<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d)
Of The Securities Exchange Act of 1934
For Quarter Ended September 30, 2000
OR
[ ] Transition Report Pursuant to Section 13 or 15(d)
Of the Securities Exchange Act of 1934
For the transition period from ____ to ____.
Commission File Number 001-15715
NETPLIANCE, INC.
Organized in the State of Delaware
Tax Identification No. 74-2902814
7600A North Capital of Texas Highway, Austin, Texas 78731
Telephone No. (512) 493-8300
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 outstanding of each of the issuer's classes of common
stock as of October 31, 2000:
Class Number of Shares
----- ----------------
Common Stock, $0.01 par value 60,494,786
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NETPLIANCE, INC.
INDEX
<TABLE>
<CAPTION>
Page
Number
------
PART I. FINANCIAL INFORMATION:
<S> <C> <C>
Item 1. Financial Statements (unaudited) 1
Condensed Balance Sheets
as of September 30, 2000 and December 31, 1999 1
Condensed Statements of Operations
for the three and nine months ended September 30, 2000 and 1999 2
Condensed Statements of Cash Flows
for the nine months ended September 30, 2000 and 1999 3
Notes to Financial Statements 4
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition 9
Item 3. Quantitative and Qualitative Disclosure About Market Risk 26
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings 26
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
</TABLE>
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PART I. FINANCIAL INFORMATION.
ITEM 1. FINANCIAL STATEMENTS.
NETPLIANCE, INC.
CONDENSED BALANCE SHEETS
(UNAUDITED)
<TABLE>
September 30, December 31,
2000 1999
----------------- ------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents.............................. $ 11,752,241 $ 9,563,362
Short-term investments................................. 64,888,546 --
--------------- --------------
Cash, cash equivalents and short-term investments... 76,640,787 9,563,362
--------------- --------------
Accounts receivable.................................... 1,273,848 --
Inventory.............................................. 2,726,993 --
Prepaid expenses....................................... 3,654,480 5,984,595
Restricted cash related to agreement with manufacturer. 11,876,472 --
Other current assets................................... 3,241,399 514,036
--------------- --------------
Total current assets................................. 99,413,979 16,061,993
--------------- --------------
Property and equipment, net............................. 8,455,636 3,102,629
Other non-current assets................................ 5,066,877 1,460,561
--------------- --------------
$ 112,936,492 $ 20,625,183
=============== ==============
Liabilities and Stockholders' Equity
Current liabilities:
Trade accounts payable................................. $ 2,310,715 $ 1,909,487
Accrued liabilities.................................... 9,036,780 2,208,087
Accrued contractual settlement and loss on purchase
commitment............................................. 8,797,210 --
Unearned revenue....................................... 1,264,227 --
Current portion of capital lease obligations........... 891,378 954,221
--------------- --------------
Total current liabilities............................ 22,300,310 5,071,795
Non-current portion of capital lease obligations........ -- 636,302
--------------- --------------
Total liabilities.................................... 22,300,310 5,708,097
--------------- --------------
Deposit received on Series D preferred stock............ -- 2,000,000
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock............................ -- 29,492,885
Common stock........................................... 604,948 189,071
Additional paid-in capital............................. 314,408,339 41,749,006
Deferred stock option compensation..................... (13,608,270) (14,164,611)
Stockholder notes receivable........................... (652,800) (821,449)
Accumulated deficit.................................... (210,116,035) (43,527,816)
--------------- --------------
Total stockholders' equity........................... 90,636,182 12,917,086
--------------- --------------
$ 112,936,492 $ 20,625,183
=============== ==============
</TABLE>
See accompanying notes to unaudited condensed financial statements.
1
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NETPLIANCE, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
Period from
January 12, 1999
Nine months (Inception)
ended through
Three months ended September 30, September 30, September 30,
2000 1999 2000 1999
--------------- ---------------- ----------------- ------------------
<S> <C> <C> <C> <C>
Revenues:
Internet appliance revenue, net.... $ 230,103 $ -- $ 230,103 $ --
Subscription revenue, net.......... 3,401,459 -- 5,701,159 --
Peripheral revenue, net............ 194,825 -- 2,117,178 --
-------------- ---------------- --------------- ----------------
Total revenue, net................ 3,826,387 -- 8,048,440 --
Operating expenses:
Cost of Internet appliances....... 556,311 -- 556,311 --
Cost of services.................. 8,021,185 -- 19,620,520 --
Cost of peripherals............... 148,023 -- 1,344,189 --
Loss on subsidized appliance sales 2,034,776 -- 27,194,786 --
Contractual settlement............ 6,340,830 -- 6,340,830 --
Write-down of inventory and loss
on purchase commitment............ 13,814,527 -- 13,814,527 --
Stock-based compensation.......... 500,276 10,352 7,073,996 232,497
Research and development.......... 3,387,224 2,814,892 8,222,847 4,054,660
Sales and marketing............... 8,503,426 2,080,334 43,312,881 3,151,696
General and administrative........ 4,323,505 1,593,101 9,711,433 1,965,656
-------------- ---------------- --------------- ----------------
Loss from operations............... (43,803,696) (6,498,679) (129,143,880) (9,404,509)
Interest income.................... 1,966,148 86,015 4,809,726 116,432
Interest expense................... (44,999) (57,519) (164,803) (62,027)
-------------- ---------------- --------------- ----------------
Net loss........................... (41,882,547) (6,470,183) (124,498,957) (9,350,104)
Effect of beneficial conversion
feature of Series D convertible
preferred stock and warrants...... -- -- (28,557,162) --
Effect of beneficial conversion
feature of Series E convertible
preferred stock................... -- -- (13,532,100) --
-------------- ---------------- --------------- ----------------
Net loss applicable to common stock $(41,882,547) $(6,470,183) $(166,588,219) $(9,350,104)
============== ================ =============== ================
Weighted average shares outstanding 60,441,976 16,935,896 48,753,903 13,567,088
============== ================ =============== ================
Loss per common share--basic and
diluted........................... $(0.69) $(0.38) $(3.42) $ (0.69)
============== ================ =============== ================
Weighted average shares
outstanding pro forma............. 60,441,976 33,127,577 57,448,834 26,558,876
============== ================ =============== ================
Pro forma loss per common
share--basic and diluted.......... $(0.69) $(0.20) $(2.90) $ (0.35)
============== ================ =============== ================
</TABLE>
See accompanying notes to unaudited condensed financial statements.
2
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NETPLIANCE, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
Period from
January 12, 1999
Nine months (Inception)
ended through
September 30, September 30,
2000 1999
---------------- ------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss............................................... $(124,498,957) $(9,350,104)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.......................... 2,021,402 349,829
Noncash compensation expense........................... 7,073,996 232,497
Write-down of inventory and loss on purchase commitment 13,814,527 --
Changes in operating assets and liabilities:
Accounts receivable................................... (1,273,848) --
Inventory............................................. (14,085,140) --
Prepaid expenses...................................... 2,091,676 (530,000)
Other current assets.................................. (2,727,360) (648,288)
Other assets.......................................... (1,083,784) (202,870)
Accounts payable and accrued liabilities.............. 13,030,496 1,434,996
Unearned revenue........................................ 1,264,227 --
---------------- ---------------
Net cash used in operating activities................... (104,372,765) (8,713,940)
---------------- ---------------
Cash flows used in investing activities:
Purchases of property and equipment.................... (7,007,565) (1,496,932)
Maturities and sales of investment securities.......... 31,190,553 --
Purchase of investment securities...................... (96,079,099) --
---------------- ---------------
Net cash used in investing activities................... (71,896,111) (1,496,932)
---------------- ---------------
Cash flows from financing activities:
Increase in restricted cash related to leases.......... (2,129,241) (445,231)
Increase in restricted cash related to agreement with
device manufacturer.................................. (11,876,472) --
Principal payments on capital lease obligations........ (699,145) (134,653)
Proceeds from issuance of common stock, net............ 132,722,255 5,783,904
Proceeds from exercise of stock options and warrants... 1,398,072 3,420
Proceeds from issuance of preferred stock, net......... 58,873,637 17,175,598
Proceeds received from shareholder for note............ 168,649 --
---------------- ---------------
Net cash provided by financing activities............... 178,457,755 22,383,038
---------------- ---------------
Increase in cash and cash equivalents................... 2,188,879 12,172,166
Cash and cash equivalents at beginning of period........ 9,563,362 --
---------------- ---------------
Cash and cash equivalents at end of period.............. 11,752,241 12,172,166
Short-term investments.................................. 64,888,546 --
---------------- ---------------
Cash, cash equivalents and short-term investments....... $ 76,640,787 $12,172,166
================ ===============
</TABLE>
See accompanying notes to unaudited condensed financial statements.
3
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(1) Basis of Presentation
Netpliance, Inc. ("Netpliance" or the "Company") has experienced operating
losses since inception as a result of selling its i-opener Internet appliance at
a significant loss; efforts to build and support its Internet service offering
for customers; and expanding its membership base. In September 2000, the
Company changed its focus from selling i-opener Internet appliances to focusing
on infrastructure software and hardware and related services to various Internet
and other service providers. The Company expects that it will continue to incur
net losses as it continues to expend significant resources on transforming its
business. There can be no assurance that the Company will achieve or sustain
profitability or positive cash flow from its operations.
On October 25, 2000, the Company's Board of Directors approved a
restructuring plan designed to reduce the Company's cost structure by
consolidating facilities and reducing the Company's workforce by approximately
38%. The restructuring plan has not been formalized therefore the Company has
not yet calculated the final amount of the restructuring charge. However, the
Company expects the charge to range from $2.5 million to $3.5 million. This
charge will be recorded in the fourth quarter of 2000.
To date, the Company has funded its activities primarily through private
equity offerings and its initial public offering on March 17, 2000, which have
included sales of its common stock and preferred stock. In the future, the
Company expects to seek additional funding through private or public equity
offerings, credit facilities or other financing arrangements, until such time as
it achieves positive cash flow from operations; however, there can be no
assurance that such financing will be available or that positive operating cash
flows will be achieved.
In the opinion of management, the accompanying unaudited condensed
financial statements contain all adjustments, consisting only of normal
recurring adjustments and accruals, necessary for a fair presentation of such
information. The balance sheet at December 31, 1999, has been derived from the
audited financial statements at that date. While the Company believes that the
disclosures are adequate to make the information not misleading, it is suggested
that these financial statements be read in conjunction with the financial
statements and accompanying notes included in the Company's prospectus dated
March 17, 2000, related to the initial public offering of its common stock. The
results of operations for the interim period ended September 30, 2000, are not
necessarily indicative of results to be expected for the full year or any other
period.
(2) Loss on Subsidized Appliance Sales and Internet Appliance Revenue
The Company subcontracts the manufacturing and assembly of its i-opener
Internet appliance. Prior to August 1, 2000, the Company exclusively arranged
for the Company's overseas manufacturer to ship the appliances directly from
Taiwan to the customer or a retailer, with the Company never taking title to the
appliances. Effective August 1, 2000, the Company restructured its arrangement
with the manufacturer of the i-opener Internet appliance whereby title passed
from the manufacturer to the Company upon delivery of the appliances to a third-
party warehouse in the United States.
The Company offers its i-opener Internet appliance at a price below cost as
an incentive for new customers to subscribe to its Internet service. Through
July 31, 2000, the Company presented the loss generated from the subsidized sale
of the units as an operating expense. Effective August 1, 2000, since the
Company now takes title to the appliances prior to their delivery to customers
or retailers, the Company recognizes revenue from sales of the i-opener Internet
appliance when delivered directly to a customer. Beginning in the third quarter
of 2000, the Company began recognizing retail sales based on sell-through to the
ultimate customer because the Company was not able to accurately estimate
returns.
4
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Direct sales and retailer sell-through revenue, subsequent to August 1, 2000, is
included in Internet appliance revenue, net of an allowance for sales returns.
The cost of the i-opener Internet appliances is recorded as a cost of Internet
appliances in the accompanying Condensed Statement of Operations. The loss on
the sale of i-opener Internet appliances prior to August 1, 2000 is recorded in
Loss on Subsidized Appliance Sales in the accompanying Condensed Statements of
Operations as follows:
<TABLE>
<CAPTION>
Three months Nine months
ended ended
September 30, September 30,
2000 2000
-------------- --------------
<S> <C> <C>
Appliance sales, net of return provision....... $ 384,365 $ 8,218,301
Cost of appliance sales........................ 2,419,141 35,413,087
-------------- --------------
Loss on subsidized appliances $2,034,776 $27,194,786
============== ==============
</TABLE>
The Company records a provision for estimated warranty costs and sales returns
at the time of sale. To date, the Company's warranty costs have not been
significant. The sales return allowance was approximately $356,000 at September
30, 2000.
(3) Write-down of Inventory and Loss on Purchase Commitment
Due to the Company's change in focus from selling devices to focusing on
providing infrastructure software and hardware and other related services to
various Internet and other service providers, the Company instructed the
manufacturer of i-opener Internet appliances to cease producing devices in
September 2000. The early cancellation of this order with the manufacturer
resulted in a $6.3 million settlement payment to the manufacturer. The $6.3
million has been accrued in the third quarter of 2000.
Additionally, during the third quarter of 2000, the Company recorded a
$11.4 million charge to reduce inventory to the lower of cost or market and
recorded a $2.5 million charge for loss on the remaining negotiated purchase
commitment based on the settlement with the manufacturer. The write-down of
inventory and the loss on the purchase commitment were associated with excess
inventory resulting from the Company's decision to refocus the Company's
business from selling devices to providing infrastructure software and hardware
and other related services to various Internet and other service providers.
These amounts are based on the Company's best estimates of product sales prices
and customer demand. Due to the difficulty in estimating future demand for
these devices, it is reasonably possible that these amounts may change in the
near term, which could have a material effect on the Company's results of
operations and financial condition.
(4) Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Short-term investments
consist of $64.9 million in certificates of deposit, commercial paper
obligations, corporate bonds and municipal bonds with original maturity dates of
approximately four to twelve months. The Company classifies its investments as
available-for-sale and fair value approximates cost at September 30, 2000.
(5) Net Loss Per Share
Basic and diluted net loss per share are presented in conformity with
Statement of Financial Accounting Standard No. 128, "Earnings Per Share." In
accordance with Statement of Financial Accounting Standard No. 128 and
Securities and Exchange Commission Staff Accounting Bulletin No.
5
<PAGE>
98, basic loss per share is computed using the weighted average number of common
shares outstanding during the period. Diluted loss per share is equivalent to
basic loss per share because outstanding stock options, warrants and convertible
preferred stock are anti-dilutive. The calculation of net loss per share
excludes potential common shares if their effect is anti-dilutive. Potential
common shares consist of common shares issuable upon the exercise of stock
options and stock warrants.
The following table sets forth the computation of basic and diluted loss
per share. Pro forma loss per share assumes the conversion of all preferred
stock into common stock and the recognition of the related effects of the
beneficial conversion feature on the later of January 1, 2000, or the date of
issuance of the preferred stock.
<TABLE>
<CAPTION>
Period from
Nine months January 12, 1999
Three months ended ended (inception) to
September 30, September 30, September 30,
2000 1999 2000 1999
---------------- --------------- --------------- ----------------
<S> <C> <C> <C> <C>
Numerator:
Net loss...................... $(41,882,547) $(6,470,183) $(124,498,957) $(9,350,104)
Effect of beneficial
conversion feature of Series
D convertible preferred -- -- (28,557,162) --
stock and warrants...........
Effect of beneficial
conversion feature of Series
E convertible preferred stock -- -- (13,532,100) --
--------------- --------------- --------------- --------------
Net loss applicable to common
stock........................ $(41,882,547) $(6,470,183) $(166,588,219) $(9,350,104)
=============== =============== =============== ==============
Denominator:
Weighted average common
shares outstanding........... 60,441,976 16,935,896 48,753,903 13,567,088
Conversion of Series A
preferred stock.............. -- 16,191,681 5,552,827 12,991,788
Conversion of Series B
preferred stock.............. -- -- 983,571 --
Conversion of Series C
preferred stock.............. -- -- 562,055 --
Conversion of Series D
preferred stock.............. -- -- 1,127,299 --
Conversion of Series E
preferred stock.............. -- -- 469,179 --
--------------- --------------- --------------- --------------
Shares used in pro forma
calculation.................. 60,441,976 33,127,577 57,448,834 26,558,876
=============== =============== =============== ==============
Net loss per share:
Basic and diluted............ $ (0.69) $ (0.38) $(3.42) $ (0.69)
Pro forma.................... $ (0.69) $ (0.20) $(2.90) $ (0.35)
</TABLE>
6
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(6) Initial Public Offering
On March 17, 2000, the Company completed an initial public offering of
8,000,000 shares of its common stock and realized net proceeds of $132.7
million. As of the closing date of the offering, all of the Company's
convertible preferred stock outstanding was converted into common stock.
(7) Stock Options
In the three and nine months ended September 30, 2000, the Company granted
to employees options to purchase 1,204,500 and 5,828,415 shares, respectively,
of common stock at exercise prices ranging from $1.70 to $18.50 per share that
will vest over a period of four years. In addition, in February 2000, the
Company granted options to non-employee directors to purchase 630,000 shares of
common stock at exercise prices ranging from $6.67 to $10.00 per share that
vested immediately. In the three and nine months ended September 30, 2000, the
Company recorded approximately $500,000 and $7.1 million, respectively, of
compensation expense resulting from the grant of options with exercise prices
below fair value. Remaining deferred compensation as of September 30, 2000, of
$13.6 million will be amortized over the applicable vesting period.
During the third quarter of 2000, the departure of certain employees with
unvested options resulted in a reversal of $5.9 million of deferred stock option
compensation and approximately $562,000 of previously recognized stock-based
compensation expense.
(8) Capital Stock
Common Stock
On February 6, 2000, the Board of Directors approved a three-for-one stock
split of common stock and reincorporation of the Company in the State of
Delaware, to be effective immediately prior to the effective date of the
Company's initial public offering. The reincorporation was completed on March
15, 2000. All common stock information has been adjusted to reflect the stock
split as if such split had taken place at inception. On the same date, the
Board of Directors authorized an increase in the number of shares reserved for
issuance under the stock option plan to 10,500,000.
Convertible Preferred Stock
On December 22, 1999, the Company entered into an irrevocable agreement to
sell 1,430,000 shares of Series D Convertible Preferred Stock ("Series D") for
$20.00 per share in a private placement. On January 5, 2000, the Company
consummated the Series D offering and issued the Series D. Net proceeds to the
Company approximated $27.0 million. The Series D was converted into 4,290,000
shares of common stock upon the closing of the Company's initial public
offering. In December 1999, a purchaser of Series D paid $2.0 million for its
shares in advance of the issuance of the shares.
On February 4, 2000, the Company entered into an irrevocable agreement to
sell 1,127,675 shares of Series E Convertible Preferred Stock ("Series E") for
$30.00 per share in a private placement. The closing for the sale of these
shares was on February 7, 2000. The Series E was converted into 3,383,025
shares of common stock upon the closing of the Company's initial public
offering.
The 1,430,000 shares of Series D, warrants to purchase 221,400 shares of
common stock issued in conjunction with Series D and the 1,127,675 shares of
Series E were issued with beneficial conversion features approximating $27.2
million, $1.4 million and $13.5 million, respectively. The beneficial
conversion feature was calculated as the difference between the conversion price
and the fair value of the common stock into which the preferred stock is
convertible. These amounts have been accounted for as
7
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an increase in additional paid-in capital and in-substance dividends to
preferred stockholders in the first quarter of 2000 and accordingly have
resulted in an increase in the loss applicable to common stockholders of $42.1
million for the nine months ended September 30, 2000.
(9) Commitments and Contingencies
Prior to the effectiveness of the registration statement covering the sale
of Netpliance common stock sold in the initial public offering, Donaldson,
Lufkin & Jenrette Securities Corporation, an underwriter of the offering,
provided written materials to approximately 200 individuals that Netpliance had
designated as potential purchasers of up to 400,000 shares of common stock in
the offering through a directed share program. These materials may have
constituted a prospectus that does not meet the requirements of the Securities
Act of 1933. If the distribution of these materials by Donaldson, Lufkin &
Jenrette Securities Corporation did constitute a violation of the Securities Act
of 1933, the recipients of the materials who purchased common stock in the
offering would have the right, for a period of one year from the date of their
purchase of common stock, to recover from the Company the consideration paid in
connection with their purchase of common stock or, if they have already sold the
stock, to seek damages resulting from their purchase of common stock. These
damages could total up to approximately $7.2 million plus interest, based on the
initial public offering price of $18.00 per share, if these investors seek
recovery or damages after an entire loss of their investment. To the extent that
any of the recipients of the materials also purchased shares in the offering
outside the program from the underwriters, the potential damages would increase
by the purchase price of those shares. The Company does not believe that the
distribution in question is a violation of the Securities Act and, therefore,
believes that it would prevail in any litigation if any such claims are made.
While the ultimate outcome of these matters cannot be determined, Netpliance
does not expect that they will have a material adverse effect on its financial
position, results of operations or cash flows.
In July 2000, the Company entered into a network service agreement with
AT&T Corp. to provide Internet service to its subscribers. Under the agreement,
the Company is obligated to pay minimum commitment amounts over the term of the
agreement equaling $405,000, $7.3 million, $14.5 million and $10.4 million for
calendar years 2000, 2001, 2002 and 2003. The agreement may be terminated by
the Company upon 60 days written notice for any reason upon the payment of a
termination fee based on a percentage of the then current commitment level and
the remaining term of the agreement.
In July 2000, the company entered into a network services agreement with
Genuity Solutions, Inc. to provide dial-up Internet service to its subscribers.
Under the agreement, the Company is obligated to pay minimum commitment amounts
over the three year term of the agreement equaling $200,000 per month.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
The discussion in Management's Discussion and Analysis of Results of
Operations and Financial Condition contains trend analysis and other forward-
looking statements within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. Actual results could differ materially from those set forth in such
forward-looking statements as a result of the "Factors That May Affect Future
Operating Results" and other risks detailed in our reports filed with the
Securities and Exchange Commission.
OVERVIEW
The following is a discussion and analysis of our financial condition and
results of operations for the three months ended September 30, 2000, and
September 30, 1999, and for the nine months ended September 30, 2000, and the
period from January 12, 1999, (inception) through September 30, 1999, (each
referred to herein as "the nine months"), including significant factors that
could affect our prospective financial condition and results of operations.
This discussion and analysis should be read in conjunction with the financial
statements included in this report and notes thereto, and with our audited
financial statements and notes thereto for the fiscal year ended December 31,
1999, contained in our Registration Statement on Form S-1, as amended (SEC File
No. 333-93545), filed with the Securities and Exchange Commission.
We were formed in January 1999, and in November 1999 we introduced our i-
opener service. On November 10, 2000, we announced plans to realign our
strategic focus. Under this new focus, we intend to provide infrastructure
software and hardware to various Internet and other service providers. We have
decided to de-emphasize our current business of offering Internet-based content,
applications and services through devices specifically designed for Internet
access, commonly known as Internet appliances, directly to consumers.
We are structuring our ongoing operations around two separate, but
complementary, business units. The first, called Netpliance.net, will continue
to provide our i-opener service to subscribers, but will expand to provide
hosting services, content and network management to Internet and other types of
service providers. As of September 30, 2000, we provided our i-opener service
to approximately 49,400 subscribers. Through January 31, 2001, we will attempt
to sell our remaining inventory of approximately 27,000 appliances to new
subscribers. After that date, we do not expect to actively market our i-opener
Internet appliances to consumers. We expect to continue our i-opener service;
however, we cannot provide assurances that, due to business or economic reasons,
we will not, at some point, discontinue our i-opener service or cease to upgrade
it. We may be unable to sell all, or any, of our remaining inventory, in part
due to our new business focus.
Our second business unit, called Netpliance IPG (Infrastructure Products
Group), will provide the infrastructure, including software, necessary to enable
the delivery of broadband and other Internet access services. This business
unit will market itself to Internet Service Providers, Multiple System
Operators, Local Exchange Carriers and Interchange Carriers and other similar
types of service providers.
We currently generate revenues from the sale of our i-opener Internet
appliances, from monthly subscriber fees for our i-opener service and from the
sale of printers and other accessories for use with our i-opener Internet
appliances. We currently charge $299 for our i-opener Internet appliances, and
we currently charge our subscribers $21.95 per month for our service.
In the future we expect to generate revenue in our Netpliance.net business
unit from application service fees, hosted service fees and network management
fees. We expect to generate revenue in our
9
<PAGE>
Netpliance IPG business unit from infrastructure appliance sales, recurring
software licensing fees, maintenance fees and professional service fees.
However, we have not proven that we can generate significant revenues in any of
these new areas.
To date, we have funded our activities primarily through private equity
offerings of our common stock and preferred stock, and through the sale of our
common stock in our initial public offering on March 17, 2000.
BUSINESS TRANSITION
In implementing our new strategic focus, we will significantly restructure
our existing operations and reallocate our existing assets. As part of this
transition, we will reduce our headcount by approximately 38%. Much of this
reduction comes in our sales and marketing departments as a result of the
discontinuation of our direct consumer sales effort. We are also reducing the
number of our administrative personnel in an effort to control costs. We expect
the headcount reduction to decrease our annual operating expenses by
approximately $5.4 million. We intend to reallocate any savings to our research
and development department, where we expect to significantly increase our
previous level of investment. We have not formalized our restructuring plan
and, although we have not yet calculated the restructuring charge we will
record, we expect to record a charge ranging from $2.5 million to $3.5 million
in the fourth quarter of 2000.
RESULTS OF OPERATIONS
The following discussion compares our financial condition and results of
operations for the periods ended September 30, 2000 and 1999, and significant
factors that could affect our prospective financial condition and results of
operations.
Revenues. Revenues consist of Internet appliance revenues, subscription
revenues and peripheral sales revenues.
Internet appliance revenues consist of sales of our "i-opener membership
pak" directly to customers or to retail outlets that in turn resell our devices
to the public. Internet appliance revenue for the quarter ended September 30,
2000 was approximately $230,000 due to the sale of approximately 1,000 i-opener
membership paks. We recognize revenue on the sale of Internet appliances upon
delivery of the product to the consumer, or the customer of the retail outlet.
Purchasers can return the product for up to 30 days after the date of sale. We
establish a reserve for returned product based upon actual returns we have
experienced. Through July 31, 2000, we never took title to the product and,
therefore, did not recognize Internet appliance revenue. Instead, we recognized
the cost of the i-opener Internet appliance, net of sales proceeds, as a loss on
subsidized appliance sales.
Subscription revenues consist primarily of monthly subscription fees paid
by consumers for our i-opener service. Subscription revenues increased to $3.4
million for the quarter ended September 30, 2000, as compared to $0 for the
quarter ended September 30, 1999. Subscription revenues increased to $5.7
million for the nine months ended September 30, 2000, as compared to $0 for the
nine months ended September 30,1999. The increase in subscription revenues is
attributable to the increase in the number of subscribers who used our i-opener
service, which began in November 1999. During the third quarter, we implemented
a plan to transition or discontinue our i-opener service to approximately 4,400
subscribers who had been accessing the service through our 800 number. This 800
service significantly increased the cost of providing our i-opener service. As
of September 30, 2000, we had approximately 49,400 subscribers.
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Peripheral revenues consist primarily of revenue earned from the sale, to
our i-opener subscribers, of printers and other accessories for use with our i-
opener Internet appliance. Peripheral revenues increased to approximately
$195,000 for the quarter ended September 30, 2000, as compared to $0 for the
quarter ended September 30, 1999. Peripheral revenue for the third quarter of
2000 decreased significantly from the preceding quarter ended June 30, 2000,
because we did not sell our i-opener Internet appliance for much of the third
quarter. After the announcement of the i-opener membership pak in July, we did
not begin shipping the pak to retail outlets until September 2000 and did not
begin shipping the pak to direct customers until October 2000. Peripheral
revenues increased to $2.1 million for the nine months ended September 30, 2000,
as compared to $0 for the nine months ended September 30, 1999.
Cost of Revenues. Cost of revenues through September 30, 2000, consists of
the costs of internet appliances, costs of providing the i-opener service and
costs of peripherals.
Cost of i-opener Internet appliances consists primarily of the cost of the
i-opener Internet appliances sold to our i-opener subscribers through our i-
opener membership pak during the period. Cost of i-opener Internet appliances
increased to $556,000 for the quarter ended September 30, 2000, as compared to
$0 for the quarter ended September 30, 1999. Cost of Internet appliances was
also $556,000 for the nine months ended September 30, 2000, as compared to $0
for the nine months ended September 30, 1999. Through the period ended July 31,
2000, the cost of the i-opener Internet appliance, net of sales proceeds, was
classified in our statement of operations as loss on subsidized appliance sales.
Cost of providing the i-opener service consists primarily of employee
salaries and expenses related to providing the i-opener service to subscribers,
content, consulting and telecommunications network charges paid to third parties
and depreciation on equipment used to provide the i-opener service. Cost of
services increased to $8.0 million for the quarter ended September 30, 2000, as
compared to $0 for the quarter ended September 30, 1999. Cost of services
increased to $19.6 million for the nine months ended September 30, 2000, as
compared to $0 for the nine months ended September 30, 1999. The increase in
cost of services is attributable to the initiation of our i-opener service in
November 1999 and the related cost of operations to provide the i-opener service
to our subscribers.
Cost of peripherals consists primarily of the costs of printers and other
accessories sold to our i-opener subscribers during the period. Cost of
peripherals increased to approximately $148,000 for the quarter ended September
30, 2000, as compared to $0 for the quarter ended September 30, 1999. Cost of
peripherals increased to $1.3 million for the nine months ended September 30,
2000, as compared to $0 for the nine months ended September 30, 1999. This
increase in cost is attributable to the purchases of printers and other
accessories that began when we initiated our i-opener service and the sale of
our i-opener Internet appliances in November 1999.
Loss on Subsidized Appliance Sales. We have offered our i-opener Internet
appliance at a price significantly below our cost, as an incentive for new
customers to subscribe to our i-opener service. Through July 31, 2000, we
presented the loss generated from the sale of these units as an operating
expense. A loss is recognized in the period in which we ship an appliance to a
customer or a retailer. We used this method because the devices were shipped
directly from the manufacturer to the customer or the retailer, and we never
took title to the devices.
As a result of supply constraints in the past, in the third quarter of 2000
we created an inventory of i-opener Internet appliances in a third-party
warehouse facility located in the United States to be used during periods of
peak demand to complement our direct shipment method of delivery. We continued
the practice of recognizing a loss on subsidized appliance sales until the
backlog of orders that existed on July 31, 2000 was fulfilled. After we filled
the backlog orders, we began taking delivery of the devices at our third party
warehouse and began recording revenues from the sale of i-openers with a related
cost of
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sales. Loss on subsidized appliance sales increased to $2.0 million for the
quarter ended September 30, 2000, as compared to $0 for the quarter ended
September 30, 1999. Loss on subsidized appliance sales increased to $27.2
million for the nine months ended September 30, 2000, as compared to $0 for the
nine months ended September 30, 1999, due to the initiation of appliance
shipments in November 1999.
Contractual Settlement. As a result of our new strategic focus, and the
de-emphasis of our direct consumer sales effort, we reduced our outstanding
purchase order with Quanta Computer, Incorporated, the manufacturer of the i-
opener Internet appliance. The reduction in our outstanding purchase order
resulted in a cancellation fee of $6.3 million. This negotiated fee compensated
Quanta for, among other things, cancellation penalties Quanta incurred to stop
shipments of raw materials they had ordered to fulfill our requirements and raw
materials Quanta had in stock that were unique to the i-opener Internet
appliance.
Write-down of Inventory and Loss on Purchase Commitment. In September
2000, although we had not fully developed our revised strategic focus, we
decided that we would cease to actively market our i-opener service through
direct consumer sales. As a result, we expect a negative effect on sales of our
remaining inventory of i-opener Internet appliances, since these products may
not be perceived to be a part of a larger integrated or complementary portion of
our ongoing business plan. Because of the uncertainty regarding the sale of
this remaining inventory, in the third quarter of 2000 we recorded a $11.4
million charge to record inventory at the lower of cost or market. In addition,
we recorded a $2.5 million charge for the loss on the remaining negotiated
purchase commitment, based on our settlement with the manufacturer. The write-
down of inventory and the loss on the purchase commitment were associated with
excess inventory resulting from our decision to refocus our business away from
selling devices and providing Internet access. Due to the difficulty in
estimating future demand for these services, it is reasonably possible that
these amounts may change in the near term which could have a material effect on
the results of operations and our financial condition in the future.
Stock-based Compensation. Stock-based compensation increased to
approximately $500,000 for the quarter ended September 30, 2000, as compared to
approximately $10,000 for the quarter ended September 30, 1999. Stock-based
compensation increased to $7.1 million for the nine months ended September 30,
2000, as compared to approximately $232,000 for the nine months ended September
30, 1999. These expenses are attributable to stock options granted during 2000
and 1999 with exercise prices that were less than the estimated fair value of
the underlying common stock on the date of grant. The $500,000 of expense in
the third quarter of 2000 consisted of $1.1 million in expense offset by
$562,000 in recapture of expense recorded in the prior quarter due to the
departure of certain employees with unvested options. Additional deferred stock
compensation totaled $13.6 million as of September 30, 2000. This amount will
be amortized over the remaining vesting period of the applicable options.
Sales and Marketing. Sales and marketing expenses consist primarily of
employee salaries for marketing, business development and sales personnel, and
costs of our marketing efforts to generate demand for and consumer awareness of
our i-opener service. These costs include development of advertising, public
relations events, promotions and trade shows. Sales and marketing expenses
increased to $8.5 million for the quarter ended September 30, 2000, as compared
to $2.1 million for the quarter ended September 30, 1999, and to $43.3 million
for the nine months ended September 30, 2000, as compared to $3.2 million for
the nine months ended September 30, 1999. The increase in sales and marketing
expenses is primarily attributable to the increase in advertising costs,
totaling $24.8 million, and the increase in our employment costs associated with
the staffing of our i-opener sales department. We expect that sales and
marketing expenses will decrease in future periods as we de-emphasize our direct
consumer sales effort, which will result in a reduction in personnel in this
area and in consumer advertising. Under our new strategic focus, we will
concentrate our business development efforts in recruiting personnel with
experience in managed network, software and infrastructure services.
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General and Administrative. General and administrative expenses consist
primarily of employee salaries and related expenses for the executive,
administrative, finance and information systems departments, and facility costs,
professional fees and recruiting. General and administrative expenses increased
to $4.3 million for the quarter ended September 30, 2000, as compared to $1.6
million for the quarter ended September 30, 1999, and to $9.7 million for the
nine months ended September 30, 2000, as compared to $2.0 million for the nine
months ended September 30, 1999. The increase in general and administrative
expenses is primarily attributable to the general increase in the number of
employees comprising the executive, administrative, finance and information
systems departments. We expect that general and administrative expenses will
decrease in future periods as a result of the lower number of employees,
including administrative personnel, after the reorganization of our operations.
Research and Development. Our research and development expenses consist
primarily of employee salaries and related expenses and consulting fees relating
to the design of the i-opener service, as well as the development of our
technology to manage and deliver content and applications to various Internet
appliances. Research and development expenses increased to $3.4 million for the
quarter ended September 30, 2000, as compared to $2.8 million for the quarter
ended September 30, 1999. Research and development expenses increased to $8.2
million for the nine months ended September 30, 2000, as compared to $4.1
million for the nine months ended September 30, 1999. We expect that research
and development expenses will increase as a result of our new strategic focus.
Interest Income and Interest Expense. Interest income increased to $2.0
million for the quarter ended September 30, 2000, as compared to approximately
$86,000 for the quarter ended September 30, 1999 and to $4.8 million for the
nine months ended September 30, 2000, as compared to approximately $116,000 for
the nine months ended September 30, 1999, as a result of an increase in the
average cash balances held at banking and financial institutions from the sale
of common stock in our initial public offering and previous sales of convertible
preferred stock sold in private offerings. Interest expense decreased to
approximately $45,000 for the quarter ended September 30, 2000, as compared to
approximately $58,000 for the quarter ended September 30, 1999, due to higher
interest cost in the first part of our two-year equipment lease entered into in
August 1999. Interest expense increased to approximately $165,000 for the nine
months ended September 30, 2000, as compared to approximately $62,000 for the
nine months ended September 30, 1999, as a result of payments made for the full
nine months on existing equipment financing arrangements.
LIQUIDITY AND CAPITAL RESOURCES
From inception in January 1999 through September 30, 2000, we financed our
operations and met our capital expenditure requirements primarily from the net
proceeds of the private and public sale of equity securities totaling
approximately $230 million. At September 30, 2000, we had $76.6 million in
cash, cash equivalents and short-term investments. Although we have taken steps
to decrease our future operating expenses, our new strategic focus will require
additional capital to fund operating losses, research and development expenses,
capital expenditures and working capital needs until such time as we achieve
positive cash flows from operations. In addition we expect to incur expenses of
between $2.5 million and $3.5 million over the next quarter in connection with
our restructuring plan. However, there can be no assurance that any additional
financing will be available or that we can achieve positive operating cash
flows.
Working capital increased by $66.1 million to $77.1 million as of September
30, 2000, from $11.0 million at December 31, 1999. During the nine months ended
September 30, 2000, we received $193.0 million from the private and public sale
of our common and preferred stock, including $132.7 million of net proceeds from
the sale of 8,000,000 shares of common stock in our initial public offering on
March 17, 2000.
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Net cash used in operating activities was $104.4 million and $8.7 for the
nine months ended September 30, 2000, and 1999, respectively. Cash used in
operating activities during the nine months ended September 30, 2000, consisted
primarily of net operating losses of $124.5 million.
Net cash used in investing activities was $71.9 million and $1.5 for the
nine months ended September 30, 2000, and 1999, respectively. Cash used in
investing activities consists of the purchase of property and equipment and the
purchase of certain investment securities.
Net cash provided by financing activities was $178.5 million and $22.4
million for the nine months ended September 30, 2000 and 1999, respectively.
The $178.5 million provided during the nine months ended September 30, 2000,
includes $132.7 million of net proceeds from the sale of 8,000,000 shares of our
common stock in our initial public offering and $58.9 million of net proceeds
from the private sale of shares of preferred stock, partially offset by $11.7
million used by us to purchase a certificate of deposit to secure a standby
letter of credit issued to our device manufacturer.
We have commitments under facility and other operating leases of $9.8
million, including a $8.4 million commitment under a second facility lease
agreement expiring in 2005, and obligations under capital leases of $891,000 as
of September 30, 2000. The obligations under capital leases relate to equipment
leased under leases with three different vendors, each of which expires in the
year 2001.
In July 2000, we provided Quanta Computer, Incorporated, our third party
manufacturer of the i-opener Internet appliance, a standby letter of credit in
the amount of $11.7 million, which was secured by a certificate of deposit of
equal amount. The letter of credit could be drawn upon in the event we failed
to make payments to Quanta pursuant to the terms and conditions of our agreement
with them. On September 20, 2000, we negotiated a reduction in our outstanding
purchase order with Quanta and, as a result, incurred a penalty of $6.3 million.
On October 27, 2000, Quanta drew this amount, plus $2.9 million to cover
outstanding invoices generated from October shipments, from the letter of credit
with our consent. On October 31, 2000, the remaining $2.5 million of the letter
of credit expired and we deposited the resulting funds into our general
operating account. In July 2000, we entered into a network service agreement
with AT&T Corp. to provide Internet service to our i-opener subscribers. Under
the agreement, we are obligated to pay minimum commitment amounts over the term
of the agreement equaling $403,000, $7.3 million, $14.5 million and $10.4
million for calendar years 2000, 2001, 2002 and 2003. We may terminate this
agreement upon 60 days written notice for any reason upon the payment of a
termination fee, which is based on a percentage of the then current commitment
level and the remaining term of the agreement. Additionally, In July 2000, we
entered into a network services agreement with Genuity Solutions, Inc. to
provide dial-up internet service to its subscribers. Under the agreement, we
are obligated to pay minimum commitment amounts over the three year term of the
agreement equaling $200,000 per month. We anticipate that we will be unable to
meet our minimum commitment amounts, and we may need to terminate these
agreements or renegotiate the terms of these agreements on a less favorable
basis, which will adversely affect our financial results.
We have not formalized our restructuring plan, and although we have not yet
calculated the restructuring charge we will record, we expect to record a charge
ranging from $2.5 million to $3.5 million in the fourth quarter of 2000.
Our future capital requirements will depend on a variety of factors,
including acceptance of broadband and implementation of our new strategy, as
well as other factors, such as the resources we devote to develop, market, sell
and support our service and product offerings. We expect to devote substantial
capital resources:
. for our business development efforts;
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. to hire and expand our engineering and research and development
departments;
. to further develop our service and product offerings; and
. for general corporate purposes.
Although we have no specific plans regarding future expenditures, we
believe that our cash, cash equivalents and other short-term investments as of
September 30, 2000 will be sufficient to fund our operations for at least the
next 12 months. Despite our expectations, we may need to raise additional
capital before that time. We may need to raise additional funds in order to:
. fund anticipated growth;
. develop new services and products; or
. acquire or invest in complementary businesses, technologies, services
or products.
In addition, in order to meet long term liquidity needs, we may need to
raise additional funds, establish a credit facility or seek other financing
arrangements. Additional funding may not be available on favorable terms, or at
all.
Finally, shares of common stock that were sold in our initial public
offering through a directed share program in connection with our initial public
offering may have been offered or sold in violation of the federal securities
laws. If these offers or sales were in violation of those laws, the purchasers
could, for a period of one year after the date of their purchase of common
stock, recover the purchase price paid for their common stock, or, if they sell
the stock, seek damages resulting from their purchase of the common stock. If
any of these investors successfully seek recovery or damages, we may need to
raise additional funds in order to pay any recovery or damages awarded to these
investors.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivatives and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including derivative instruments embedded
in other contracts, and for hedging activities. We will adopt SFAS No. 133 as
required by SFAS No. 137, "Deferral of the Effective Date of the FASB Statement
No. 133," in fiscal year 2001. We do not expect the adoption of SFAS No. 133 to
have a significant impact on our financial condition or results of operations.
In October 1999, the Chief Accountant of the Securities and Exchange
Commission (the "SEC") requested that the Emerging Issues Task Force (the
"EITF") address a number of accounting and financial reporting issues that the
SEC believes had developed with respect to Internet businesses. The SEC
identified several issues for which they believed some form of standard setting
or guidance may be appropriate either because (1) there appeared to be diversity
in practice, (2) the issues are not specifically addressed in current accounting
literature or (3) the SEC Staff is concerned that developing practice may be
inappropriate under generally accepted accounting principles. Many of the
issues identified by the SEC are potentially applicable to us. Although the
EITF has begun to deliberate these issues, it has not yet issued formal guidance
for the majority of them. In addition, in December 1999, the SEC issued Staff
Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements
(as recently amended by SAB 101A and SAB 101B), requiring implementation no
later than the fourth fiscal quarter of fiscal years beginning after December
15, 1999. We are currently analyzing the potential impact of
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SAB No. 101 on our revenue recognition policies. Although we believe that our
historical accounting policies and practices conform with generally accepted
accounting principles, there can be no assurance that final consensuses reached
by the EITF on the issues referred to above, or other actions by standard
setting bodies, or our formal implementation of SAB No. 101, will not result in
changes to our historical accounting policies and practices or to the manner in
which certain transactions are presented and disclosed in our financial
statements.
The FASB recently issued Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation." This interpretation provides
guidance related to the implementation of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees." This interpretation is to
be applied prospectively to all new awards, modifications to outstanding awards
and changes in employee status on or after July 1, 2000. For changes made after
December 15, 1998 to awards that affect exercise prices of the awards, we must
prospectively account for the impact of those changes. We do not believe the
adoption of this interpretation will have a material impact on our financial
position or results of operations.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Our future operating results and financial condition are dependent on our
ability to successfully develop, manufacture, and market technologically
innovative products in order to meet dynamic customer demand patterns. Inherent
in this process are a number of factors that the Company must successfully
manage in order to achieve favorable future operating results and financial
condition. Potential risks and uncertainties that could affect the Company's
future operating results and financial condition include, without limitation the
following:
We cannot predict our future results because we have a limited operating
history and have recently undergone a restructuring of our business.
We were incorporated in January 1999, and we began offering our i-opener
service in November 1999. However, due primarily to a subsidy of the sale price
of our i-opener Internet appliance, we have suffered operating losses sufficient
to potentially jeopardize our ability to continue operations. In order to
preserve our remaining operating cash and to attempt to become profitable, we
have formulated a new strategic direction and announced certain restructuring
actions aimed at reducing our cost structure, improving our competitiveness and
becoming profitable. There are several risks and costs inherent in our efforts
to transition to a new business model. These include the risk that we may not
be able to reduce expenditures and improve liquidity before our cash is depleted
and the risk that cost-cutting initiatives will impair our ability to innovate
and remain competitive in our industry. We expect to incur operating losses
throughout at least the remainder of 2000 and continuing into 2001, and it is
possible that we may never become profitable.
As part of our restructuring effort, we intend to reorganize into two
distinct but complementary business units, Netpliance.net and Netpliance IPG.
Netpliance.net will handle our existing i-opener service, and will expand into
hosted consumer applications, contract delivery services and infrastructure
management. Netpliance IPG will provide infrastructure appliances and
management tools for Internet Service Providers (ISPs), Local Exchange Carriers
(LECs), Multiple System Operators (MSOs) and InterExchange Carriers (IECs) and
other types of similar service providers. After our reorganization, we intend
to attempt to add new subscribers to our i-opener service until our current
inventory of i-opener Internet appliances has been sold, and we intend to
continue our i-opener service; however, we cannot provide assurances that, due
to business or economic reasons, we will not at some point, discontinue our i-
opener service or cease to upgrade it. Successful implementation of our
reorganization involves several risks. These risks include:
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. reliance upon unproven products and technology;
. the effect of continued degradation of the Company's liquidity;
. market acceptance of our new products and services;
. our ability to anticipate and adapt to a developing market and to
rapidly changing technologies;
. the effect of competitive pressures in the marketplace;
. our new, unproven and evolving business model;
. our need to expand significantly our internal resources to support
growth of our products and service offerings;
. uncertainties concerning the Company's strategic direction and financial
condition or revenue and liquidity;
. our need for network operators to launch and maintain commercial
services utilizing our new products and services;
. the effect of restructuring actions;
. the uncertainty of market acceptance of commercial services utilizing
our products and services;
. our need to introduce reliable products and services that meet the
demanding needs of network operators and service providers; and
. our need to realign and enhance our business development, research and
development, consulting and support organizations, and expand our
distribution channels.
Even if our new business model is successfully implemented, there can be no
assurance that it will effectively resolve the various issues we currently face.
In addition, although we believe that the actions that we are taking under our
reorganization plan should help us become profitable, there can be no assurance
that such actions will succeed.
Internal and external changes resulting from our reorganization and
transition towards our new strategic focus may disrupt our customers, strategic
partners, distributors and employees, and create a prolonged period of
uncertainty, which could have a material adverse affect on our business. Our
new strategy requires substantial changes including, over time, pursuing new
strategic relationships, increasing our research and development expenditures,
reducing employee headcount, adding employees who possess the new skills we will
need, investing in new technologies, establishing leadership positions in new
high-growth markets and realigning and enhancing our sales and marketing
departments. Many factors may impact our ability to implement this strategy,
including our ability to finalize agreements with other companies, manage the
implementation internally, sustain the productivity of our workforce, introduce
innovative new products in a timely manner, reduce operating expenses, and
quickly respond to and recover from unforeseen events associated with our
transition and realignment.
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As a result of our reorganization, it will be difficult to forecast our
financial performance. However, we expect that both sales and operating income
may continue to be negatively impacted, and we expect to report operating losses
in fiscal 2001.
For the foregoing reasons there can be no assurance that the current
restructuring actions will achieve their goals or that similar actions will not
be required in the future. Our future operating results and financial condition
could be adversely affected should we encounter difficulty in effectively
managing the transition to our new business model and cost structure.
For more information regarding our restructuring actions refer to Note 1 of
the Notes to Consolidated Financial Statements (Unaudited) in Part I, Item I,
and to Management's Discussion and Analysis of Results of Operations and
Financial Condition in Part I, Item II of this Quarterly Report on Form 10-Q,
which information is hereby incorporated by reference.
We may be unsuccessful at establishing new product lines and markets.
Our financial performance and future growth depend upon the rapid growth of
new markets, and our ability to establish a leadership position in those
markets. We are investing a significant proportion of our resources in several
emerging product lines in markets that are forecasted to grow at a significantly
higher rate than the networking industry average. We will focus on the
following high-growth and emerging market opportunities to enable other
businesses to provide enhanced broadband access to residential consumers.
At the present time, the markets for these products and solutions are still
emerging. Industry standards for these technologies are yet to be widely
adopted and the market potential remains unproven. If these markets do not grow
at a significant rate, or if we do not generate sufficient sales in these
product lines, our financial results will be adversely affected.
Our ability to develop and introduce new products is unproven.
Products in the markets in which we compete have short life cycles.
Therefore, our success depends on our ability to identify new market and product
opportunities, to develop and introduce new products in a timely manner, and to
gain market acceptance of new products, particularly in our targeted high-
growth, emerging markets.
Any delay in new product introductions or lower than anticipated demand for
our new products could have an adverse affect on our operating results or
financial condition, particularly in those product markets we have identified as
emerging high-growth opportunities.
We may compete with our potential partners which may prevent us from
forming strategic alliances.
We must compete in some business areas with companies with which we need to
form strategic alliances and, at the same time, cooperate with such companies in
other business areas. If these companies fail to perform, or if these
relationships fail to materialize as expected, we could suffer delays in product
or market development or other operational difficulties. Also, our results of
operations or financial condition could be adversely impacted if we experience
difficulties managing relationships with our partners or if projects with
partners are unsuccessful. In addition, if our competitors enter into
successful strategic relationships, they could increase the competition that we
face.
If our products are defective, we may be liable to make payments under
warranties and our business will suffer.
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Because our products are often covered by warranties, we may be subject to
contractual and/or legal commitments to perform under such warranties. If our
products fail to perform as warranted and we do not resolve product quality or
performance issues in a timely manner, our operating results or financial
condition could be adversely affected. Likewise, if we fail to meet commitments
related to the installation of networks, we could be subject to claims for
business disruption or consequential damages if a network implementation is not
completed successfully in a timely manner. Our i-opener Internet appliances are
subject to a 90-day warranty for parts and labor and a one year warranty for
parts. If a significant number of appliances are returned pursuant to these
warranties, our financial condition could be adversely affected.
If we are unable to acquire key components or unable to acquire them on
favorable terms, our business will suffer.
Some key components of our products and some services on which we will rely
are currently available only from single or limited sources. In addition, some
of these suppliers are also our competitors. We cannot be certain that we will
be able to meet our demand for components in a timely and cost-effective manner.
For example, due to strong world-wide demand, the electronics industry is facing
shortages on various memory devices and passive components. Due to these
shortages, our ability to procure these components and meet our on-time delivery
requirements in a cost-effective manner could be impacted. Our operating
results, financial condition, or customer relationships could be adversely
affected by these shortages. These adverse effects could result from an
inability to fulfill customer demand or increased costs to acquire key
components or services.
Also, there has recently been a trend toward consolidation of vendors of
electronic components. This greater reliance on a smaller number of suppliers
increases our risk of experiencing unfavorable price fluctuations or a
disruption in supply.
The cost, quality, and availability of third party manufacturing operations
are essential to the successful production and sale of many of our products.
The inability of any third party manufacturer to meet our cost, quality, and
availability standards could adversely impact our financial condition or results
of operations.
If we are unable to meet our contractual commitments, our financial results
may be adversely affected.
We have entered into and intend to continue to enter into minimum quantity
or other non-cancelable commitments as needed such as our contracts with AT&T
and Genuity. These types of agreements subject us to risk depending on future
events. We may be unable to meet our commitments under our contracts with AT&T
and Genuity or any other minimum quantity or other non-cancelable commitments we
may enter into in the future. This may result in renegotiation of the contracts
on a less favorable basis, or we may incur other liabilities that adversely
affect our financial results.
We are not profitable and expect to incur future losses and negative cash
flow that could cause our stock price to fall.
As of September 30, 2000, we had an accumulated deficit of $210.1 million
due primarily to our subsidy of the sales price of our i-opener Internet
appliance. From January 1, 2000 through September 30, 2000, we generated only
$8.0 million in revenues. We will need to generate and sustain dramatically
greater revenues from sales of our products and services if we are to achieve
profitability. If we are unable to achieve dramatically greater revenues, our
losses will likely continue indefinitely and we may never generate profits. If
this occurs, the market price of our common stock will suffer.
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Our new business focus will be dependent upon our infrastructure products
and services and our future revenue depends on the commercial success of
our products and services.
Growth in our new business will depend on the commercial success of our
infrastructure products and services and other services and products we may
develop and/or offer. Our other services and products under development may not
achieve widespread market acceptance. If our target customers do not adopt,
purchase and successfully deploy our planned products and services, our revenue
will not grow significantly and our business, results of operations and
financial condition will be seriously harmed. In addition, to the extent we
promote any portion of our technology as an industry standard by making it
readily available to users for little or no charge, we may not receive revenue
that we might otherwise have received.
Adoption and integration of our infrastructure software and hardware and
other related services by large customers is complex, time consuming and
expensive.
We will market our infrastructure software and hardware and other related
services primarily to large organizations. The adoption and integration of our
infrastructure software and hardware and other related services by large
organizations is complex, time consuming and expensive. In many cases, our
customers must consider a wide range of issues before committing to use our
infrastructure software and hardware and other related services, including
benefits, ease of use, ability to work with existing systems, functionality and
reliability. Furthermore, we must educate potential customers on the use and
benefits of our products and services. In addition, we believe that the purchase
of our infrastructure software and hardware and other related services will
often be discretionary. It will frequently takes several months to develop a
customer relationship and will require approval at a number of management levels
within the customer's organization. These long cycles may cause delays in our
sales and we may spend a large amount of time and resources on potential
customers who decide not to use our products or services, which could materially
and adversely affect our business.
The infrastructure products and services market is new and our business
will suffer if the market does not develop as we expect.
The market for infrastructure products and services is new and evolving.
We cannot be certain that a broad-based market for our products or services will
emerge or be sustainable. If this market does not develop, or develops more
slowly than we expect, our business, results of operations and financial
condition will be seriously harmed.
Because our Internet hosted delivery services are complex and are deployed
in complex environments, they may have errors or defects that could
seriously harm our business.
Our Internet hosted services are highly complex and are designed to be
deployed in and across numerous large and complex networks. We and our
customers have from time to time discovered errors and defects in our software
and hardware. In the future, there may be additional errors and defects in our
software or hardware that may adversely affect our services. If we are unable
to efficiently fix errors or other problems that may be identified, we could
experience:
. loss of or delay in revenues and loss of market share;
. loss of customers;
. failure to attract new customers or achieve market acceptance;
. diversion of development and engineering resources;
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. loss of credibility or damage to business reputation; and
. increased service costs.
Any failure of our telecommunications and network providers to provide
required transmission capacity to us could result in interruptions in our
services.
Our existing and future operations are dependent in part upon transmission
capacity provided by third-party telecommunications network providers. Any
failure of these network providers to provide the capacity we require may result
in a reduction in, or interruption of, service to our customers. This failure
may be a result of the telecommunications providers or Internet or other service
providers experiencing interruptions or other failures, failing to comply with
or terminating their existing agreements with us, or otherwise denying or
interrupting service or not entering into relationships with us at all or on
terms commercially acceptable to us. If we do not have access to third-party
transmission capacity, we could lose customers. If we are unable to obtain
transmission capacity on terms commercially acceptable to us, our business and
financial results could suffer. In addition, our telecommunications and network
providers typically provide rack space for our servers. Damage or destruction
of, or other denial of access to, a facility where our servers are housed could
result in a reduction in, or interruption of, service to our customers.
We may in the future experience a delay in revenue recognition or be
required to encumber available funds in order to secure certain business
relationships, which could delay or reduce our recognition of revenue and
profitability.
We believe that, due in part to turbulence in the financial markets during
the first nine months of 2000 and market skepticism about the stability of
Internet-related companies, some companies have begun to, and may in the future,
require businesses such as ours to post bonds, obtain letters of credit, or
otherwise encumber available funds as a pre-requisite for entering into business
relationships with suppliers, vendors, co-marketers, landlords and other types
of conventional business relationships. If we are required to encumber our
resources in order to establish or maintain our current or future business
relationships, our cost to establish and maintain such relationships will
increase and our profitability may be reduced or delayed as a result, or we may
not enter into some relationships that would otherwise benefit the development
of our business due to such requirements.
Our market share and revenues will suffer if we are not able to compete
successfully for customers for our infrastructure products and services.
The markets for infrastructure products and services are intensely
competitive, evolving and subject to rapid technological change. These markets
are characterized by an increasing number of entrants. We compete for
customers, directly or indirectly, with the following categories of companies:
. software platform providers such as Aether Systems and Liberate
Technologies;
. Internet infrastructure products and/or service providers such as Intel,
Akamai, Marimba, Inktomi, 3com and Phone.com; and
. providers of the communications equipment such as Alcatel, Cisco
Systems, Hewlett Packard, Intel, Lucent Technologies, Nortel Networks
and Siemens.
Virtually all of our current and potential competitors have longer
operating histories, significantly greater financial, technical, marketing and
other resources, significantly greater name recognition and a
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substantially larger base of customers than we do. In addition, many of our
competitors have nationally known brands and have extensive knowledge of our
industry. Moreover, our current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties
to increase the ability of their products to address consumer needs or to
combine hardware product and service offerings. We expect the intensity of
competition in this market to increase in the future. Increased competition is
likely to result in price reductions, reduced or negative margins and difficulty
in gaining market share. Any of these effects could seriously harm our business.
Our success depends on acceptance of our products and services by network
operators.
Our future success depends on our ability to increase revenues from sales
of our products and services and related server-based software and services to
new and existing network operator customers and on market acceptance of new
products and services and related server-based communications applications
software products, and we may not be able to achieve widespread adoption of
these products and services by these customers. This dependence is exacerbated
by the relatively small number of network operators worldwide. We cannot assure
you that network operators will widely deploy or successfully market services
based on our products, or that large numbers of subscribers will use these
services.
If we are unable to integrate our products with third-party technology,
such as network operators' systems, our business may suffer.
Our Internet infrastructure products and services will be integrated with
network operators' systems and third party internet devices such as PCs,
residential gateways, set-top boxes and Internet appliances. If we are unable to
integrate our platform products with these third-party technologies, our
business could suffer materially. For example, if, as a result of technology
enhancements or upgrades of these systems, we are unable to integrate our
products with these systems, we could be required to redesign our software
products. Moreover, many network operators use legacy, or custom-made, systems
for their general network management software. Legacy systems and certain
custom-made systems are typically very difficult to integrate with new
infrastructure software.
Beginning operations of our new business strategy will require significant
expense and could strain management, financial and operational resources.
Implementing our new business strategy will require significant additional
expense and could strain our management, financial and operational resources. In
addition, we have limited or no experience in this new business area. We may
not be able to expand our operations in a cost-effective or timely manner. If
customers do not receive this new business favorably, our reputation and brand
name could be damaged.
Our systems may fail and consequently our business may suffer.
Our ability to facilitate transactions successfully and provide high-
quality customer service also depends on the efficient and uninterrupted
operation of our computer and communications hardware systems. Our systems and
operations also are vulnerable to damage or interruption from human error,
natural disasters, power loss, telecommunication failures, break-ins, sabotage,
computer viruses, intentional acts of vandalism and similar events. While we
currently maintain redundant servers to provide limited service during system
disruptions, we do not have fully redundant systems, a formal disaster recovery
plan or alternative providers of hosting services. In addition, we do not carry
any business interruption insurance to compensate us for any losses that may
occur. Any system failure that causes an interruption in service or decreases
the responsiveness of our services could impair our reputation, damage our brand
name and consequently reduce our revenues.
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We will not be able to expand our business if we fail to attract and retain
key personnel.
Our future success depends on our continuing ability to attract, hire,
train and retain a substantial number of highly skilled personnel and on the
continued service and performance of our senior management and other key
personnel. The loss of the services of our executive officers or other key
employees could adversely affect our business, as could the loss of our
technical support and operations personnel who are key to developing and
maintaining the operations of our services. Recently, a significant number of
our employees have been terminated in cost cutting and restructuring activities
or voluntarily departed to pursue other opportunities. Our facilities are
located in Austin, Texas, which has a high demand for technical and other
personnel and a relatively low unemployment rate. Competition for qualified
personnel possessing the skills necessary for success in the competitive market
of infrastructure software and hardware and related services is intense, and we
may fail to attract or retain the employees necessary to execute our new
business model successfully.
Rapid technological change could render our products and services obsolete.
The Internet and the related industries are characterized by rapid
technological innovation, sudden changes in customer requirements and
preferences, frequent new product and service introductions and the emergence of
new industry standards and practices. Each of these characteristics could
render our services, products, intellectual property and systems obsolete. The
rapid evolution of our market will require that we improve continually the
performance, features and reliability of our products and services, particularly
in response to competitive offerings. Our success also will depend, in part, on
our ability:
. to develop or license new products, services and technology that address
the varied needs of our customers and prospective customers; and
. to respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis.
If we are unable, for technical, financial, legal or other reasons, to
adapt in a timely manner to changing market conditions or subscriber
preferences, we could lose customers, which would cause a decrease in our
revenue.
We may be unable to obtain the additional capital required to grow our
business, which could seriously harm our business. If we raise additional
funds, our current stockholders may suffer substantial dilution.
As of September 30, 2000, we had $76.6 million in cash, cash equivalents
and short-term investments on hand, which we expect will meet our working
capital and capital expenditure needs for at least the next 12 months. We may
need to raise additional funds at any time, and we cannot be certain that we
will be able to obtain additional financing on favorable terms, if at all. Due
to the recent volatility of the U.S. equity markets, particularly for smaller
technology companies, we may not have access to the capital markets when we need
to raise additional funds. Our future capital requirements will depend upon
several factors, including the rate of market acceptance of our products and
services, our level of expenditures for sales and marketing and the cost of
product and service upgrades. If our capital requirements vary materially from
those currently planned, we may require additional financing sooner than
anticipated. If we cannot raise funds on acceptable terms, we may not be able
to develop our products and services, take advantage of future opportunities or
respond to competitive pressures or unanticipated requirements, any of which
could have a material adverse effect on our ability to grow our business.
Further, if we issue equity securities, our existing stockholders will
experience dilution of their
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ownership percentage, and the new equity securities may have rights, preferences
or privileges senior to those of our common stock. If we do not obtain
additional funds, we may, in the near future, cease to be a viable going
concern.
We may not be able to compete effectively if we are not able to protect our
intellectual property.
We rely on a combination of trademark, trade secret and copyright law and
contractual restrictions to protect our intellectual property. We have applied
to register several trademarks, including Netpliance and i-opener, in the United
States. We have also applied for trademark protection for "i-opener" and
"Netpliance" in Europe and select Asian countries. We have not yet attempted to
register other marks that may become important to us in the future. We have
several United States patent applications currently pending. If we are not
successful in obtaining the patent protection we seek, our competitors may be
able to replicate our technology and compete more effectively against us. The
legal protections described above would afford only limited protection.
Unauthorized parties may attempt to copy aspects of our products, services, or
otherwise attempt to obtain and use our intellectual property. Enforcement of
trademark rights against unauthorized use, particularly over the Internet and in
other countries, may be impractical or impossible and could generate confusion
and diminish the value of those rights. Litigation may be necessary to enforce
our intellectual property rights, to protect our trade secrets and to determine
the validity and scope of the proprietary rights of others. Any litigation
could result in substantial costs and diversion of our resources and could
seriously harm our business and operating results. In addition, our inability
to protect our intellectual property may harm our business and financial
prospects. Also, if we cannot protect our domain names and prevent others from
using similar domain names or trademarks, we may not be able to establish a
strong brand and our business and financial results could suffer.
Our products and services employ technology that may infringe on the
proprietary rights of others, and we may be liable to others for
significant damages.
We believe there is an increasing amount of litigation in the Internet
industry regarding intellectual property rights. It is possible that third
parties may in the future claim that we or our products or services infringe
upon their intellectual property rights. We expect that providers of
infrastructure software and hardware and other related services will be subject
to an increasing number of infringement claims as the number of products,
services and competitors in our market grows. Any claim, with or without merit,
could consume management time, result in costly litigation, cause delays in
implementation of our products or services or require us to enter into royalty
or licensing agreements. Royalty or licensing agreements, if required and
available, may be on terms unacceptable to us or detrimental to our business.
Moreover, a successful claim of product infringement against us or our failure
or inability to license the infringed or similar technology on commercially
reasonable terms could seriously harm our business.
If Internet use does not continue to increase, we may not be able to expand
our business and increase our revenues.
Use of the Internet has grown dramatically, but we cannot assure you that
Internet use will continue to grow at the same rate, or at all. Substantially
all of our revenue is dependent on the continued growth in use of the Internet.
A decrease in the demand for Internet services or a reduction in the anticipated
growth for such services may prevent us from expanding our business and
increasing our revenue.
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If we are unable to sell our inventory of i-opener Internet appliances our
business will suffer.
We currently hold a significant number of our i-opener Internet appliances
in inventory. We have written down a significant portion of the value of this
inventory. If we are unable to sell these appliances as fast as we anticipate,
we may have to write down much of the remaining value, if not all, of this
inventory, which will negatively affect our business. Further, because we book
revenue on the sale of our i-opener Internet appliances on a sell-through basis,
if our distributors return their inventory of our appliances it could damage our
ability to liquidate our inventory.
We do not expect to pay dividends on our common stock, and investors should
not buy our common stock expecting to receive dividends.
We have never declared or paid any cash dividends on our common stock. We
presently intend to retain future earnings, if any, to finance the expansion of
our business and do not expect to pay any dividends in the foreseeable future.
Investors should not purchase our common stock with the expectation of receiving
dividends.
Fluctuations in operating results, market volatility and other factors may
adversely affect our stock price.
The market price of our common stock may fluctuate significantly in
response to a number of factors, some of which are beyond our control,
including:
. variations in quarterly operating results;
. changes in estimates of our financial performance by securities analysts
or a decrease or cessation of analyst coverage of our stock;
. changes in market valuations of comparable companies;
. announcements by us or our competitors of new products, services,
significant contracts, acquisitions, strategic relationships, joint
ventures or capital commitments;
. our inability to locate or maintain suppliers of our products at prices
that will allow us to attain profitability;
. product or design flaws, product recalls or similar occurrences;
. additions or departures of key personnel;
. sales of capital stock in the future; and
. fluctuations in stock market prices and volume, which are particularly
common among highly volatile Internet-related securities.
The large number of shares eligible for public sale could cause our stock
price to decline.
The market price of our common stock could decline as a result of sales by
our existing stockholders of a large number of shares of our common stock in the
market or the perception that such
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sales could occur. This circumstance could become a significant issue if we sell
securities in private placements at such time as the shares sold are either
registered or may be resold in reliance on Rule 144.
Our continued Nasdaq National Market listing is not assured.
Our common stock is presently authorized for quotation on the Nasdaq
National Market. Accordingly, we are subject to all requirements of our listing
agreement with Nasdaq. Among the events that could cause us to have our status
as a National Market Issuer terminated are:
. failure to maintain a minimum bid price for the common stock of either
$1.00 per share or $5.00 per share, depending on, among other things,
whether or not tangible net assets for the Company is greater than or
less than $4 million;
. failure to maintain an audit committee that comports to the
independence and other standards of the Nasdaq and the SEC; and
. failure to timely hold annual meetings of stockholders and comply with
other corporate governance requirements.
Our stock has recently had trading days near to the $1.00 minimum bid. If
our stock price falls below that level, that could result in delisting or the
need to complete a reverse stock split. If we lose our Nasdaq National Market
status, our common stock would trade either as a Nasdaq Small Cap issue or in
the over-the-counter market, both of which are viewed by most investors as less
desirable, and less liquid, marketplaces. Loss of our Nasdaq National Market
status would also complicate compliance with state blue sky laws.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
All of our current contracts are denominated in United States dollars and
we do not currently invest in derivative financial instruments. However, we
invest our excess cash balances in short-term, interest bearing, investment-
grade securities, certificates of deposit or direct or guaranteed U.S.
government obligations, such as Treasury bills, that are subject to market risk.
We believe the effect on our financial position, results of operations and cash
flows as the result of any reasonably likely changes in interest rates would not
be material.
PART II. OTHER INFORMATION.
ITEM I. LEGAL PROCEEDINGS
The Federal Trade Commission ("FTC") has instituted a review of our sales
and marketing practices to determine whether we were, among other things, in
compliance with the FTC's mail or telephone order merchandise rule. We have
produced documents for the FTC pursuant to its requests, and have met with the
FTC to further the FTC's review. Based on our discussions and our meeting with
the FTC and ongoing review of the inquiry, we believe that the foregoing and any
resulting action against us will not have a material adverse effect upon our
business, financial condition or results of operations. However, there can be
no assurances that any action the FTC may take against us will not include fines
and penalties that may, in fact, be material to our business.
We have commenced litigation in Austin, Texas, against our former
advertising agency BBDO Worldwide, Inc. for actions arising from the agency's
handling of our advertising account. The lawsuit asserts causes of action for
breach of contract, breach of fiduciary duty, conversion, business
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disparagement and fraud. BBDO Worldwide, Inc. has answered the suit and denied
our claims, but has asserted no counterclaims seeking damages. The action is
currently pending in the United States District Court for the Western District
of Texas, Austin Division, Action Number 00CV613SS.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a)
10.1+ Internetworking Services Agreement, as amended, by and between
Genuity Solutions, Inc. and Netpliance dated July 31, 2000.
10.2+ Internet Services Agreement, as amended, by and between AT&T Corp.
and Netpliance dated July 28, 2000.
10.3 Employment Agreement by and between Francis S. Webster and
Netpliance dated as of August 22, 2000.
27 Financial Data Schedule
+ Portions of this exhibit have been omitted pursuant to a request for
confidential treatment. The omitted information has been filed with the
Securities and Exchange Commission.
(b) No reports on Form 8-K have been filed during the quarter for which
this report is filed.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETPLIANCE, INC.
Date: November 10, 2000 /S/ FRANCIS S. WEBSTER
-------------------------
Francis S. Webster
Chief Financial Officer
<PAGE>
EXHIBIT INDEX
10.1+ Internetworking Services Agreement, as amended, by and between
Genuity Solutions, Inc. and Netpliance dated July 31, 2000.
10.2+ Internet Services Agreement, as amended, by and between AT&T
Corp. and Netpliance dated July 28, 2000.
10.3 Employment Agreement by and between Francis S. Webster and
Netpliance dated as of August 22, 2000.
27 Financial Data Schedule
+ Portions of this exhibit have been omitted pursuant to a request for
confidential treatment. The omitted information has been filed with the
Securities and Exchange Commission.
