi-user Internet equipment and Web platforms for creating and
hosting Web sites, creating and hosting electronic commerce stores, and
conducting real-time Internet communications.
We sell our products and related maintenance, support and other services
through telecommunication service providers, Internet service providers (ISPs),
distributors, value-added resellers (VARs) and directly to end users.
During the three months ended December 31, 1999:
o Our four largest customers, who each individually represented at least 5%
of our total revenues, accounted for 33% of our total revenues; and
o Northpoint Communications, a competitive local exchange carrier (CLEC),
accounted for 12% of our revenues. No other customer during the three
months ended December 31, 1999 accounted for 10% or more of our total
revenues.
During the three months ended December 31, 1998:
o Our three largest customers, who each individually represented at least 5%
of our total revenues, accounted for 25% of our total revenues; and
o No customer during the three months ended December 31, 1998 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 December 31, 1999 and 1998, international revenues
accounted for 25% and 36% of our total revenues, respectively.
10
<PAGE>
Our international revenues are currently denominated in United States
dollars, and revenues generated by our international distributors are paid to us
in United States dollars.
Our revenues are derived from the sale of hardware and software products
and include license revenues for our Web site server and Timbuktu Pro software,
recurring revenues from our Web sites and E-stores and sales of our Internet
equipment 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 provide end users of our products with a 90-day limited warranty on
single-user versions of our Timbuktu Pro software and a one-year limited
warranty on our Internet equipment. We permit end users to return Timbuktu Pro
and our Internet equipment for replacements or for refund of the full purchase
price if the products do not perform as warranted. Our Web sites are provided on
an "as is" basis, and we generally do not offer a warranty on this product. End
users of our Web sites 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.
<PAGE>
Results of Operations
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
December 31,
--------------------------
1999 1998
---------- -----------
<S> <C> <C>
Revenues:
Internet equipment...................................... 66.5% 52.4%
Web platform licenses and services...................... 33.5% 47.6%
---------- -----------
100.0% 100.0%
Cost of revenues:
Internet equipment...................................... 46.7% 33.4%
Web platform licenses and services...................... 0.8% 2.0%
---------- -----------
47.5% 35.4%
---------- -----------
Gross profit............................................ 52.5% 64.6%
Operating expenses:
Research and development................................ 18.4% 25.1%
Selling and marketing................................... 34.7% 60.1%
General and administrative.............................. 6.0% 9.9%
Acquired in-process research
and development....................................... 34.8% 53.1%
Amortization of goodwill and other intangible assets.... 10.5% --
---------- -----------
Total operating expenses.............................. 104.3% 148.1%
---------- -----------
Operating loss........................................ (51.8%) (83.5%)
---------- -----------
Other income, net......................................... 5.1% 7.2%
---------- -----------
Loss from continuing operations
before income taxes................................. (46.7%) (76.3%)
Income tax provision (benefit)........................... -- --
---------- -----------
Loss from continuing operations........................ (46.7%) (76.3%)
Income from discontinued operations, net of taxes......... 7.0% --
---------- -----------
Net loss............................................ (39.7%) (76.3%)
========== ===========
- ---------------------------------------------------------------------------------------------------
</TABLE>
Three Months Ended December 31, 1999 and 1998
Revenue. Our revenues increased 105.6% to $16.3 million in the three months
ended December 31, 1999 from $7.9 million in the three months ended December 31,
1998.
The increase in the three months ended December 31, 1999 was primarily due
to:
o Increased sales in North America of our DSL Internet equipment as our
strategic relationships for the distribution of our DSL products
continued to expand, and the introduction of new Internet equipment
interoperable with Nokia's DSL central office access concentrator; and
o Increased sales of our Web site licenses including the introduction of
our E-commerce enabled Web sites.
12
<PAGE>
These increases were partially offset by decreased sales of our integrated
services digital network (ISDN) Internet routers in North America as demand for
DSL products increased and decreased sales of the shrink wrap versions of
Timbuktu Pro for the Macintosh.
International revenues increased 41.0% to $4.0 million in the three months
ended December 31, 1999 from $2.8 million in the three months ended December 31,
1998. International revenues increased primarily due to sales of our DSL
internet equipment which were not available during the three months ended
December 31, 1998, the introduction of our integrated voice and data ISDN router
acquired in connection with our acquisition of StarNet as well as increased
sales of our Web site licenses. International revenues accounted for 25% and 36%
of our total revenues for the three months ended December 31, 1999 and 1998,
respectively. International revenues declined as a percentage of total revenues
primarily due to increasing sales of our 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 December 31,
-------------------------------
1999 1998
- ------------------------------------------------------------------------------
Europe.................................. 20% 29%
Pacific Rim............................. 2 3
Canada and Other........................ 3 4
-------- --------
Subtotal international revenues....... 25 36
United States........................... 75 64
-------- --------
Total revenues...................... 100% 100%
======== ========
- ------------------------------------------------------------------------------
Although international revenues as a percentage of total revenue decreased
in the three months ended December 31, 1999, a substantial portion of our
revenues was derived from sales to international customers, and we expect sales
to international customers to continue.
Gross Margin. Our total gross margin decreased to 52.5% in the three months
ended December 31, 1999 from 64.6% in the three months ended December 31, 1998.
The decrease was primarily due to:
o Increased sales of our Internet equipment, which have a lower gross margin
than our Web platform products; and
o Declining average selling prices of our Internet equipment as a result of
price competition and more volume DSL contracts.
These decreases were partially offset by increased volume and server
license sales of our Web platform products as well as declining average costs of
our products. In the past, our gross margin has varied significantly and will
likely vary significantly in the future. Our gross margins depend primarily on:
o The mix of hardware and software products sold;
o Pricing strategies;
o Standard cost changes;
o New versions of existing products; and
o External market factors, including, but not limited to, price competition.
13
<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
51.0% to $3.0 million for the three months ended December 31, 1999 from $2.0
million for the three months ended December 31, 1998. Research and development
expenses increased primarily due to increased employee and development related
expenses primarily as a result of our acquisitions of Serus, netOctopus and
StarNet. The employees and operations acquired were not included in our research
and development expenses for the three months ended December 31, 1998.
We expect to continue to devote substantial resources to product and
technological development and therefore, research and development costs may
increase in absolute dollars in fiscal years 2000 and 2001. Historically, we
have believed that 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 December 31, 1999, we capitalized $111,000 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 18.6%
to $5.6 million for the three months ended December 31, 1999 from $4.8 million
for the three months ended December 31, 1998. Selling and marketing expenses
increased primarily due to:
o Increased headcount and other employee related expenses; and
o Increased participation in tradeshows.
These expenses were partially offset by reduced advertising expenses.
We believe that our selling and marketing expenses will increase in
absolute dollars in fiscal years 2000 and 2001 as a result of:
o Our acquisition of StarNet;
o Increased advertising and promotion campaigns related to our Web site and
electronic commerce platform as well as our DSL Internet equipment; and
o Continued expansion of our sales staff domestically and internationally.
General and Administrative. Our general and administrative expenses
increased 24.8% to $976,000 for the three months ended December 31, 1999 from
$782,000 for the three months ended December 31, 1998. General and
administrative expenses increased primarily due to:
o Increased employee related expenses including employee recruitment costs;
o Increased use of third party contractors and temporary employee services;
and
o Increased occupancy costs related to our Alameda facility.
Acquired In-Process Research and Development. Based upon an independent
third party valuation analysis of our acquisition of StarNet, we allocated a
one-time charge of approximately $5.7 million of the purchase price to acquired
in-process research and development for the three months ended December 31,
1999. See Note 6 of "Notes To Condensed Consolidated Financial Statements."
Based upon an independent third party valuation analysis of our acquisitions of
Serus and netOctopus, we allocated one time charges of
14
<PAGE>
approximately $3.9 million of the Serus purchase price and $400,000 of the
netOctopus purchase price to acquired in-process research and development for
the three months ended December 31, 1998.
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 re-state the charges to operations taken in connection with such
transactions.
Amortization of Goodwill and Other Intangible Assets. For the three months
ended December 31, 1999, 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 and StarNet.
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. The amount
allocated to goodwill and other intangible assets in connection with our
acquisition of Serus was $2.1 million and 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 related to
these transactions over four years.
Other Income, Net. Other income, net, primarily represents interest we earn
on our cash, cash equivalents and short-term investments. Other income, net,
increased 45.3% to $828,000 for the three months ended December 31, 1999 from
$570,000 for the three months ended December 31, 1998. 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.
We expect interest income to decrease moderately in absolute dollars due to the
cash used for operating activities.
Income Tax Benefit. We did not record an income tax benefit during the
three months ended December 31, 1999 or 1998 primarily due to continued
substantial uncertainty regarding our ability to realize our tax assets.
Discontinued Operations. Income from discontinued operations of $1.1
million during the three months ended December 31, 1999 primarily represents the
reversal of a liability we recorded for the excess space created at our Alameda,
California facility, in connection with the sale of our LAN Division on August
5, 1998, that we believed could not be subleased to third parties.
Year 2000 Disclosure
Except for expenditures disclosed in prior filings, our business was not
adversely affected by the risks posed by Year 2000 issues. Based on our testing,
which was completed before December 31, 1999 and our experience to date, we have
confirmed that our internally developed systems and technology (including our
financial, order entry, inventory, shipping and customer database systems) are
Year 2000 compliant, and have been functioning properly in calendar year 2000.
Additionally, we do not believe the risks posed by Year 2000 issues adversely
affected any of our critical vendors and suppliers or our strategic partners. In
addition to the investment of employee time and resources, we estimate that we
spent approximately $130,000 to upgrade certain facility related items for Year
2000 compliance. As a result of our Year 2000 preparedness, the preparedness
efforts of our critical vendors and suppliers and strategic partners, while no
assurances are possible, we currently assess future risks posed by Year 2000
issues as not material to our business.
15
<PAGE>
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, and we expect to incur
losses and we may incur 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 $7.6 million
and $6.0 for the three months ended December 31, 1999 and 1998, respectively. We
expect to incur net losses in the future, and these losses may be substantial.
Further, we may incur negative cash flow in the future particularly to the
extent we complete any acquisition opportunities. Because of continuing
substantial capital expenditures and product development, sales, marketing and
administrative expenses, we will need to generate significant revenues to
achieve profitability and positive cash flow. Even if we do achieve
profitability and positive cash flow, we may not be able to sustain or increase
profitability or cash flow on a quarterly or annual basis.
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:
o Variations in the timing and size of orders for our Internet equipment;
o Our ability to license, and the timing of licenses, of our Web platform
products, particularly site server licenses and Timbuktu Pro;
o The growth rate in the number of Web sites that are built using our Web
platform, from which we derive revenues;
o Loss of significant distributors or customers, or significant decreases or
delays in purchases by significant distributors or customers, such as
Ingram Micro, Softway International, NorthPoint Communications and Covad
Communications;
o 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;
o The price and availability of chip sets, which we obtain from Conexant
Systems, for our DSL Internet equipment;
o The timing and size of expenses, including operating expenses and expenses
of developing new products and product enhancements; and
o Our ability to attract and retain key personnel.
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:
16
<PAGE>
o The timing and rate of deployment of DSL services by telecommunications
service providers;
o The timing and rate of deployment of alternative high-speed data
transmission technologies, such as cable modems and high-speed wireless
data transmission;
o Anticipated price competition in the market for Internet equipment and Web
platform products;
o The level of market penetration of our Internet equipment and Web platform
products relative to those of our competitors; and
o Anticipated increases in competition among producers of Web site
development and Web site server 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:
o Costs associated with future litigation, including litigation relating to
the use or ownership of intellectual property;
o Acquisition costs or other non-recurring charges in connection with the
acquisition of companies, products or technologies;
o Foreign currency and exchange rate fluctuations which may make our
dollar-denominated products more expensive in foreign markets or could
expose us to currency rate fluctuation risks if our sales become
denominated in foreign currencies; and
o 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,
Lucent Technologies, 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, Sitematic, Verio, Yahoo!Geocities 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.
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
17
<PAGE>
recognition and a larger base of customers than we do. In addition, many of our
customers 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
voice over DSL 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 and Nokia's ATM/DSL D50 Speedlink digital
subscriber line 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. For example, in December
1998, we acquired netOctopus and Serus and in October 1999, we acquired StarNet
Technologies, Inc. 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 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.
18
<PAGE>
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 our losses will increase 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 December 31, 1999, our top four
customers who each individually represented at least 5% of our total revenues
accounted for approximately 33% of our total revenues as a group, respectively.
In this period, sales to Northpoint Communications represented approximately 12%
of our total revenues.
Our limited operating history in DSL Internet equipment makes it difficult to
evaluate our prospects.
Our DSL Internet equipment has only recently been introduced. 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 our losses will increase if we cannot continue to
successfully introduce, market and sell our DSL Internet equipment.
A substantial 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 dependent on the selection of Copper Mountain and Nokia DSL
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 equipment manufactured by Copper Mountain Networks. We have
recently introduced our DSL routers for use with DSL central office access
concentrators manufactured by Nokia. If Copper Mountain or Nokia 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:
o A prolonged approval process by service providers, including laboratory
tests, technical trials, marketing trials, initial commercial deployment
and full commercial deployment;
o The development of a viable business model for DSL services, including the
capability to market, sell, install and maintain DSL services;
o Cost constraints, such as installation costs and space and power
requirements at the telecommunications service provider's central office;
19
<PAGE>
o Lack of compatibility of DSL equipment that is supplied by different
manufacturers;
o Evolving industry standards for DSL technologies; and
o 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 NorthPoint
Communications and Covad Communications. We depend upon the ability of such
competitive telecommunications service providers to successfully offer DSL
services. 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 semi-conductor chips for our DSL routers from a limited number
of suppliers.
All of our DSL routers rely on certain semi-conductor 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
semi-conductor 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 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.
20
<PAGE>
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 the independent contractors or
specialized suppliers for any reason, sales of our Internet equipment could be
delayed or halted. 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 our losses will increase if we cannot
successfully introduce, market and sell our Web platform.
A substantial 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 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. 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 success fully 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 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.
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
21
<PAGE>
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 come from sales to international
customers.
A substantial portion of our revenues come from sales to international
customers. We expect sales to international customers to continue to comprise a
significant portion of our revenues. While our international sales are typically
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.
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.
The proceeds we expect to receive for the sale of our LAN Division could be
affected by its future performance under the new owner.
In connection with the sale of our LAN Division in August 1998 to
Farallon Communications, or Farallon, an affiliate of Gores Technology Group, or
Gores, we received consideration which included (i) a two year $1.0 million
promissory note from Farallon, guaranteed by Gores, and (ii) royalties on
Farallon's revenues for a period of five years which are currently recorded on
our balance sheet as an amount receivable of $537,000. Because a substantial
portion of Farallon's products are designed for products sold by Apple Computer,
or Apple, the ability of the buyer to make these payments depends in large part
upon the market for Apple's products.
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
22
<PAGE>
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 90-day limited warranty on our
Timbuktu Pro software and a one-year limited warranty on our Internet equipment.
In addition, we provide end users of our Web sites a free 30-day trial period
after which time end users can cancel at no cost. We permit end users to return
our Internet connectivity equipment, Timbuktu Pro software and Web sites for
replacement or refund of the full purchase price if the products do not perform
as warranted. If a substantial portion of our customers return our products for
replacement or refund, we will lose revenue and our business could be seriously
damaged.
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 indirect damages and similar provisions, we cannot assure you
that such limitations of liability will be legally enforceable.
23
<PAGE>
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:
o Acceptance of and demand for our products;
o The number and timing of acquisitions;
o The costs of developing new products;
o The costs associated with our expansion; and
o 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:
o Variations in our quarterly operating results;
o Changes in securities analysts' estimates of our financial
performance;
o Changes in market valuations of similar companies;
24
<PAGE>
o Announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
o Losses of major customers or the failure to complete significant
licensing transactions;
o Additions or departures of key personnel; and
o 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 initial public offering of our common stock. As of
December 31, 1999, we had cash, cash equivalents and short-term investments
representing 53% of total assets.
Our operating activities used $1.0 million of cash for the three months
ended December 31, 1999 and $3.5 million for the three months ended December 31,
1998. The cash used by operations in the three months ended December 31, 1999
was primarily due to supporting our operating activities as well as the increase
in accounts receivable and inventories, partially offset by an increase in
accounts payable and accrued liabilities. The cash used by operations in the
three months ended December 31, 1998 was primarily due to supporting our
operating activities as well as the increase in accounts receivable and the
reduction of accounts payable and accrued liabilities related to the sale of our
LAN Division.
Cash used in investing activities for the three months ended December 31,
1999 was primarily due to:
o Purchases of short-term investments; and
o The acquisition of StarNet.
Cash provided by investing activities for the three months ended December
31, 1998 was primarily due to proceeds from the sale of short-term investments
partially offset by:
o Purchases of short-term investments; and
o The acquisitions of Serus and netOctopus.
Cash provided by our financing activities for the three months ended
December 31, 1999 and 1998 was primarily related to the exercise of employee
stock options.
25
<PAGE>
Although we believe that our existing cash balance will decrease moderately
during the remainder of fiscal 2000 as a result of increased operating expenses,
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 and in October 1999, we acquired StarNet.
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 December 31, 1999. All of our investments mature in twelve months
or less.
<TABLE>
<CAPTION>
Carrying Average
Principal (notional) amounts in United States dollars: Amount Interest Rate
- ------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Cash equivalents - fixed rate............................. $ 9,150 6.00%
Short-term investments - fixed rate....................... 5.84%
32,918
-------------
$ 42,068
=============
</TABLE>
26
<PAGE>
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
On October 13, 1999 we issued 447,852 shares of our Common Stock as partial
consideration for the acquisition of StarNet Technologies, Inc. In addition to
the issuance of the Common Stock, the consideration we paid included (i) $8.4
million in cash paid on the closing date of the transaction; (ii) 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; and; (iii) the substitution of stock options to purchase 39,311
shares of 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. The shares were issued in reliance on Section 4(2)
of the Securities Act and/or Rule 506 of Regulation D promulgated under the
Securities Act, in part based on the limited number and the nature of the
StarNet shareholders.
Item 6. Exhibits and Reports on Form 8-K
- --------------------------------------------------------------------------------
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
On October 28, 1999, we filed a Form 8-K, with disclosures made under Item
2 "Acquisition of Securities" and Item 7 "Financial Statements and Exhibits," in
connection with our acquisition of StarNet Technologies, Inc.
On December 28, 1999, we filed a Form 8-K/A, with disclosures under Item 5
"Registrants' Audited Consolidated Financial Statements" and Item 7 "Financial
Statements and Exhibits," in connection with our acquisition of StarNet and the
filing of certain other financial information.
The financial statements filed under Item 5 were:
o Netopia, Inc. and Subsidiaries consolidated balance sheets as of
September 30, 1999 and 1998;
o Netopia, Inc. and Subsidiaries consolidated statements of operations
for the years ended September 30, 1999, 1998 and 1997;
o Netopia, Inc. and Subsidiaries consolidated statements of
stockholders' equity for the years ended September 30, 1999, 1998 and
1997;
o Netopia, Inc. and Subsidiaries consolidated statements of cash flows
for the years ended September 30, 1999, 1998 and 1997; and
o Netopia, Inc. and Subsidiaries notes to consolidated statements.
The financial statements filed under Item 7 were:
o StarNet Technologies, Inc. balance sheets as of September 30, 1999 and
1998;
o StarNet Technologies, Inc. statements of operations for the years
ended September 30, 1999 and 1998;
27
<PAGE>
o StarNet Technologies, Inc. statements of stockholders' equity
(deficit) for the years ended September 30, 1999 and 1998;
o StarNet Technologies, Inc. statements of cash flows for the years
ended September 30, 1999 and 1998; and
o StarNet Technologies, Inc. notes to financial statements.
The financial statements filed under Item 7(b) were:
o Netopia, Inc. and Subsidiaries unaudited pro forma condensed balance
sheet as of September 30, 1999; and
o Netopia, Inc. and Subsidiaries unaudited pro forma condensed
consolidated statement of operations for the year ended September 30,
1999.
28
<PAGE>
SIGNATURE
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: February 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)
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> Sep-30-2000
<PERIOD-START> Oct-01-1999
<PERIOD-END> Dec-31-1999
<EXCHANGE-RATE> 1
<CASH> 26,141
<SECURITIES> 32,764
<RECEIVABLES> 12,654
<ALLOWANCES> 931
<INVENTORY> 4,818
<CURRENT-ASSETS> 79,850
<PP&E> 13,679
<DEPRECIATION> 11,010
<TOTAL-ASSETS> 110,335
<CURRENT-LIABILITIES> 12,098
<BONDS> 0
0
0
<COMMON> 16
<OTHER-SE> 97,768
<TOTAL-LIABILITY-AND-EQUITY> 110,335
<SALES> 16,292
<TOTAL-REVENUES> 16,292
<CGS> 8,561
<TOTAL-COSTS> 8,561
<OTHER-EXPENSES> 16,998
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (828)
<INCOME-PRETAX> (6,462)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,609)
<DISCONTINUED> 1,147
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,462)
<EPS-BASIC> (0.40)
<EPS-DILUTED> (0.40)
</TABLE>
