<PAGE> 1
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 September 28, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 333-15627
NETERGY NETWORKS, INC.
Delaware 77-0142404
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2445 Mission College Blvd.
Santa Clara, CA 95054
(408) 727-1885
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 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 [ ]
The number of shares of the Registrant's Common Stock outstanding as of November
10, 2000 was 25,408,221.
The exhibit index begins on page 34.
<PAGE> 2
NETERGY NETWORKS, INC.
INDEX
<TABLE>
<CAPTION>
Page
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
September 30, 2000 and March 31, 2000.....................................1
Condensed Consolidated Statements of Operations
for the three and six months ended September 30, 2000 and 1999............2
Condensed Consolidated Statements of Cash Flows
for the six months ended September 30, 2000 and 1999......................3
Notes to Unaudited Condensed Consolidated Financial Statements................4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.............................................................9
Item 3. Quantitative and Qualitative Disclosures about Market Risk..................19
PART II- OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds....................................32
Item 4. Submission of Matters to a Vote of Security Holders..........................33
Item 6. Exhibits and Reports on Form 8-K............................................34
Signatures...........................................................................34
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NETERGY NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
<TABLE>
<CAPTION>
September 30, March 31,
2000 2000
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............. $ 43,200 $ 48,576
Accounts receivable, net .............. 2,362 2,394
Inventory ............................. 1,136 1,367
Prepaid expenses and other assets ..... 4,302 1,043
--------- ---------
Total current assets ................ 51,000 53,380
Property and equipment, net ............. 5,254 2,687
Intangibles and other assets ............ 39,778 3,136
Deferred debt issuance costs ............ 636 780
--------- ---------
$ 96,668 $ 59,983
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ...................... $ 2,658 $ 1,887
Accrued compensation .................. 2,380 2,154
Accrued warranty ...................... 572 694
Deferred revenue ...................... 5,322 731
Other accrued liabilities ............. 2,218 1,629
--------- ---------
Total current liabilities .......... 13,150 7,095
Long-term debt ........................ 810 --
Convertible subordinated debentures ... 5,868 5,498
--------- ---------
Total liabilities .................. 19,828 12,593
--------- ---------
Stockholders' equity:
Common stock .......................... 27 23
Additional paid-in capital ............ 149,353 101,559
Notes receivable from stockholders .... (43) (69)
Deferred compensation ................. (564) (376)
Cumulative translation adjustment ..... 10 --
Accumulated deficit ................... (71,943) (53,747)
--------- ---------
Total stockholders' equity .............. 76,840 47,390
--------- ---------
$ 96,668 $ 59,983
========= =========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
<PAGE> 4
NETERGY NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Product revenues .......................... $ 2,604 $ 5,214 $ 7,574 $ 10,774
License and other revenues ................ 842 1,496 1,695 1,830
Service revenues .......................... 446 -- 446 --
------- -------- -------- --------
Total revenues ................... 3,892 6,710 9,715 12,604
Cost of product revenues .................. 1,258 1,388 2,794 4,741
Cost of license and other revenues ........ 69 58 111 58
Cost of service revenues .................. 438 -- 438 --
-------- -------- -------- --------
Gross profit .............................. 2,127 5,264 6,372 7,805
-------- -------- -------- --------
Operating expenses:
Research and development .............. 4,788 2,860 9,002 5,283
Selling, general and administrative ... 4,728 3,786 8,427 7,373
In-process research and development ... 4,563 -- 4,563 10,100
Amortization of intangibles ........... 3,573 185 3,763 235
-------- -------- -------- --------
Total operating expenses .......... 17,652 6,831 25,755 22,991
-------- -------- -------- --------
Loss from operations ...................... (15,525) (1,567) (19,383) (15,186)
Other income, net ......................... 918 195 1,894 2,076
Interest expense .......................... (364) -- (695) --
-------- -------- -------- --------
Loss before provision for income taxes .... (14,971) (1,372) (18,184) (13,110)
Provision for income taxes ................ -- 66 12 66
-------- -------- -------- --------
Net loss .................................. $(14,971) $ (1,438) $(18,196) $(13,176)
======== ======== ======== ========
Net loss per basic and diluted share ...... $ (0.60) $ (0.08) $ (0.77) $ (0.77)
Basic and diluted shares outstanding ...... 24,923 17,886 23,688 17,074
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE> 5
NETERGY NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
<TABLE>
<CAPTION>
Six months ended
September 30,
-----------------------
2000 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss .................................................. $(18,196) $(13,176)
Adjustment to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ......................... 1,091 819
Amortization of deferred compensation ................. 625 70
Amortization of debt discount ......................... 370 --
Amortization of intangibles ........................... 3,764 --
Purchased in-process research and development ......... 4,563 10,100
Gain on sale of investments, net ...................... (225) (1,687)
Other ................................................. 69 --
Net effect of changes in current and other assets
and current liabilities, net of businesses acquired ....... (2,205) 3,012
-------- --------
Net cash used in operating activities .................. (10,144) (862)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment ....................... (2,475) (627)
Proceeds from sale of nonmarketable equity investment ..... 225 1,880
Cash paid for acquisitions, net ........................... (493) (120)
Proceeds from disposition of business, net ................ 5,160 --
-------- --------
Net cash provided by investing activities .............. 2,417 1,133
-------- --------
Cash flows from financing activities:
Long-term debt repayment .................................. (74) --
Proceeds from issuance of common stock .................... 2,399 448
Loan to stockholders ...................................... -- (76)
Repayment of notes receivable from stockholders ........... 26 74
-------- --------
Net cash provided by financing activities ............. 2,351 446
-------- --------
Net (decrease) increase in cash and cash equivalents ......... (5,376) 717
Cash and cash equivalents at the beginning of the period ..... 48,576 15,810
-------- --------
Cash and cash equivalents at the end of the period ........... $ 43,200 $ 16,527
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE> 6
NETERGY NETWORKS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
1. DESCRIPTION OF THE BUSINESS
Netergy Networks, Inc. (the "Company") was incorporated in California in
February 1987. In December 1996, the Company was reincorporated in Delaware and
in August 2000 the Company officially changed its' name from 8x8, Inc. to
Netergy Networks, Inc.
We develop and market prepackaged Internet Protocol (IP) network
services, an open service creation environment and embedded network appliance
technology for converged voice and data networks. We market our embedded network
appliance technology products mainly to telecommunications equipment
manufacturers. We market our IP network services, including our Netergy iPBX and
Unified Messaging solutions, as well as our open service creation environment,
to both telecommunications equipment manufacturers and to emerging
communications service providers.
In addition, until May 19, 2000, the Company developed and marketed
remote video monitoring systems to dealers and distributors of security
products. See Note 6 regarding the sale of net assets and the license of certain
related technologies associated with the Company's video monitoring business.
2. BASIS OF PRESENTATION
Our fiscal year ends on the last Thursday on or before March 31. Fiscal
2001 will be a 52 week year, while fiscal 2000 was a 53 week year. Our fiscal
quarters end on the last Thursday of each calendar quarter. The three and six
month periods ended September 28, 2000 included 13 weeks and 26 weeks of
operations, respectively. The three and six month periods ended September 30,
1999 included 14 and 27 weeks of operations, respectively. For purposes of these
condensed consolidated financial statements, we have indicated our fiscal year
as ending on March 31 and our interim periods as ending on September 30.
The accompanying interim condensed consolidated financial statements are
unaudited and have been prepared on substantially the same basis as our annual
financial statements for the fiscal year ended March 31, 2000. In the opinion of
management, these financial statements reflect all adjustments (consisting only
of normal recurring accruals) considered necessary for a fair statement of our
financial position, results of operations and cash flows for the periods
presented. These financial statements should be read in conjunction with our
audited financial statements for the year ended March 31, 2000, including notes
thereto, included in our fiscal 2000 Annual Report on Form 10-K.
The results of operations and cash flows for the interim periods
included in these financial statements are not necessarily indicative of the
results to be expected for any future period or the entire fiscal year.
4
<PAGE> 7
3. BALANCE SHEET DETAIL
(in thousands)
<TABLE>
<CAPTION>
September 30, March 31,
2000 2000
------------- ----------
<S> <C> <C>
Inventory:
Raw materials .......... 338 65
Work-in-process ........ 633 797
Finished goods ......... 165 505
------ ------
$1,136 $1,367
====== ======
</TABLE>
4. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing net income
(loss) available to common stockholders (numerator) by the weighted average
number of common and vested, unrestricted Exchangeable Shares (see Note 7)
outstanding during the period (denominator). Diluted net income (loss) per share
is computed using the weighted average number of common shares and potential
common shares outstanding during the period. Potential common shares result from
the assumed exercise, using the treasury stock method, of common stock options,
convertible subordinated debentures, warrants and unvested, restricted common
stock and Exchangeable Shares having a dilutive effect. The numerators for each
period presented are equal to the reported net loss. Additionally, due to net
losses incurred for all periods presented, weighted average basic and diluted
shares outstanding for the respective three and six month periods are the same.
The following equity instruments were not included in the computations of net
income (loss) per share because the effect on the calculations would be
anti-dilutive (in thousands):
<TABLE>
<CAPTION>
Three and Six Months Ended
September 30,
--------------------------
2000 1999
------ ------
<S> <C> <C>
Common stock options ...................... 6,743 3,918
Convertible subordinated debentures ....... 638 --
Warrants .................................. 701 --
Unvested restricted common stock .......... 143 620
Unvested restricted Exchangeable Shares ... 2,108 --
------ ------
10,333 4,538
====== ======
</TABLE>
5. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss), as defined, includes all changes in equity
(net assets) during a period from non-owner sources. For us, the primary
differences between net income (loss) and comprehensive income (loss) are gains
and losses on short-term investments classified as available-for-sale and
cumulative translation adjustments resulting from exchange rate gains and
losses. Comprehensive losses for the current reporting and comparable periods in
the prior year are as follows (in thousands):
5
<PAGE> 8
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
----------------------- -----------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net loss, as .......................... $(14,971) $( 1,438) $(18,196) $(13,176)
reported
Unrealized gain on investments ........ -- -- -- 193
Cumulative translation adjustments .... 10 -- 10 --
-------- -------- -------- --------
Comprehensive loss .................... $(14,961) $( 1,438) $(18,186) $(12,983)
======== ======== ======== ========
</TABLE>
6. DISPOSITION OF VIDEO MONITORING BUSINESS
On May 19, 2000, the Company entered into an Asset Purchase Agreement
with Interlogix, Inc. ("Interlogix") providing for the sale of certain assets
comprising the Company's video monitoring business (the "Business") to
Interlogix. The assets sold included certain accounts receivable, inventories,
technical information, machinery, equipment, contract rights, intangibles,
records and supplies. Concurrently with the execution of the Asset Purchase
Agreement, the Company and Interlogix entered into a Technology License
Agreement ("License Agreement") providing for the licensing of certain related
intellectual property to Interlogix, a Development Agreement providing
Interlogix continuing rights in certain products to be developed by the Company,
a Transition Services Agreement providing for certain services to be rendered by
the Company to Interlogix in respect of the Business, and a Supply Agreement
providing for the continuing sale of certain products to Interlogix by the
Company. The aggregate purchase price paid by Interlogix was approximately $5.2
million in cash.
At September 30, 2000, the Company's continuing obligations under the
above noted agreements include (1) providing future updates and upgrades to the
licensed technology, if any, over the initial three-year term of the License
Agreement, (2) certain warranty obligations related to video monitoring products
manufactured prior to May 19, 2000, and (3) certain potential obligations
("Development Obligations") under the Development Agreement. Upon satisfactory
completion of the Development Obligations, the Company will commence recognition
of the resulting net gain of approximately $3.9 million, which has been recorded
as deferred revenue, over the remaining term of the License Agreement.
7. ACQUISITION OF U|FORCE
The Company's condensed consolidated financial statements reflect the
acquisition of U|Force Inc., a developer of IP-based software applications (such
as unified messaging) and provider of professional services, based in Montreal,
Canada. U|Force is also developing a Java-based open service creation
environment (SLCE) that is being designed to allow telecommunication service
providers to develop, deploy and manage telephony applications and services to
their customers. The Company intends to integrate the products currently being
developed by U|Force into its IP telephony solutions product line. The Company
closed the acquisition of UForce on June 30, 2000 for a total purchase price of
approximately $46.8 million in a transaction to be accounted for as a purchase.
The Company issued or will issue 3,555,303 shares of Netergy Networks common
stock, with a fair value of approximately $38.0 million, for all of the
outstanding stock of U|Force. The share total is comprised of 1,447,523 shares
issued at closing of the acquisition and 2,107,780 shares
6
<PAGE> 9
that will be issued upon the exchange or redemption of the exchangeable shares
(the "Exchangeable Shares") of Canadian entities held by former shareholders or
indirect owners of U|Force stock. All of the Exchangeable Shares are held by
U|Force employees and are subject to certain restrictions, including the
Company's right to repurchase the Exchangeable Shares if an employee departs
prior to vesting. In addition, the Company agreed to create a Special Voting
Share that provides holders of Exchangeable Shares with voting rights that are
equivalent to the shares of common stock into which their shares are
convertible. The common stock was valued using the Company's average stock price
on May 19, 2000, the date the merger agreement was announced, including the
prices of the stock four days before and four days after the announcement. The
average price was $10.70. Netergy Networks also assumed outstanding stock
options to purchase 1,023,898 shares of common stock for which the Black-Scholes
option-pricing model value of approximately $6.6 million will be included in the
purchase price. Direct transaction costs related to the merger are estimated to
be approximately $653,000. Additionally, the Company advanced $1.5 million to
U|Force upon signing the agreement, but prior to the close of the transaction.
The purchase price has been allocated to tangible assets acquired and
liabilities assumed based on the book value of U|Force's assets and liabilities,
which we believe approximates their fair value. In addition, we engaged an
independent appraiser to value the intangible assets, including amounts
allocated to U|Force's in-process research and development. The in-process
research and development relates to UForce's initial products, Unified Messaging
and the open service creation environment (the "SLCE"), for which technological
feasibility has not been established. The estimated percentage complete for the
Unified Messaging and SLCE products was approximately 44% and 34%, respectively,
at June 30, 2000. The fair value of the in-process technology was based on a
discounted cash flow model, similar to the traditional "Income Approach," which
discounts expected future cash flows to present value, net of tax. In developing
cash flow projections, revenues were forecasted based on relevant factors,
including aggregate revenue growth rates for the business as a whole,
characteristics of the potential market for the technology and the anticipated
life of the technology. Projected annual revenues for the in-process research
and development projects were assumed to ramp up initially and decline
significantly at the end of the in-process technology's economic life. Operating
expenses and resulting profit margins were forecasted based on the
characteristics and cash flow generating potential of the acquired in-process
technologies. Associated risks include the inherent difficulties and
uncertainties in completing the projects and thereby achieving technological
feasibility, and risks related to the impact of potential changes in market
conditions and technology. The resulting estimated net cash flows have been
discounted at a rate of 25%. This discount rate was based on the estimated cost
of capital plus an additional discount for the increased risk associated with
in-process technology. Based on a preliminary appraisal, the value of the
acquired U|Force in-process research and development, which was expensed in the
second quarter of fiscal 2001, is approximately $4.6 million. The excess of the
purchase price over the net tangible and intangible assets acquired and
liabilities assumed has been allocated to goodwill. Amounts allocated to
goodwill, the value of an assumed distribution agreement and workforce are being
amortized on a straight-line basis over three, three and two years,
respectively.
7
<PAGE> 10
The allocation of the purchase price is as follows (in thousands):
<TABLE>
<S> <C>
In-process research and development $ 4,563
Distribution agreement 1,053
Workforce 1,182
U|Force net tangible assets 1,801
Goodwill 38,155
-------
$46,754
=======
</TABLE>
The consolidated results of the Company include the results of the
operations of U|Force from the date of the acquisition, i.e., June 30, 2000, the
beginning of our second quarter of fiscal 2001. Had the acquisition of U|Force
taken place as of the beginning of the current fiscal year, the Company's pro
forma revenue, net loss, and net loss per share would have been $10.2 million,
$23.2 million and $.95, respectively.
8. SEGMENT REPORTING
Due to a change in the Company's organizational structure during its
second quarter of fiscal 2000, the Company determined that it had two reportable
segments, Broadband Communications and Video Monitoring, as defined by Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information." The Broadband Communications segment was
comprised of revenues and direct expenses associated with sales of the Company's
products, licensed software and professional services focused on the IP
telephony and videoconferencing markets. The Video Monitoring segment was
comprised of revenues and direct expenses associated with sales of the Company's
products focused on the video monitoring market. However, due to the sale of the
Company's video monitoring business effective May 19, 2000, as discussed above
in Note 6, the Company now only has one reportable operating segment.
The following illustrates net revenues by groupings of similar products
(in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
-------------------- --------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Videoconferencing semiconductors ...... $ 2,397 $ 2,704 $ 5,959 $ 5,244
IP telephony semiconductors ........... 43 4 315 5
Media Hub systems ..................... 164 66 381 99
Video monitoring systems .............. -- 1,392 919 2,900
Consumer videophone systems ........... -- 1,048 -- 2,526
------- ------- ------- -------
Total product revenues ............. 2,604 5,214 7,574 10,774
------- ------- ------- -------
Videoconferencing ..................... 451 1,485 1,164 1,813
Video monitoring software ............. -- -- 44 --
IP telephony .......................... 391 11 487 17
------- ------- ------- -------
Total license and other revenues ... 842 1,496 1,695 1,830
------- ------- ------- -------
Professional services ................. 446 -- 446 --
------- ------- ------- -------
Total revenues .................... $ 3,892 $ 6,710 $ 9,715 $12,604
======= ======= ======= =======
</TABLE>
8
<PAGE> 11
9. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133 ("FAS 133"), "Accounting for
Derivative Instruments and Hedging Activities." FAS 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000 pursuant to the
issuance of FAS 137, "Accounting for Derivative Instruments and Hedging
Activities -- Deferral of the Effective Date of FASB Statement No. 133," which
deferred the effective date of FAS 133 by one year. FAS 133 establishes methods
of accounting for derivative financial instruments and hedging activities
related to those instruments as well as other hedging activities. The Company
does not expect that the adoption of FAS 133 will have a material impact on its
consolidated financial statements.
In March 2000, the FASB issued Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions involving Stock Compensation, an
interpretation of APB Opinion No. 25." FIN 44 clarifies the application of APB
25 for certain issues including: (a) the definition of employee for purposes of
applying APB 25, (b) the criteria for determining whether a plan qualifies as a
noncompensatory plan, (c) the accounting consequence 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 combination. In
general, FIN 44 became effective July 1, 2000. The adoption of FIN 44 did not
have a material effect on our consolidated financial position or results of
operations.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on applying generally accepted accounting
principles to revenue recognition issues in financial statements. The Company is
required to adopt SAB 101 by no later than the fourth quarter of fiscal 2001.
The Company has reviewed SAB 101 and believes it should not have a significant
impact on its revenue recognition practices.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Statements contained in this Report on Form 10-Q that are not purely historical
are forward-looking statements within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act, including without limitation
statements regarding our expectations, beliefs, estimates, intentions or
strategies regarding the future, our planned integration of U|Force products
into our IP telephony product solutions, our research and development plans, our
sales and administrative costs, our in-process research and development expenses
and the sufficiency of our cash position. All forward-looking statements
included in this Report on Form 10-Q are based on information available to us on
the date hereof, and we assume no obligation to update any such forward-looking
statements. You should not place undue reliance on these forward-looking
statements. Our actual results could differ materially from those anticipated in
these forward-looking statements as a result of a number of factors, including,
but not limited to, those set forth
9
<PAGE> 12
below under the heading "Factors That May Affect Future Results" and elsewhere
in this Report on Form 10-Q.
Overview
We began developing multimedia communication technology in the form of
programmable multimedia semiconductors and accompanying software in 1990, and
have subsequently become a leading manufacturer of semiconductors for the
embedded videoconferencing and videophone markets. We maintain sales and
marketing operations to support our videoconferencing semiconductor business,
but we have focused virtually all of our ongoing research and development
efforts on IP telephony products and technologies.
In an effort to expand the available market for our multimedia
communication products, and to capitalize on our vertically integrated
technology, we began developing low-cost consumer videophones and marketing
these products to consumers under the ViaTV brand name in 1997. Over the next
two years, we became a leading manufacturer of consumer videophones. However, in
1999 we determined that a combination of factors including the high cost of
maintaining a consumer distribution channel, the slower than expected growth
rate of the consumer videophone market, and the low gross margins typical of a
consumer electronics product made it unlikely that the consumer videophone
business would be profitable in the foreseeable future. Therefore, we announced
in April 1999 that we would cease production of the ViaTV product line and
withdraw from our ViaTV distribution channels over the subsequent several
quarters, resulting in a charge of $5.7 million related to the write off of
ViaTV inventories. We completed the exit from the consumer videophone business
during fiscal 2000 and we expect no further revenues from ViaTV products.
In June 1998, using technology designed for our consumer videophone
business, we entered the video monitoring market with our RSM (remote
surveillance module) line of video monitoring products, focusing on security
applications for small businesses. Until recently, we sold our video monitoring
products primarily to security distributors and dealers in North America and
Europe. However, in an effort to align our strategic focus on the IP telephony
market, we announced the sale of our entire video monitoring business to
Interlogix, a leading manufacturer of security equipment, in May 2000. We have
fully transitioned our video monitoring operations to Interlogix and expect no
further revenues from this business.
We entered the market for embedded IP telephony products in December
1998 with the announcement of our Audacity Internet Telephony Processor. The
Audacity processor combines IP telephony protocol support with audio
compression/decompression capability and runs multiple simultaneous IP phone
calls on a single integrated circuit. In April 1999, we announced our Netergy
Media Hub (formerly known as the Symphony module), an integrated system product
that is based on the Audacity semiconductor and that connects up to four analog
telephone lines to an IP network. In September 1999, we announced our
Audacity-T2 IP Phone Processor, which combines all the digital processing
required to implement an IP telephone onto a single integrated circuit. In
February 2000, we announced our Veracity software which includes all the call
control protocol stacks, network transport software, and audio modules necessary
to build a complete voice-over-
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<PAGE> 13
packet terminal or gateway. Our embedded IP telephony products target OEM
manufacturers of IP telephony equipment, such as voice-enabled cable and DSL
modems, as well as IP phones and gateways.
In May 1999, we acquired Odisei S.A., a privately held developer of IP
telephony software based in Sophia Antipolis, France. We have leveraged the
acquisition of Odisei to develop and market IP telephony solutions to
communication service providers such as competitive local exchange carriers
(CLECs). In March 2000 the Company announced its Netergy Advanced Telephony
System (ATS), an all-IP hosted iPBX solution that is being designed to allow
service providers to offer dial tone and advanced private branch exchange (PBX)
services to business customers over any broadband IP connection, including DSL,
cable, T1/E1 and broadband wireless. The ATS makes use of our embedded IP
telephony products, including the Netergy Media Hub, semiconductors and embedded
IP telephony software.
The Company's condensed consolidated financial statements reflect the
acquisition of U|Force Inc., a developer of IP-based software applications (such
as unified messaging) and provider of professional services, based in Montreal,
Canada. U|Force is also developing a Java-based open service creation
environment (SLCE) that is being designed to allow telecommunication service
providers to develop, deploy and manage telephony applications and services to
their customers. The Company intends to integrate the products currently being
developed by U|Force into its IP telephony solutions product line. The Company
closed the acquisition of UForce on June 30, 2000 for a total purchase price of
approximately $46.8 million in a transaction to be accounted for as a purchase.
The Company issued or will issue 3,555,303 shares of Netergy Networks common
stock, with a fair value of approximately $38.0 million, for all of the
outstanding stock of U|Force. The share total is comprised of 1,447,523 shares
issued at closing of the acquisition and 2,107,780 shares that will be issued
upon the exchange or redemption of the exchangeable shares (the "Exchangeable
Shares") of Canadian entities held by former shareholders or indirect owners of
U|Force stock. All of the Exchangeable Shares are held by U|Force employees and
are subject to certain restrictions, including the Company's right to repurchase
the Exchangeable Shares if an employee departs prior to vesting. In addition,
the Company agreed to create a Special Voting Share that provides holders of
Exchangeable Shares with voting rights that are equivalent to the shares of
common stock into which their shares are convertible. The common stock was
valued using the Company's average stock price on May 19, 2000, the date the
merger agreement was announced, including the prices of the stock four days
before and four days after the announcement. The average price was $10.70.
Netergy Networks also assumed outstanding stock options to purchase 1,023,898
shares of common stock for which the Black-Scholes option-pricing model value of
approximately $6.6 million will be included in the purchase price. Direct
transaction costs related to the merger are estimated to be approximately
$653,000. Additionally, the Company advanced $1.5 million to U|Force upon
signing the agreement, but prior to the close of the transaction.
The purchase price has been allocated to tangible assets acquired and
liabilities assumed based on the book value of U|Force's assets and liabilities,
which we believe approximates their fair value. In addition, we engaged an
independent appraiser to value the intangible assets, including amounts
allocated to U|Force's in-process research and development. The in-process
research and development relates to UForce's initial
11
<PAGE> 14
products, Unified Messaging and the open service creation environment (the
"SLCE"), for which technological feasibility has not been established. The
estimated percentage complete for the Unified Messaging and SLCE products was
approximately 44% and 34%, respectively, at June 30, 2000. The fair value of the
in-process technology was based on a discounted cash flow model, similar to the
traditional "Income Approach," which discounts expected future cash flows to
present value, net of tax. In developing cash flow projections, revenues were
forecasted based on relevant factors, including aggregate revenue growth rates
for the business as a whole, characteristics of the potential market for the
technology and the anticipated life of the technology. Projected annual revenues
for the in-process research and development projects were assumed to ramp up
initially and decline significantly at the end of the in-process technology's
economic life. Operating expenses and resulting profit margins were forecasted
based on the characteristics and cash flow generating potential of the acquired
in-process technologies. Associated risks include the inherent difficulties and
uncertainties in completing the projects and thereby achieving technological
feasibility, and risks related to the impact of potential changes in market
conditions and technology. The resulting estimated net cash flows have been
discounted at a rate of 25%. This discount rate was based on the estimated cost
of capital plus an additional discount for the increased risk associated with
in-process technology. Based on a preliminary appraisal, the value of the
acquired U|Force in-process research and development, which was expensed in the
second quarter of fiscal 2001, is approximately $4.6 million. The excess of the
purchase price over the net tangible and intangible assets acquired and
liabilities assumed has been allocated to goodwill. Amounts allocated to
goodwill, the value of an assumed distribution agreement and workforce are being
amortized on a straight-line basis over three, three and two years,
respectively. The allocation of the purchase price is as follows (in thousands):
<TABLE>
<S> <C>
In-process research and development $ 4,563
Distribution agreement 1,053
Workforce 1,182
U|Force net tangible assets 1,801
Goodwill 38,155
-------
$46,754
=======
</TABLE>
Lastly, in August 2000 we officially changed our name to Netergy
Networks, Inc. The name change reflects our strategic transition to the IP
telephony market.
12
<PAGE> 15
RESULTS OF OPERATIONS
The following table sets forth consolidated statement of operations data
expressed as percentages of total revenue for the three and six month periods
ended September 30, 2000 and 1999, respectively. Cost of revenues are presented
as a percentage of each respective revenue category.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Product revenues 67% 78% 78% 85%
License and other revenues 22% 22% 17% 15%
Service revenues 11% -- 5% --
---- ---- ---- ----
Total revenues 100% 100% 100% 100%
---- ---- ---- ----
Cost of product revenues 48% 27% 37% 44%
Cost of license and other revenues 8% 4% 7% 3%
Cost of service revenues 98% -- 98% --
---- ---- ---- ----
Total cost of revenues 45% 22% 34% 38%
---- ---- ---- ----
Gross profit 55% 78% 66% 62%
---- ---- ---- ----
Operating expenses:
Research and development 123% 43% 93% 42%
Selling, general and administrative 121% 56% 87% 58%
In-process research and development 117% -- 47% 80%
Amortization of intangibles 92% 3% 39% 2%
---- ---- ---- ----
Total operating expenses 453% 102% 266% 182%
---- ---- ---- ----
Loss from operations (398%) (24%) (200%) (120%)
Other income, net 24% 3% 19% 16%
Interest expense (9%) -- (7%) --
---- ---- ---- ----
Loss before income taxes (383%) (21%) (188%) (104%)
Provision for income taxes -- 1% -- 1%
---- ---- ---- ----
Net loss (383%) (22%) (188%) (105%)
==== ==== ==== ====
</TABLE>
The following discussion should be read in conjunction with our
Condensed Consolidated Statements of Operations and the notes thereto:
Revenues
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
------------------------------------- ------------------------------------
2000 1999 2000 1999
--------------- ----------------- --------------- ----------------
($ in millions)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Product revenues:
Videoconferencing semiconductor $ 2.4 $ 2.7 $ 6.0 $ 5.3
IP telephony semiconductor and 0.2 0.1 0.7 0.1
Media Hub
Video monitoring -- 1.4 0.9 2.9
Consumer videophone -- 1.0 -- 2.5
----- ----- ----- ----- ----- ----- ----- -----
Total product revenues 2.6 67% 5.2 78% 7.6 78% 10.8 86%
License and other revenues:
Videoconferencing 0.5 1.5 1.2 1.8
IP telephony 0.4 -- 0.5 --
----- ----- ----- ----- ----- ----- ----- -----
Total license and other revenues 0.9 23% 1.5 22% 1.7 18% 1.8 14%
Service revenues 0.4 10% -- -- 0.4 4% --
----- ----- ----- ----- ----- ----- ----- -----
Total revenues $ 3.9 100% $ 6.7 100% $ 9.7 100% $12.6 100%
===== ===== ===== ===== ===== ===== ===== =====
</TABLE>
13
<PAGE> 16
Total product revenues decreased by $2.6 million in the second quarter
of fiscal 2001, as compared to the second quarter of fiscal 2000, and decreased
by $3.2 million in the first six months of fiscal 2001 as compared to the same
period in the prior year. The decrease in current quarter and year to date
product revenues is due primarily to significantly lower ViaTV product revenue,
resulting from our decision in fiscal 1999 to exit the consumer videophone
market, a decrease in video monitoring product revenues due to the sale of our
video monitoring business on May 19, 2000, and lower average selling prices or
ASPs on sales of our videoconferencing semiconductors. These decreases were
partially offset by increases in unit shipments of our videoconferencing
semiconductor, IP telephony semiconductor and Netergy Media Hub products.
License and other revenues consist of technology licenses, including
royalties required under such licenses, and nonrecurring engineering fees for
services performed by us for our customers. License and other revenues decreased
by approximately $600,000 in the second quarter of fiscal 2001 as compared to
the second quarter of fiscal 2000, and decreased by $100,000 in the first six
months of fiscal 2001 as compared to the first six months of fiscal 2000. The
decrease in current quarter and year to date license and other revenues is due
to a decrease in licensing activities associated with our videoconferencing
technology, offset by an increase in IP telephony license revenues related to
the sale of Netergy ATS evaluation systems and the license of our Veracity
software.
Service revenue represents a new source of revenue resulting from the
integration of U|Force's professional services organization during the current
quarter.
Revenue recognized from one customer represented approximately 13% of
our current quarter revenue. No customer represented 10% or more of our total
revenues for the six month period ended September 30, 2000. No customer
represented 10% or more of our total revenues for the quarter or six month
periods ended September 30, 1999.
Revenues derived from customers outside of North America as a percentage
of total revenue are indicated on the chart below:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
------------------ -----------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Asia Pacific 23% 21% 30% 19%
Europe 15% 21% 25% 22%
-- -- -- --
Total 38% 42% 55% 41%
== == == ==
</TABLE>
Cost of Revenues and Gross Profit
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
----------------------- -----------------------
2000 1999 2000 1999
------- ------- ------- -------
($ in millions)
<S> <C> <C> <C> <C>
Gross profit from product revenues $ 1.3 $ 3.9 $ 4.7 $ 6.1
Gross margin 50% 75% 63% 56%
Gross profit from license and other revenues 0.7 1.4 1.6 1.7
Gross margin 88% 93% 94% 94%
</TABLE>
14
<PAGE> 17
The cost of product revenues consists of costs associated with
components, semiconductor wafer fabrication, system and semiconductor assembly
and testing performed by third-party vendors and direct and indirect costs
associated with purchasing, scheduling and quality assurance. Gross profit from
product revenues was approximately $1.3 million and $3.9 million for the
quarters ended September 30, 2000 and 1999, respectively. Product gross margin
decreased from 75% in the quarter ended September 30, 1999 to 50% in the current
quarter principally due to higher than expected selling prices and lower
product costs realized during the quarter ended September 30, 1999 on our ViaTV
product line and a decrease in average selling prices on our videoconferencing
semiconductors in the current quarter as compared to the prior year. These
factors were partially offset by favorable shift in product mix.
Gross profit from product revenues decreased from $6.1 million for the
six month period ended September 30, 2000 to $4.7 million during the same period
of the prior year, however, gross margin increased from 56% to 63%. This was due
mainly to a larger percentage of total revenues coming from sales of higher
margin videoconferencing semiconductors, offset by the impact of the movement in
inventory reserves noted above.
Gross profit from license and other revenues, all of which are
considered nonrecurring, was $700,000 and $1.4 million in the fiscal quarters
ended September 30, 2000 and 1999, respectively. The gross margin decreased from
93% during the three months ended September 30, 1999 to 88% in the same quarter
of the current fiscal year. During the six month periods ended September 30,
2000 and 1999 gross profit from license and other revenue decreased slightly to
$1.6 million from $1.7 million but gross margin remained unchanged at 94%. There
can be no assurance that we will receive any revenues from such license and
other revenue sources in the future.
Gross profit from service revenues was $8,000 with a resulting gross
margin of 2% during the most recent quarter. This is a result of lower than
expected utilization of our professional services resources.
Our gross margin is affected by a number of factors including, product
mix, the recognition of license and other revenues for which there may be no or
little corresponding cost of revenues, product pricing, the allocation between
international and domestic sales, the percentage of direct sales and sales to
resellers, the utilization levels of our professional services resources, and
manufacturing and component costs. The markets for our products are
characterized by falling average selling prices. We expect that, as a result of
competitive pressures and other factors, gross profit as a percentage of revenue
for our videoconferecing semiconductor products will likely decrease for the
foreseeable future. Because the market is emerging, the average selling price
for IP telephony semiconductors and Netergy Media Hubs is uncertain. We may not
be able to attain average selling prices ("ASPs") for IP telephony
semiconductors similar to those of our historical videoconferencing
semiconductors. If ASPs for IP telephony semiconductors are lower, gross margins
will be lower than our historical gross margins, unless costs for IP telephony
semiconductors are also proportionately lower. In the likely event that we
encounter significant price competition in the markets for our products, we
could be at a significant
15
<PAGE> 18
disadvantage compared to our competitors, many of whom have substantially
greater resources, and therefore may be better able to withstand an extended
period of downward pricing pressure.
Research and Development Expenses
Research and development expenses consist primarily of personnel, system
prototype design and fabrication, mask, prototype wafer and equipment costs
necessary for us to conduct our development efforts. Research and development
costs, including software development costs, are expensed as incurred. Research
and development expenses increased by $1.9 million in the second quarter of
fiscal 2001 as compared to the second quarter of fiscal 2000, and increased by
approximately $3.7 million in the first six months of fiscal 2001 as compared to
the first six months of fiscal 2000.
Higher research and development expenses during the three months ended
September 30, 2000 as compared to the comparable period in the prior year
primarily reflects increases in new personnel, partly through the acquisition of
U|Force, as well as higher consulting expenses associated with development of
the graphical user interface for the Netergy ATS product, and higher
depreciation and maintenance expenses as a result of additional lab equipment
and computer aided design tools.
Higher research and development expenses during the six months ended
September 30, 2000 as compared to the comparable period in the prior year
primarily reflects increases in new personnel, partly through the acquisition of
U|Force, as well as higher consulting expenses associated with development of
the graphical user interface for the Netergy ATS product, mask charges
associated with Audacity-T2 development, higher depreciation and maintenance
expenses as a result of additional lab equipment and computer aided design tools
and a stock compensation charge of approximately $300,000 related to the
acceleration of stock option vesting pursuant to an existing bonus program.
We expect to continue to allocate substantial resources to research and
development. However, future research and development costs may vary both in
absolute dollars and as a percentage of total revenues.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of
personnel and related overhead costs for sales, marketing, finance, human
resources and general management. Such costs also include sales commissions,
trade show, advertising and other marketing and promotional expenses. Selling,
general and administrative expenses were $4.7 million and $3.8 million in the
second quarters of fiscal 2001 and 2000, respectively, and $8.4 million and $7.4
million in the six month periods ended September 30, 2000 and 1999,
respectively.
The significant increase in selling, general and administrative expenses
during the quarter ended September 30, 2000 as compared to the comparable period
in the prior year is primarily attributable to increased expenses associated
with the integration of the existing U|Force sales, marketing, finance and
corporate organizations pursuant to our acquisition of U|Force on June 30, 2000.
16
<PAGE> 19
The significant increase in selling, general and administrative expenses
during the six months ended September 30, 2000 as compared to the comparable
period in the prior year is also primarily attributable to increased expenses
associated with the integration of the existing U|Force sales, marketing,
finance and corporate organizations. Additionally, expenses increased during the
six months ended September 30, 2000 compared to the corresponding period in the
prior year as a result of higher market research and trade show expenditures, as
well as costs incurred related to the Company's pending name change. These
increases were offset by lower headcount and other costs required to support
ViaTV sales, promotion and support activities due to our exit from the consumer
videophone business.
As we introduce and promote new IP telephony products, attempt to expand
distribution channels for such products, and build the customer support
infrastructure necessary to support the commercial release of the Netergy ATS,
Unified Messaging and open service creation environment products, we expect that
future selling, general and administrative costs may be higher both in absolute
dollars and as a percentage of total revenues for the foreseeable future.
In-Process Research and Development and Amortization of Intangibles
We incurred in-process research and development charges of (1) $10.1
million in the first quarter of fiscal 2000 related to the acquisition of
Odisei, and (2) $4.6 million in the second quarter of fiscal 2001 related to the
acquisition of U|Force (see Note 7 to the condensed consolidated financial
statements above).
In conjunction with the acquisition of Odisei, we recorded intangible
assets related to goodwill and workforce that are being amortized on a
straight-line basis over five and three years, respectively. In conjunction with
the acquisition of U|Force in the second quarter of fiscal 2001, we recorded
intangible assets related to goodwill, the value of an assumed distribution
agreement and workforce that are being amortized on a straight-line basis over
three, three and two years, respectively.
Amortization of intangible assets charged to operations was $3.6 million
and $185,000 during the quarters ended September 30, 2000 and 1999,
respectively. Amortization of intangible assets charged to operations was $3.8
million and $235,000 during the quarters ended September 30, 2000 and 1999,
respectively.
Other Income, Net
In the second quarters of fiscal 2001 and 2000, other income, net, was
$918,000 and $195,000, respectively, and is comprised primarily of interest
earned on our cash and cash equivalents. In the first six months of fiscal 2001
and 2000, other income, net, was $1.9 million and $2.1 million, respectively.
During fiscal 1996, we acquired an equity position in a privately held company.
We realized gains of $225,000 and $1.9 million during the quarters ended June
30, 2000 and 1999, respectively, resulting from the sale of this investment.
Interest income increased significantly in the three and six month periods ended
September 30, 2000 as compared to the corresponding periods in the prior fiscal
year due primarily to significantly higher average cash and cash equivalent
balances. Other
17
<PAGE> 20
income, net, in the first six months of fiscal 2000 also included approximately
$200,000 of losses realized on the sale of certain of our cash equivalent
investments during the period.
Interest Expense
Interest expense of $364,000 and $695,000 for the three month and six
month periods ended September 30, 2000, respectively, is primarily comprised of
interest charges associated with the convertible subordinated debentures issued
in December 1999, as well as the amortization of the related debt discount and
debt issuance costs. In addition, it includes approximately $32,000 of interest
expense associated with lines of credit assumed as part of the U|Force
acquisition.
Provision for Income Taxes
The provision of $12,000 for the six months ended September 30, 2000
represents certain foreign taxes. There was no tax provision for the quarter
ended September 30, 2000 or for the three and six month periods ended September
30, 1999 due to the net losses incurred.
Year 2000 Impact
We have not experienced any problems with our computer systems or our
products relating to their inability to recognize appropriate dates related to
the year 2000. We are also not aware of any material problems with our clients
or vendors. Accordingly, we do not anticipate incurring material expenses or
experiencing any material operational disruptions as a result of any year 2000
issues.
Liquidity and Capital Resources
As of September 30, 2000, we had cash and liquid investments totaling
$43.2 million, representing a decrease of $5.4 million from March 31, 2000.
Cash used in operations of approximately $10.1 million in the first six
months of fiscal 2001 is primarily attributable to the net loss of $18.2
million, increases in prepaid expenses and other assets of approximately $3.1
million, decreases in accounts payable and deferred revenue of $926,000 and
$349,000, and a net gain resulting from the sale of investments of $225,000.
Cash used in operations was partially offset by an increase in other accrued
liabilities of $601,000, and noncash items, including depreciation and
amortization of $1.1 million, amortization of intangibles of $3.8 million,
amortization of the debt discount of $370,000, stock compensation charge of
$625,000 and a charge for purchased in-process research and development of $4.6
million. Cash used in operations of $862,000 in the first six months of fiscal
2000 is primarily attributable to the net loss of $13.2 million, decreases in
deferred revenue and accounts payable of $2.5 million and $410,000,
respectively, and a net gain resulting from the sale of investments of $1.7
million. Cash used in operations was partially offset by decreases in accounts
receivable, net, and inventory of $4.3 million and $2.2 million, respectively,
an increase in accrued compensation of $286,000, and noncash items, including a
charge for purchased in-process research and development of $10.1 million and
depreciation and amortization of $819,000.
18
<PAGE> 21
Cash provided by investing activities in the six months ended September
30, 2000 is primarily attributable to net proceeds from the disposition of our
video monitoring business of $5.2 million and proceeds from the sale of a
nonmarketable equity investment of $225,000, offset by capital expenditures of
$2.5 million and net cash paid of $493,000 related to the acquisition of
U|Force. Cash provided by investing activities in the six month period ended
September 30, 1999 is primarily attributable to proceeds from the sale of a
nonmarketable equity investment of $1.9 million, offset by capital expenditures
of $627,000 and net cash paid of $120,000 related to the acquisition of Odisei.
Cash provided by financing activities in the six month period ended
September 30, 2000 consisted primarily of net proceeds from the repayment of
stockholders' notes receivable and net proceeds from sales of the Company's
common stock upon the exercise of employee stock options, offset by the
repayment of certain debt obligations. Cash provided by financing activities in
the six month period ended September 30, 1999 consisted primarily of net
proceeds from the repayment of stockholders' notes receivable and net proceeds
from sales of the Company's common stock upon the exercise of employee stock
options, offset by loans to certain stockholders.
At September 30, 2000, we had a line of credit totaling approximately
$675,000, which expires in September 2001 and is subject to certain financial
ratios. There have been no borrowings under this agreement.
We believe that our current cash and cash equivalents, lines of credit,
and cash generated from operations, if any, will satisfy our expected working
capital and capital expenditure requirements through at least the next 12
months. However, we currently estimate that we will be required to raise
additional financing at some point during calendar year 2001 and if we are
unable to do so, our growth may be limited. We will be evaluating financing
alternatives prior to that time. We may also seek to explore business
opportunities, including acquiring or investing in complementary businesses or
products that will require additional capital from equity or debt sources.
Additionally, the development and marketing of new products could require a
significant commitment of resources, which could in turn require us to obtain
additional financing earlier than otherwise expected. We may not be able to
obtain additional financing as needed on acceptable terms, or at all, which
would force us to delay our plans for growth and implementation of our strategy
which could seriously harm our business, financial condition and results of
operations. If we issue additional equity or convertible debt securities to
raise funds, the ownership percentage of our existing stockholders would be
reduced. New investors may demand rights, preferences or privileges senior to
those of existing holders of our common stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial market risk includes risks associated with international
operations and related foreign currencies. We derive a significant portion of
our revenues from customers in Europe and Asia. In order to reduce the risk from
fluctuation in foreign exchange rates, the vast majority of our sales are
denominated in U.S. dollars. In addition, all of our arrangements with our
semiconductor foundry and assembly vendors, and with our subcontract
manufacturer for our Netergy Media Hub products, are denominated in U.S.
dollars. We have subsidiaries in Europe and Canada, and as such we are exposed
to market risk from changes in exchange rates. We have not entered into any
currency hedging
19
<PAGE> 22
activities. To date, our exposure to exchange rate volatility has not been
significant, however, there can be no assurance that there will not be a
material impact in the future.
Factors That May Affect Future Results
The following factors should be considered in conjunction with the
information in this Report on Form 10-Q.
WE HAVE A HISTORY OF LOSSES AND WE ARE UNCERTAIN AS TO OUR FUTURE PROFITABILITY
We recorded an operating loss of approximately $19.4 million in the six
month period ended September 30, 2000 and had an accumulated deficit of $71.9
million at September 30, 2000. In addition, we recorded operating losses for the
fiscal years ended March 31, 2000 and 1999, respectively. We expect to continue
to incur operating losses for the foreseeable future, and such losses may be
substantial. We will need to generate significant revenue growth to achieve
profitability. Given our history of fluctuating revenues and operating losses,
we cannot be certain that we will be able to achieve profitability on either a
quarterly or annual basis.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL TO SUPPORT OUR GROWTH, AND FAILURE TO DO
SO IN A TIMELY MANNER MAY CAUSE US TO DELAY OUR PLANS FOR GROWTH
As of September 30, 2000, we had approximately $43.2 million in cash and
cash equivalents. We believe that our current cash and cash equivalents, lines
of credit, and cash generated from operations, if any, will satisfy our expected
working capital and capital expenditure requirements through at least the next
12 months. However, we currently estimate that we will be required to raise
additional financing at some point during calendar year 2001 and if we are
unable to do so, our growth may be limited. We will be evaluating financing
alternatives prior to that time. We may also seek to explore business
opportunities, including acquiring or investing in complementary businesses or
products that will require additional capital from equity or debt sources.
Additionally, the development and marketing of new products could require a
significant commitment of resources, which could in turn require us to obtain
additional financing earlier than otherwise expected. We may not be able to
obtain additional financing as needed on acceptable terms, or at all, which
would force us to delay our plans for growth and implementation of our strategy
which could seriously harm our business, financial condition and results of
operations. If we issue additional equity or convertible debt securities to
raise funds, the ownership percentage of our existing stockholders would be
reduced. New investors may demand rights, preferences or privileges senior to
those of existing holders of our common stock.
THE GROWTH OF OUR BUSINESS AND FUTURE PROFITABILITY DEPENDS ON FUTURE IP
TELEPHONY REVENUE
We believe that our business and future profitability will be largely
dependent on widespread market acceptance of our IP telephony products. Our
videoconferencing semiconductor business has not provided, nor is it expected to
provide, sufficient revenues to profitably operate our business. To date, we
have not generated significant revenue from the sale of our IP telephony
products. If we are not able to generate significant revenues
20
<PAGE> 23
selling into the IP telephony market, it would have a material adverse effect on
our business and operating results.
Success of our IP telephony product strategy assumes that there will be
future demand for IP telephony systems. In order for the IP telephony market to
continue to grow, several things need to occur. Telephone service providers must
continue to invest in the deployment of high speed broadband networks to
residential and commercial customers. IP networks must improve quality of
service for real-time communications, managing effects such as packet jitter,
packet loss and unreliable bandwidth, so that toll-quality service can be
provided. IP telephony equipment must achieve the 99.999% reliability that users
of the public switched telephone network have come to expect from their
telephone service. IP telephony service providers must offer cost and feature
benefits to their customers that are sufficient to cause the customers to switch
away from traditional telephony service providers. If any or all of these
factors fail to occur our business may not grow.
OUR FUTURE OPERATING RESULTS MAY NOT FOLLOW PAST OR EXPECTED TRENDS DUE TO MANY
FACTORS AND ANY OF THESE COULD CAUSE OUR STOCK PRICE TO FALL
Our historical operating results have fluctuated significantly and will
likely continue to fluctuate in the future, and a decline in our operating
results could cause our stock price to fall. On an annual and a quarterly basis
there are a number of factors that may affect our operating results, many of
which are outside our control. These include, but are not limited to:
- changes in market demand;
- the timing of customer orders;
- competitive market conditions;
- lengthy sales cycles, regulatory approval cycles;
- new product introductions by us or our competitors;
- market acceptance of new or existing products;
- the cost and availability of components;
- the mix of our customer base and sales channels;
- variation in capital spending budgets of communications service providers;
- the mix of products sold;
- the management of inventory;
- the level of international sales;
- continued compliance with industry standards; and
- general economic conditions.
Our gross margin is affected by a number of factors including, product
mix, the recognition of license and other revenues for which there may be no or
little corresponding cost of revenues, product pricing, the allocation between
international and domestic sales,
21
<PAGE> 24
the percentage of direct sales and sales to resellers, and manufacturing and
component costs. The markets for our semiconductor and Media Hub products are
characterized by falling average selling prices. We expect that, as a result of
competitive pressures and other factors, gross profit as a percentage of revenue
for our semiconductor products will likely decrease for the foreseeable future.
The market for IP telephony semiconductors is likely to be a high volume market
characterized by commodity pricing. We will not be able to generate average
selling prices or gross margins for our IP telephony semiconductors similar to
those that we have historically commanded for our videoconferencing
semiconductors. In addition, the gross margins for our Media Hub systems
products are, and will likely continue to be, substantially lower than the gross
margins for our videoconferencing semiconductors. In the likely event that we
encounter significant price competition in the markets for our products, we
could be at a significant disadvantage compared to our competitors, many of
which have substantially greater resources, and therefore may be better able to
withstand an extended period of downward pricing pressure.
Variations in timing of sales may cause significant fluctuations in
future operating results. In addition, because a significant portion of our
business may be derived from orders placed by a limited number of large
customers, including OEM customers, the timing of such orders can also cause
significant fluctuations in our operating results. Anticipated orders from
customers may fail to materialize. Delivery schedules may be deferred or
canceled for a number of reasons, including changes in specific customer
requirements or international economic conditions. The adverse impact of a
shortfall in our revenues may be magnified by our inability to adjust spending
to compensate for such shortfall. Announcements by us or our competitors of new
products and technologies could cause customers to defer purchases of our
existing products, which would also have a material adverse effect on our
business and operating results.
As a result of these and other factors, it is likely that in some or all
future periods our operating results will be below the expectations of
securities analysts or investors, which would likely result in a significant
reduction in the market price of our common stock.
THE LONG AND VARIABLE SALES AND DEPLOYMENT CYCLES FOR OUR IP TELEPHONY SOFTWARE
PRODUCTS MAY CAUSE OUR REVENUE AND OPERATING RESULTS TO VARY SIGNIFICANTLY
Our IP telephony software products, including our Netergy iPBX, Unified
Messaging and Service Life Cycle Environment (SLCE) products, have lengthy sales
cycles and we may incur substantial sales and marketing expenses and expend
significant management effort without making a sale. A customer's decision to
purchase our products often involves a significant commitment of its resources
and a lengthy product evaluation and qualification process. In addition, the
length of our sales cycles will vary depending on the type of customer to whom
we are selling and the product being sold. Even after making the decision to
purchase our products, our customers may deploy our products slowly. Timing of
deployment can vary widely and will depend on:
- the size of the network deployment;
- the complexity of our customers' network environments;
- our customers' skill sets;
- the hardware and software configuration and customization necessary to
deploy our products; and
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- our customers' ability to finance their purchase of our products.
As a result, it is difficult for us to predict the quarter in which our
customers may purchase our products and our revenue and operating results may
vary significantly from quarter to quarter.
IF OUR PRODUCTS DO NOT INTEROPERATE WITH OUR CUSTOMERS' NETWORKS, ORDERS FOR OUR
PRODUCTS WILL BE DELAYED OR CANCELED AND SUBSTANTIAL PRODUCT RETURNS COULD
OCCUR, WHICH COULD HARM OUR BUSINESS
Many of the potential customers for our Netergy iPBX and Unified
Messaging products have requested that our products be designed to interoperate
with their existing networks, each of which may have different specifications
and use multiple standards. Our customers' networks may contain multiple
generations of products from different vendors that have been added over time as
their networks have grown and evolved. Our products must interoperate with these
products as well as with future products in order to meet our customers'
requirements. In some cases, we may be required to modify our product designs to
achieve a sale, which may result in a longer sales cycle, increased research and
development expense, and reduced operating margins. If our products do not
interoperate with existing equipment or software in our customers' networks,
installations could be delayed, orders for our products could be canceled or our
products could be returned. This could harm our business, financial condition
and results of operations.
INTENSE COMPETITION IN THE MARKETS IN WHICH WE COMPETE COULD PREVENT US FROM
INCREASING OR SUSTAINING OUR REVENUE AND PREVENT US FROM ACHIEVING PROFITABILITY
IP Telephony and Multimedia Communication Semiconductors and Media Hub Markets
We compete with both manufacturers of digital signal processing
semiconductors and media hub products developed for the growing VoIP
marketplace. We also compete with manufacturers of multimedia communication
semiconductors. The markets for our products are characterized by intense
competition, declining average selling prices and rapid technological change.
The principal competitive factors in the market for IP telephony and
videoconferencing semiconductors and firmware include product definition,
product design, system integration, chip size, code size, functionality,
time-to-market, adherence to industry standards, price and reliability. We have
a number of competitors in this market including Analog Devices, Inc.,
AudioCodes Ltd., Broadcom Corporation, Conexant Systems, Inc., DSP Group, Inc.,
Lucent Technologies, Motorola, Inc., Philips Electronics NV, Texas
Instruments/Telogy Networks, Inc., Mitel Semiconductor, Winbond Electronics
Corporation, and Radvision Ltd. Certain of our competitors for IP telephony and
videoconferencing semiconductors maintain their own semiconductor foundries and
may therefore benefit from certain capacity, cost and technical advantages.
Principle competitive factors in the market for VoIP media hub products
include product definition, product design, system integration, system
functionality, time-to-market, interoperability with common network equipment,
adherence to industry standards, price and reliability. Currently there are a
limited number of system suppliers offering residential and small office VoIP
media hub-like products, including Komodo Technology (which was acquired by
Cisco Systems), Nx Networks and MCK Communications. We
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expect, however, that this market will be characterized by intense competition,
declining average selling price and rapid technology change. In addition, our
presence in the VoIP systems business may result in certain customers or
potential customers perceiving us as a competitor or potential competitor, which
may be used by other semiconductor manufacturers to their advantage.
Netergy iPBX Server Software Market
We compete with suppliers of traditional PBXs, Centrex equipment and
newer generation IP-based solutions that seek to sell such products to
telecommunication service providers, which in turn offer voice services to the
Small Medium Enterprise (SME) marketplace. This market is rapidly shifting to a
network centric, IP-based solutions model. New IP-based solutions are
cannibalizing traditional markets due to increased efficiencies of IP
technology, ability to integrate vertical services, lower costs, increases in
return on investment (ROI), improved features sets and the requirement for rapid
innovation. As an IP-based solution, the Netergy iPBX product competes by
leveraging the innate efficiencies of IP architectures and combining those
efficiencies with best-of-class features from competitive products. This market
is characterized by rapid technological change, intense competition and first
mover advantage.
The main competition includes Lucent Technologies, Nortel Networks,
VocalData, Inc., VocalTec Communications, Inter-tel Inc. and several other
providers of traditional and newer generation IP-based solutions. Although each
of these companies is in competition with our iPBX product suite, all today
provide solutions based on past-generation integrated solutions, whereas the ATS
product suite and hosted iPBX establishes a new methodology for addressing an
existing growth market. Directly competitive products targeted for general
release in calendar year 2001 are currently under development at several pre-IPO
startup companies, including BroadSoft, Inc. (which is being acquired by
Unisphere Networks), Sylantro Systems, UniData Corporation, Tundo Corporation
and Shoreline Communications.
Principle competitive factors in the market for hosted iPBX solutions
include product feature parity, interface design, product reliability,
time-to-market, adherence to standards, price, functionality and IP network
delivery/design. We believe that the market for iPBX solutions is currently in
the initial adoption phase and that growth of the market will be driven by the
ability of iPBX products to meet the advanced feature requirements of service
providers and SME users, by the lower costs of IP-based solutions, and by a
general trend toward the replacement of circuit-switched networks with packet
switched ones.
Netergy Service Life Cycle Environment (SLCE) Software
We compete with suppliers of traditional telecom AIN (Advanced
Intelligent Networks - SS7) infrastructure and newer generation IP-based
solutions that seek to sell such products to telecommunication service
providers, which in turn offer voice, video and data services to the
marketplace. This market is rapidly shifting to an IP-based solutions model. New
IP-based solutions are cannibalizing traditional solutions due to increased
efficiencies of IP technology, ability to integrate vertical services, lower
costs, increases in return on investment (ROI), improved features sets and the
requirement for rapid innovation. As an IP-based solution, the Netergy SLCE
product competes by leveraging the innate efficiencies of IP architectures and
combining those efficiencies with best-of-class features
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from competitive products. This market is characterized by rapid technological
change, intense competition and first mover advantage.
The main competition includes Lucent, Nortel Networks, Tekelec, Alcatel
and several other providers of traditional and newer generation IP-based
solutions. Although each of these companies is in competition with our SLCE
product suite, all today provide solutions based on past-generation integrated
solutions, whereas the SLCE product suite establishes a new methodology for
addressing the existing market and the new emerging IP services market. Directly
competitive products targeted for general release in calendar year 2001 are
currently under development at several pre-IPO startup companies, including
Ubiquity Software Corporation, Pagoo, dynamicsoft, Inc., Sylantro Systems, and
LongBoard, Inc.
Principle competitive factors in the market for the SLCE solutions
include product feature parity, interface design, product reliability,
time-to-market, adherence to standards, price, functionality and IP network
delivery/design. We believe that the market for SLCE solutions is currently in
the initial adoption phase and that growth of the market will be driven by the
ability of SLCE type products to meet the advanced feature requirements of
service providers and vertical systems integrators, by the lower costs of
IP-based solutions, and by a general trend toward the replacement of
circuit-switched networks with packet-switched networks.
We expect our competitors to continue to improve the performance of
their current products and introduce new products or new technologies. If our
competitors successfully introduce new products or enhance their existing
products, this could reduce the sales or market acceptance of our products and
services, increase price competition or make our products obsolete. To be
competitive, we must continue to invest significant resources in research and
development, sales and marketing and customer support. We may not have
sufficient resources to make these investments or to make the technological
advances necessary to be competitive, which in turn will cause our business to
suffer.
Our reliance on developing vertically integrated technology, comprising
systems, software and semiconductors, places a significant strain on our
research and development resources. Competitors that focus on one aspect of
technology, such as systems or semiconductors, may have a considerable advantage
over us. In addition, many of our current and potential competitors have longer
operating histories, are substantially larger, and have greater financial,
manufacturing, marketing, technical and other resources. Many also have greater
name recognition and a larger installed base of products than us. Competition in
our markets may result in significant price reductions. As a result of their
greater resources, many current and potential competitors may be better able
than us to initiate and withstand significant price competition or downturns in
the economy. There can be no assurance that we will be able to continue to
compete effectively, and any failure to do so would have a material adverse
effect on our business and operating results.
THE PRIMARY MARKET WE HAVE IDENTIFIED FOR OUR IP TELEPHONY SOFTWARE PRODUCTS,
THE EMERGING TELECOMMUNICATIONS SERVICE PROVIDERS MARKET, MAY REDUCE OR
DISCONTINUE ITS CURRENT LEVELS OF CAPITAL INVESTMENT WHICH WOULD IMPACT OUR
ABILITY TO INCREASE OUR REVENUE AND PREVENT US FROM ACHIEVING PROFITABILITY
The market for the services provided by telecommunications service
providers who compete against traditional telephone companies has only begun to
emerge, and many of
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these service providers are still building their infrastructure and rolling out
their services. These telecommunications service providers require substantial
capital for the development, construction and expansion of their networks and
the introduction of their services. Financing may not be available to emerging
telecommunications service providers on favorable terms, if at all. The
inability of our current or potential emerging telecommunications service
provider customers to acquire and keep customers, to successfully raise needed
funds, or to respond to any other trends such as price reductions for their
services or diminished demand for telecommunications services generally, could
adversely affect their operating results or cause them to reduce their capital
spending programs. If our customers or potential customers are forced to defer
or curtail their capital spending programs, our sales to those telecommunication
service providers may be adversely affected, which would have a material adverse
effect on our business, financial condition and results of operations. In
addition, many of the industries in which telecommunications service providers
operate have recently experienced consolidation. The loss of one or more of our
current or potential telecommunications service provider customers, through
industry consolidation or otherwise, could reduce or eliminate our sales to such
a customer and consequently have a material adverse effect on our business,
financial condition and results of operations.
WE DEPEND ON SUBCONTRACTED MANUFACTURERS TO MANUFACTURE SUBSTANTIALLY ALL OF OUR
PRODUCTS, AND ANY DELAY OR INTERRUPTION IN MANUFACTURING BY THESE CONTRACT
MANUFACTURERS WOULD RESULT IN DELAYED OR REDUCED SHIPMENTS TO OUR CUSTOMERS AND
MAY HARM OUR BUSINESS
We outsource the manufacturing of our semiconductors and IP telephony
system products to independent foundries and subcontract manufacturers,
respectively. Our primary semiconductor manufacturer is Taiwan Semiconductor
Manufacturing Corporation. Subcontract system manufacturers include EFA
Corporation in Taiwan. We also rely on Amkor Electronics in South Korea,
Integrated Packaging Assembly Corporation in San Jose, California, and Digital
Testing Services in Santa Clara, California, for packaging and testing of our
semiconductors. We do not have long-term purchase agreements with our
subcontract manufacturers or our component suppliers. There can be no assurance
that our subcontract manufacturers will be able or willing to reliably
manufacture the our products, or that our component suppliers will be able or
willing to reliably supply components for the our products, in volumes, on a
cost effective basis or in a timely manner. We may experience difficulties due
to its reliance on independent semiconductor foundries, subcontract
manufacturers and component suppliers that could have a material adverse effect
on our business and operating results.
WE MAY NOT BE ABLE TO MANAGE OUR INVENTORY LEVELS EFFECTIVELY WHICH MAY LEAD TO
INVENTORY OBSOLESCENCE WHICH WOULD FORCE US TO LOWER OUR PRICES
Our products have lead times of up to several months, and are built to
forecasts that are necessarily imprecise. Because of our practice of building
our products to necessarily imprecise forecasts, it is likely that, from time to
time, we will have either excess or insufficient product inventory. Excess
inventory levels would subject us to the risk of inventory obsolescence and the
risk that our selling prices may drop below our inventory costs, while
insufficient levels of inventory may negatively affect relations with customers.
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Any of these factors could have a material adverse effect on our operating
results and business.
WE DEPEND ON PURCHASE ORDERS FROM KEY CUSTOMERS AND FAILURE TO RECEIVE
SIGNIFICANT PURCHASE ORDERS IN THE FUTURE WOULD CAUSE A DECLINE IN OUR OPERATING
RESULTS
Historically, a significant portion of our sales have been to relatively
few customers, although the composition of these customers has varied. Revenues
from our ten largest customers for the quarters ended September 30, 2000 and
1999, respectively, accounted for approximately 51% and 49%, respectively, of
total revenues. Revenues from our ten largest customers for the fiscal years
ended March 31, 2000 and 1999 accounted for 35% and 40%, respectively, of total
revenues. Substantially all of our product sales have been made, and are
expected to continue to be made, on a purchase order basis. None of our
customers has entered into a long-term agreement requiring it to purchase our
products. In the future, we will need to gain purchase orders for our products
to earn additional revenue. Further, all of our license and other revenues are
nonrecurring.
THE IP TELEPHONY MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND WE DEPEND
ON NEW PRODUCT INTRODUCTION IN ORDER TO MAINTAIN AND GROW OUR BUSINESS
IP telephony is an emerging market that is characterized by rapid
changes in customer requirements, frequent introductions of new and enhanced
products, and continuing and rapid technological advancement. To compete
successfully in this emerging market, we must continue to design, develop,
manufacture and sell new and enhanced products that provide increasingly higher
levels of performance and reliability and lower cost, take advantage of
technological advancements and changes, and respond to new customer
requirements. Our success in designing, developing, manufacturing and selling
such products will depend on a variety of factors, including:
- the identification of market demand for new products;
- product selection;
- timely implementation of product design and development;
- product performance and reliability;
- the ability to manage long development cycles;
- cost-effectiveness of products under development;
- effective manufacturing processes; and
- the success of promotional efforts.
Additionally, we may also be required to collaborate with third parties
to develop our products and may not be able to do so on a timely and
cost-effective basis, if at all. We have in the past experienced delays in the
development of new products and the enhancement of existing products, and such
delays will likely occur in the future. If we are unable, due to resource
constraints or technological or other reasons, to develop and introduce new or
enhanced products in a timely manner, if such new or enhanced products
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do not achieve sufficient market acceptance or if such new product introductions
decrease demand for existing products our operating results would decline and
our business would not grow.
IF WE DO NOT DEVELOP AND MAINTAIN SUCCESSFUL PARTNERSHIPS FOR IP TELEPHONY
PRODUCTS, WE MAY NOT BE ABLE TO SUCCESSFULLY MARKET OUR SOLUTIONS
We are entering into new market areas and our success is partly
dependent on our ability to forge new marketing and engineering partnerships. IP
telephony communications systems are extremely complex and no single company
possesses all the required technology components needed to build a complete end
to end solution. Partnerships will be required to augment our development
programs and to assist us in marketing complete solutions to our targeted
customers. We may not be able to develop such partnerships in the course of our
product development. Even if we do establish the necessary partnerships, we may
not be able to adequately capitalize on these partnerships to aid in the success
of our business.
INABILITY TO PROTECT OUR PROPRIETARY TECHNOLOGY OR INFRINGEMENT BY US OF A THIRD
PARTY'S PROPRIETARY TECHNOLOGY WOULD DISRUPT OUR BUSINESS
We rely in part on trademark, copyright and trade secret law to protect
our intellectual property in the United States and abroad. We seek to protect
our software, documentation and other written materials under trade secret and
copyright law, which afford only limited protection. We also rely in part on
patent law to protect our intellectual property in the United States and abroad.
We currently hold 14 United States patents, including patents relating to
programmable integrated circuit architectures, telephone control arrangements,
software structures and memory architecture technology, and have a number of
United States and foreign patent applications pending. We cannot predict whether
such patent applications will result in an issued patent. We may not be able to
protect our proprietary rights in the United States or abroad (where effective
intellectual property protection may be unavailable or limited) and competitors
may independently develop technologies that are similar or superior to our
technology, duplicate our technology or design around any patent of ours. We
have in the past licensed and in the future expect to continue licensing our
technology to others, many of whom are located or may be located abroad. There
are no assurances that such licensees will protect our technology from
misappropriation. Moreover, litigation may be necessary in the future to enforce
our intellectual property rights, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Such litigation could result in substantial costs and diversion of
management time and resources and could have a material adverse effect on our
business and operating results.
There has been substantial litigation in the semiconductor, electronics
and related industries regarding intellectual property rights, and from time to
time third parties may claim infringement by us of their intellectual property
rights. Our broad range of technology, including systems, digital and analog
circuits, software and semiconductors, increases the likelihood that third
parties may claim infringement by us of their intellectual property rights. If
we were found to be infringing on the intellectual property rights of any third
party, we could be subject to liabilities for such infringement, which could be
material, and we could be required to refrain from using, manufacturing or
selling certain
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products or using certain processes, either of which could have a material
adverse effect on our business and operating results. From time to time, we have
received, and may continue to receive in the future, notices of claims of
infringement, misappropriation or misuse of other parties' proprietary rights.
There can be no assurance that we will prevail in these discussions and actions,
or that other actions alleging infringement by the Company of third-party
patents will not be asserted or prosecuted against the Company.
We rely on certain technology, including hardware and software licensed
from third parties. In addition, we may be required to license technology from
third parties in the future to develop new products or product enhancements.
Third-party licenses may not be available to us on commercially reasonable
terms, if at all. Our inability to obtain third-party licenses required to
develop new products and product enhancements could require us to obtain
substitute technology of lower quality or performance standards or at a greater
cost, any of which could seriously harm our business, financial condition and
results of operations.
OUR PRODUCTS MUST COMPLY WITH INDUSTRY STANDARDS AND FCC REGULATIONS, AND
CHANGES MAY REQUIRE US TO MODIFY EXISTING PRODUCTS
In addition to reliability and quality standards, the market acceptance
of telephony over broadband IP networks is dependent upon the adoption of
industry standards so that products from multiple manufacturers are able to
communicate with each other. IP telephony products rely heavily on standards
such as H.323, Session Initiation Protocol (SIP), Megaco and Media Gateway
Control Protocol (MGCP) to interoperate with other vendors' equipment. There is
currently a lack of agreement among industry leaders about which standard should
be used for a particular application, and about the definition of the standards
themselves. Furthermore, the industry has had difficulty achieving true
multivendor interoperability for highly complex standards such as H.323. We also
must comply with certain rules and regulations of the Federal Communications
Commission regarding electromagnetic radiation and safety standards established
by Underwriters Laboratories as well as similar regulations and standards
applicable in other countries. Standards are continuously being modified and
replaced. As standards evolve, we may be required to modify our existing
products or develop and support new versions of our products. The failure of our
products to comply, or delays in compliance, with various existing and evolving
industry standards could delay or interrupt volume production of our IP
telephony products, which would have a material adverse effect on our business
and operating results.
FUTURE REGULATION OR LEGISLATION COULD RESTRICT OUR BUSINESS OR INCREASE OUR
COST OF DOING BUSINESS
At present there are few laws or regulations that specifically address
access to or commerce on the Internet, including IP telephony. We are unable to
predict the impact, if any, that future legislation, legal decisions or
regulations concerning the Internet may have on our business, financial
condition and results of operations. Regulation may be targeted towards, among
other things, assessing access or settlement charges, imposing tariffs or
imposing regulations based on encryption concerns or the characteristics and
quality of products and services, which could restrict our business or increase
our cost of doing business. The increasing growth of the broadband IP telephony
market and popularity of
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broadband IP telephony products and services heighten the risk that governments
will seek to regulate broadband IP telephony and the Internet. In addition,
large, established telecommunications companies may devote substantial lobbying
efforts to influence the regulation of the broadband IP telephony market, which
may be contrary to our interests.
WE MAY TRANSITION TO SMALLER GEOMETRY PROCESS TECHNOLOGIES AND HIGHER LEVELS OF
DESIGN INTEGRATION WHICH COULD DISRUPT OUR BUSINESS
We continuously evaluate the benefits, on an integrated circuit,
product-by-product basis, of migrating to smaller geometry process technologies
in order to reduce costs. We have commenced migration of certain future products
to smaller geometry processes. We believe that the transition of our products to
increasingly smaller geometries will be important for us to remain competitive.
We have in the past experienced difficulty in migrating to new manufacturing
processes, which has resulted and could continue to result in reduced yields,
delays in product deliveries and increased expense levels. Moreover, we are
dependent on relationships with our foundries and their partners to migrate to
smaller geometry processes successfully. If any such transition is substantially
delayed or inefficiently implemented we may experience delays in product
introductions and incur increased expenses. As smaller geometry processes become
more prevalent, we expect to integrate greater levels of functionality as well
as customer and third-party intellectual property into our products. Some of
this intellectual property includes analog components for which we have little
or no experience or in-house expertise. We cannot predict whether higher levels
of design integration or the use of third-party intellectual property will
adversely affect our ability to deliver new integrated products on a timely
basis, or at all.
OUR ACQUISITION OF U|FORCE AND ANY FUTURE ACQUISITIONS MAY BE DIFFICULT TO
INTEGRATE, DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER VALUE OR DIVERT MANAGEMENT
ATTENTION
We announced our intention to acquire U|Force on May 19, 2000 and closed
the transaction on June 30, 2000. There are significant risks associated with
the assimilation and integration of U|Force, including:
- unanticipated problems and costs associated with combining the businesses
and integrating U|Force's products and technologies;
- impact of integration efforts on management's attention to our core
business;
- adverse effects on existing business relationships with suppliers and
customers;
- risks associated with entering markets in which we have limited or no prior
experience; and
- potential loss of key employees, particularly those of the acquired
organizations.
If we are unable to successfully integrate U|Force or to create new or
enhanced products, we may not achieve the anticipated benefits from the
acquisition. If we fail to achieve the anticipated benefits from the
acquisition, we may incur increased expenses, experience a shortfall in our
anticipated revenues and we may not obtain a satisfactory return on our
investment. In addition, if any significant number of U|Force employees fail
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to remain employed with us, we may experience difficulties in achieving the
expected benefits of the acquisition.
IF WE DISCOVER PRODUCT DEFECTS, WE MAY HAVE PRODUCT-RELATED LIABILITIES WHICH
MAY CAUSE US TO LOSE REVENUES OR DELAY MARKET ACCEPTANCE OF OUR PRODUCTS
Products as complex as those offered by us frequently contain errors,
defects and functional limitations when first introduced or as new versions are
released. We have in the past experienced such errors, defects or functional
limitations. We sell products into markets that are extremely demanding of
robust, reliable, fully functional products. Therefore delivery of products with
production defects or reliability, quality or compatibility problems could
significantly delay or hinder market acceptance of such products, which could
damage our credibility with our customers and adversely affect our ability to
retain our existing customers and to attract new customers. Moreover, such
errors, defects or functional limitations could cause problems, interruptions,
delays or a cessation of sales to our customers. Alleviating such problems may
require significant expenditures of capital and resources by us. Despite testing
by us, our suppliers or our customers may find errors, defects or functional
limitations in new products after commencement of commercial production,
resulting in additional development costs, loss of, or delays in, market
acceptance, diversion of technical and other resources from our other
development efforts, product repair or replacement costs, claims by our
customers or others against us, or the loss of credibility with our current and
prospective customers.
WE HAVE SIGNIFICANT INTERNATIONAL OPERATIONS, WHICH SUBJECTS US TO RISKS THAT
COULD CAUSE OUR OPERATING RESULTS TO DECLINE
Sales to customers outside of the North America represented 55%, 47% and
43% of total revenues in the six months ended September 30, 2000 and the fiscal
years ended March 31, 2000 and 1999, respectively. Specifically, sales to
customers in the Asia Pacific region represented 30%, 24% and 26% of our total
revenues in the six months ended September 30, 2000 and for the fiscal years
ended March 31, 2000 and 1999, respectively, while sales to customers in Europe
represented 25%, 23% and 17% of our total revenues for the same periods,
respectively.
International sales of our videoconferencing semiconductors will
continue to represent a substantial portion of our product revenues for the
foreseeable future. In addition, substantially all of our current products are,
and substantially all of our future products will be, manufactured, assembled
and tested by independent third parties in foreign countries. International
sales and manufacturing are subject to a number of risks, including general
economic conditions in regions such as Asia, changes in foreign government
regulations and telecommunications standards, export license requirements,
tariffs and taxes, other trade barriers, fluctuations in currency exchange
rates, difficulty in collecting accounts receivable and difficulty in staffing
and managing foreign operations. We are also subject to geopolitical risks, such
as political, social and economic instability, potential hostilities and changes
in diplomatic and trade relationships, in connection with its international
operations. A significant decline in demand from foreign markets could have a
material adverse effect on our business and operating results.
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WE NEED TO HIRE AND RETAIN KEY PERSONNEL TO SUPPORT OUR PRODUCTS
The development and marketing of our IP telephony products will continue
to place a significant strain on our limited personnel, management and other
resources. Competition for highly skilled engineering, sales, marketing and
support personnel is intense because there are a limited number of people
available with the necessary technical skills and understanding of our market,
particularly in the San Francisco Bay area where our corporate headquarters is
located. Any failure to attract, assimilate or retain qualified personnel to
fulfill our current or future needs could impair our growth. We currently do not
have employment contracts with any of our employees and we do not maintain key
person life insurance policies on any of our employees.
OUR STOCK PRICE HAS BEEN VOLATILE AND WE CANNOT ASSURE YOU THAT OUR STOCK PRICE
WILL NOT DECLINE
The market price of the shares of our common stock has been and is
likely to be highly volatile. It may be significantly affected by factors such
as:
- actual or anticipated fluctuations in our operating results;
- announcements of technical innovations;
- loss of key personnel;
- new products or new contracts by us, our competitors or their customers;
- governmental regulatory action; and
- developments with respect to patents or proprietary rights, general market
conditions, changes in financial estimates by securities analysts and other
factors which could be unrelated to, or outside our control.
The stock market has from time to time experienced significant price and
volume fluctuations that have particularly affected the market prices for the
common stocks of technology companies and that have often been unrelated to the
operating performance of particular companies. These broad market fluctuations
may adversely affect the market price of our common stock. In the past,
following periods of volatility in the market price of a company's securities,
securities class action litigation has often been initiated against the issuing
company. If our stock price is volatile, we may also be subject to such
litigation. Such litigation could result in substantial costs and a diversion of
management's attention and resources, which would disrupt business and could
cause a decline in our operating results. Any settlement or adverse
determination in such litigation would also subject us to significant liability.
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
On June 30, 2000, in connection with our acquisition U|Force Inc., we
issued 1,447,523 shares of common stock. In addition, we issued securities of
Canadian entities that are exchangeable for 2,107,780 shares of our common
stock. These securities were issued in
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reliance upon an exemption from registration provided by Regulation S adopted
pursuant to the Securities Act of 1933, as amended, based on representations
from the securities holders that they are non-U.S. persons within the meaning of
Regulation S.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's 2000 Annual Meeting of Stockholders was held on August 14,
2000 at the Company's principal executive offices in Santa Clara, California. At
the meeting, 20,065,433 shares of the Company's common stock, and one share of
preferred stock, designated as Special Voting Stock, having a total of 1,231,864
votes, were present in person or by proxy. The number of votes present in person
or by proxy represented approximately 80% of eligible votes associated with
outstanding votable securities.
(a) Each person elected as a Director will serve until the next annual
meeting of stockholders or until such person's successor is elected and
qualified. The following nominees for Director were elected:
<TABLE>
<CAPTION>
Name of Nominee Votes Cast For Votes Withheld
--------------- -------------- --------------
<S> <C> <C>
Lee Camp 20,958,417 338,880
Dr. Bernd Girod 20,956,110 341,187
Ret. Maj. Gen. Guy L. Hecker 20,961,450 335,847
Christos Lagomichos 20,963,925 333,372
Joe Markee 20,961,340 335,957
William Tai 20,963,225 334,072
Dr. Paul Voois 20,949,730 347,567
</TABLE>
(b) The ratification and appointment of PricewaterhouseCoopers LLP as
independent public accountants of the Company for the fiscal year ended
March 31, 2001 was approved by the stockholders with 20,014,297 voting
in favor, 36,305 voting against and 14,831 abstaining.
(c) The amendment to the Company's Restated Certificate of Incorporation, as
amended, to change the Company's name to "Netergy Networks, Inc." was
approved by the stockholders with 21,189,104 voting in favor, 93,944
voting against and 14,249 abstaining.
(d) The amendment to the Company's Restated Certificate of Incorporation, as
amended, to increase the number of authorized shares of common stock
from 40,000,000 to 100,000,000 was approved by the stockholders with
20,481,217 voting in favor, 769,330 voting against and 46,750
abstaining.
(e) The amendment to the Company's 1996 Stock Option Plan (the "Plan") to
increase the number of shares of common stock authorized for issuance
over the term of the Plan by an additional 2,000,000 shares was approved
by the stockholders with 9,862,171 voting in favor, 835,709 voting
against, 29,983 abstaining and 10,569,434 not voted.
33
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(f) The amendment of the Company's 1996 Director Option Plan (the "Director
Plan") to (i) increase the aggregate number of shares of common stock
authorized for issuance under such plan by 350,000 shares, from 150,000
shares to 500,000 shares and (ii) provide for an increase in the number
of shares granted pursuant to non-discretionary option grants under the
Director Plan was approved by the stockholders with 9,834,512 voting in
favor, 797,125 voting against, 96,226 abstaining and 10,569,434 not
voted.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Exhibit Index.
(b) Reports on Form 8-K.
On September 12, 2000, we filed an amendment to our Current Report on
Form 8-K dated May 19, 2000 reporting the completion of our agreement to acquire
U|Force, Inc.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized:
Date: November 13, 2000.
NETERGY NETWORKS, INC.
By: /s/ DAVID STOLL
----------------------------------
David Stoll
Chief Financial Officer and Vice President of Finance
(Principal Financial and Accounting Officer)
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT TITLE
27.1+ Financial Data Schedule.
All other schedules are omitted because they are not required, are not
applicable or the information is included in the Condensed Consolidated
Financial Statements or notes thereto.
34
