SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the Fiscal Year Ended March 31, 2000
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ______________ to ______________
Commission File Number 0-15323
NETWORK EQUIPMENT TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2904044
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6530 Paseo Padre Parkway
Fremont, California 94555
(510) 713-7300
(Address of principal executive offices, including zip code, area code,
and telephone number)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.01 Par Value New York Stock Exchange
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(Title of each class) (Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
7 1/4% Convertible Subordinated Debentures
(Title of Class)
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 |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
The aggregate market value of the voting stock held by non-affiliates of
the registrant on June 9, 2000 was $185,160,471; calculated by excluding holders
of 10% and more, directors and current executive officers.
The number of shares outstanding of the Common Stock, $0.01 par value, on
June 9, 2000 was 21,539,584.
DOCUMENTS INCORPORATED BY REFERENCE:
The registrant's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on August 8, 2000 is incorporated by reference in Part
III of this Form 10-K to the extent stated herein.
This document consists of 67 pages of which this is page 1.
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PART I
Item 1. Business
OVERVIEW
Network Equipment Technologies, Inc., doing business as net.com ("net.com") is a
leading provider of mission critical multi-service wide area networks (WANs)
used by enterprise, service provider and government customers worldwide. WANs
are comprised of information switching systems interconnected by long-distance
digital transmission links which enable individuals, groups, and businesses to
exchange information electronically. net.com's WAN products allow customers to
integrate voice, data, image, and video traffic for Asynchronous Transfer Mode
("ATM"), frame relay, Internet Protocol ("IP") and ISDN services across a single
network infrastructure.
In fiscal year 2001, we are introducing a new generation of broadband products,
net.com's SCREAM(TM), that targets service creation. These service creation
products sit at the edge or intersection of networks, allowing
telecommunications service providers to manage and create services across their
networks and, ultimately, allow users to determine the services they require.
We complement our product offerings with service offerings in network design,
installation, implementation and provide ongoing service and support.
net.com was incorporated in California in 1983 and reincorporated in Delaware in
1986. net.com's initial public offering was in 1987 and its Common Stock is
publicly traded on the New York Stock Exchange under the symbol NWK. It is
headquartered in Fremont, California and has approximately 843 employees
worldwide. In fiscal 2000, net.com completed the acquisition of FlowWise
Networks, Inc., see discussion in Management Discussion and Analysis,
Acquisitions on page 11 of this Form 10-K.
FORWARD-LOOKING STATEMENTS
This Form 10-K contains forward-looking statements in addition to statements of
historical information. Statements are forward-looking when they discuss
net.com's "expectations", "beliefs", "hopes", "intentions", "strategies" or
words of similar import. Forward-looking statements are based upon management
expectations and involve risks and uncertainties that may cause actual results
to differ materially from those anticipated in the forward-looking statements.
Many factors may cause actual results to vary including, but not limited to, the
factors discussed in this Form 10-K. net.com expressly disclaims any obligation
or undertaking to revise or publicly release any updates or revisions to any
forward-looking statement contained in this Form 10-K. Investors should
carefully review the risk factors described in this document along with other
documents net.com files from time to time with the Securities and Exchange
Commission.
NETWORKING INDUSTRY BACKGROUND
The networking equipment industry has experienced rapid growth over the last
five years due to increases in demand for data, voice, and video communications
services by businesses, governments and consumers and the requirement for these
organizations to be connected both internally - within an organization - and
externally - between different organizations. The growth in internal
connectivity demand has led to the development of high speed Local Area Networks
("LANs") and Wide Area Networks ("WANs") to facilitate internal communication
while growth in external connectivity demand has led to the development and
growth of the public Internet. Bandwidth refers to the information carrying
capacity of a channel, and is a key factor for determining the amount, quality,
and speed of a particular service available to a user. As the number of users
that make use of corporate and public networks continues to increase, the
requirement for additional bandwidth will grow. This enormous growth of required
bandwidth to deliver various voice, data and video communications services more
rapidly and efficiently creates an opportunity for those equipment vendors who
can more effectively help service providers deliver these new services and
manage their network resources.
The increased capability and capacity of the network to support ever-increasing
demands for services and speed over the last few years, has been largely enabled
by various technology advances in the wide-area-networking industry.
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These developments are facilitating the convergence of voice, video, and data
networks and address the needs for Quality of Service (QOS) controls, security
mechanisms, and other Virtual Private Network (VPN) capabilities. In particular,
broadband technologies rely on cell or packet switching to move information
across the network as contrasted with legacy circuit switched ("narrowband")
approaches. By breaking information into smaller pieces, cell or packet
switching enables information to be moved much more swiftly through the network
and enables more traffic to be sent in a shorter time.
As end customers seek to manage their businesses more efficiently and cost
effectively they are profoundly changing the ways in which the network is used.
New business models are emerging that leverage the high bandwidth connectivity
that the new broadband networks provide. The Internet, VPNs, and application and
content service providers are playing an important role in facilitating this
fundamental change. Traditional providers of transmission facilities such as
carriers, cable operators, wireless service providers and network service
providers recognize the need to offer broadband access and to differentiate
their services in order to remain competitive and profitable.
SERVICE CREATION IS OUR STRATEGIC FOCUS
net.com's strategy is to provide its customers the ability to access and create
services using broadband technology while continuing to leverage its
multi-service WAN or narrowband technology in areas of the world where the rate
of broadband deployment is slower. As service providers have expanded their
ability to provide high-speed access, their initial focus has been on managing
network subscriber connections. We believe that in a competitive access
environment the delivery of services will become more critical as these service
providers seek to differentiate their services to generate more revenue and
reduce customer churn. In fiscal year 2001, we are introducing a new generation
of broadband products, net.com's SCREAM, that targets service creation. These
service creation products sit at the edge or intersection of networks, allowing
service providers to manage and create services across their networks and,
ultimately, allow users to determine the services they require.
PRODUCTS
NARROWBAND
net.com designs, develops and supplies multi-service wide area networks that
integrate voice, data, image and video traffic across a single network
infrastructure. net.com multi-service WAN networks offer ATM, frame relay, IP,
ISDN switching, advanced voice compression and extensive network management
capabilities. Traditional narrowband WANs rely on circuit switched technology to
provide the infrastructure and capability to link local area networks ("LANs"),
campus networks, voice traffic, video and other applications to each other via
service provider transmission facilities or services. WAN products may be
located at both the service provider and the enterprise premises.
Historically, the majority of net.com's product revenue has been generated by
net.com's IDNX(R) and its replacement, Promina(R) Multi-service Bandwidth
Managers. In fiscal years 2000, 1999 and 1998, net.com's IDNX and Promina
accounted for 95.4%, 93.9% and 90.2% of product revenue respectively. As of
April 30, 1999 IDNX products have been replaced by our Promina products and
net.com's Panavue(TM) network management systems.
PROMINA 800
net.com's Promina 800 Series family of multi-service access platforms adapt and
aggregate voice, data, video and fax traffic for access to ATM and other WAN
services. The Promina 800 Series enables standards-based connection of
carrier-located equipment or customer-premise equipment through one of the
industry's broadest range of user-side interfaces. From a trunk-side
perspective, the multi-service systems offer single-platform delivery of
feature-rich services such as virtual private networks that could be based on
ATM networking, frame relay or Internet Protocol (IP).
The Promina 800 network incorporates intelligence both at its core and in
signaling to attached devices. This feature allows the network to quickly
reroute traffic automatically in the event of a failure. ATM adaptation of
various types of traffic is accomplished via net.com's CellXpress(TM), an
internal ATM module option. The CellXpress module provides Class of Service
support for constant bit rate and variable bit rate (CBR/VBR) traffic in
addition to inverse multiplexing over ATM (IMA).
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Voice plays an increasingly significant role as international networking and
increased IP traffic impacts the WAN. net.com has an industry-leading set of
voice compression products marketed under its PrimeVoice(TM) name. Toll-quality
voice compression improves cost efficiencies for emerging international voice
resellers and enterprises alike. Combined with the CellXpress ATM access
capability, the voice compression capabilities found in the Promina 800 family
creates a differentiator allowing enterprises and carriers to take advantage of
ATM service offerings.
IP traffic is carried over the multi-service network via an internal
multi-protocol router based on Cisco IOS(R) source code. This means that the IP
capabilities are well matched to some 70 percent of the routers deployed
throughout the world. Frame relay traffic is also supported via an internal
frame relay switching module. This combination of voice, data and video
capabilities means that customers are not locked to a particular technology, a
somewhat unique form of investment protection.
NETWORK MANAGEMENT
The net.com Panavue Network Management System provides SNMP, Simple Network
Management Protocol, based management capabilities featuring web-based user
interfaces. Its open design based on industry standards provides scalability.
The platform's user interface lowers the cost of network ownership by reducing
training time, improving access and streamlining operations throughout the
network. The platform supports the main family of net.com products.
Additionally, the platform's Advanced Fault Management System ("AFMS") provides
unified fault management plus integrated service and network management for
devices in the network including those from other vendors.
NET.COM'S SHOUTIP(TM)
During the first quarter of fiscal 2001, net.com acquired the assets of
Convergence Equipment Technologies, those assets included a small voice-over-IP
platform and related software. SHOUTip is a voice-over-IP product that provides
an effective way of transmitting circuit voice over an IP packet network. We
believe that the voice-over-IP market is set for rapid expansion and that the
SHOUTip product provides an early entry vehicle for net.com to participate.
BROADBAND
We believe that net.com is a leader in the creation, management and delivery of
services with the introduction of the SCREAM200 Service Creation Manager, our
first product in a range of products to be introduced over the next 24 months.
We believe net.com may be one of the first to offer next generation service
creation capabilities.
net.com's SCREAM200 is a solution that leapfrogs traditional subscriber
management solutions to transform the economics of the service provider
industry. SCREAM200 and its open service creation platform empower service
providers to dynamically create new services and provide the flexibility to
accommodate the unpredictable changes in user demand and traffic.
For service providers, a distributed network topology uniquely delivered by
net.com's SCREAM200 makes it possible for a service provider to differentiate
his service offering thereby positioning it to become the "network of choice"
for enterprises, small business and individuals looking to harness the strategic
power of networks. SCREAM200 enables the user to customize the creation and
delivery of services to individuals, applications, or even IP addresses and
pro-actively stimulate demand across the network. We anticipate shipping the
first SCREAM product for revenue in the third quarter of 2000. Additional
releases are scheduled throughout fiscal year 2001.
CUSTOMERS AND MARKETS
net.com pioneered the concept of multi-service networking and has been
delivering these capabilities for seventeen years. With more than 25,000
multi-service systems sold around the globe, net.com serves approximately 1,500
customers in more than 75 countries. The focus of our narrowband product-line
has been on large enterprises and carriers for their enterprise business. The
initial focus of net.com's new SCREAM broadband product family will be on
service providers while ultimately, the service creation features will also be
attractive to enterprises. For both net.com's broadband and narrowband products,
we focus primarily on information and communication intensive organizations.
These customers may be local, national, multinational, or global in their
operations.
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NARROWBAND
net.com's Promina product line is targeted for service provider, enterprise and
government customers. In the service provider marketplace, global carriers use
net.com networks for subscriber services as do a variety of emerging carriers,
cellular providers and international voice resellers. net.com's strategy for
enterprise customers is to provide an integrated range of solutions and
alternatives with which to address the complexity required to successfully grow
a network by maximizing bandwidth use. For its government customers, net.com
addresses the needs of government agencies for reliable, mission critical
communications solutions. Current enterprise customers include corporations
representing the financial, banking, insurance, energy, transportation,
manufacturing and retail sectors. Government customers represent a variety of
federal and international agencies and organizations including the Department of
Defense, NATO, and ministries throughout the world including Austria, China and
Thailand.
The Promina product line currently sees more demand outside the United States
especially in emerging markets such as China and Eastern Europe where the
telecommunications infrastructure is still being developed. Applications that
can be enabled by Promina based solutions include Digital Data Networks ("DDN")
that provide basic data services in these emerging markets. International sales
represented 28.1%, 32.2%, and 37.3% of net.com's revenue in fiscal 2000, 1999
and 1998, respectively.
Sales to the federal government represented 50.4%, 37.6%, and 33.6% of net.com's
revenue in fiscal 2000, 1999 and 1998, respectively. We sell to the federal
government through net.com's wholly owned subsidiary, N.E.T. Federal, Inc.
("Federal"), which sells products both directly and through collaborative
government contracting and subcontracting arrangements. Government contracts
with Federal are for various terms, but most may be terminated by the
contracting government agency at their convenience or at annual intervals. Sales
to the Federal government include sales under contracts with certain agencies
within the Department of Defense ("DoD"). These DoD contracts may be used by
other government agencies to purchase net.com products and services. Failure to
renew one of these DoD contracts, or to continue as a subcontractor under any of
our government contracts could materially effect net.com's operating results and
financial condition.
Other than orders from the federal government, no other single customer
accounted for more than ten percent of net.com revenue in fiscal 2000, 1999 or
1998.
BROADBAND
We did not ship any SCREAM product for revenue in fiscal 2000, although various
trials were being conducted at customer sites. net.com's SCREAM is targeted
initially at the service provider market. Within the service provider market,
net.com has targeted the following vertical markets for this new broadband
product:
1) Traditional incumbent service providers ("IXC" & "ISP"). These are the
companies providing communications services of various kinds to both
consumers and business;
2) Competitive local exchange carriers ("CLEC"). A subset of the service
provider market, these are telecommunications companies providing services
to local consumers and business in competition with the traditional
incumbent service providers;
3) Application service providers ("ASP"). These companies provide application
services over the network;
4) Integration Communication Providers ("ICP). One of the new categories of
service providers who are building next generation networks both
domestically and globally.
The rate of deployment of broadband services is expected to be largest in the
United States in the near term and is, therefore, where our initial marketing
efforts will be focused. We expect that the capabilities and features of
net.com's SCREAM product line will ultimately be applicable to the international
market place.
COMPETITION
The Networking equipment industry is highly competitive and both our current
Promina products and our new SCREAM products face significant competition. We
compete against companies that have substantially greater financial, technical,
marketing and other resources than net.com. These include companies such as
Cisco, Nortel,
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Newbridge/Alcatel and Lucent, which are large established companies that offer
end-to-end solutions competing directly against Promina product line
capabilities. In addition, the ability to offer a complete networking solution,
rather than a part, makes their products attractive to certain potential net.com
customers.
The emerging broadband access market is relatively new but is likely to attract
an increasing number of competitors over the next several years since this is
where large investments will be made. Although a much newer market there are
already a number of companies that have broadband networking solutions for the
broadband access market. Many of these companies have focused on the management
of a large number of high-speed subscriber connections. Companies targeting this
problem include start-ups such as Redback, Redstone and Shasta (now owned by
Nortel) along with established companies such as Cisco and Nortel.
Service creation is an emerging market. Currently, there are only a handful of
companies targeting this market, which include small start-up companies such as
Cosine and Quarry. As the service creation opportunity expands, we expect to see
increasing amounts of competition from other companies as well as from the large
established networking companies such as Cisco, Lucent and Nortel. These larger
companies can use greater financial, technical, and marketing resources to
quickly enter the market through internal development of their own products or
by acquiring various start-ups. In addition, we may face competition from
currently unknown companies and technologies that may offer attractive solutions
to our targeted markets.
SALES
Our products and services are sold through both direct and indirect channels. We
believe that a direct sales force effort, supported by sales engineers who
provide customers with pre- and post-sale technical assistance, allows net.com
to gain more in-depth knowledge of customers' network requirements. We have
sales offices in 11 countries and more than 111 direct sales and service
personnel. This sales effort is supported through more than 80 channel partners.
Products and services are sold into more than 75 countries. Our International
sales are managed from the net.com Crawley, United Kingdom office.
In North America we sell primarily through direct channels although there are a
small number of distributors focused on niche vertical markets. Our
International sales are made almost entirely through indirect channels that
include distributors and resellers worldwide. In addition to the marketing and
sale of products, international resellers provide system installation and
technical support. In most cases, international resellers have non-exclusive
agreements to resell net.com products within particular geographic areas. Resale
agreements do not contain a sales commitment or required sales quota.
net.com has two strategic reseller partnerships, Ericsson Business Networks AB
of Sweden ("Ericsson") and Datacraft Asia Ltd. ("Datacraft"). Ericsson is a
worldwide partner reselling net.com products in Europe, Asia and Latin America.
Datacraft resells net.com products throughout Asia and is responsible for a
significant portion of net.com sales in China. Both Ericsson and Datacraft
provide service support for the products they sell. Additionally, net.com has an
agreement with Commscraft Pty Ltd (formerly Datacraft Technologies Pty Ltd. and
affiliate of Datacraft Asia) to resell a jointly developed HINTU (high speed
integrated network terminating unit) product and a jointly developed HDSL (high
speed digital subscriber line) product. Datacraft Asia is also a reseller of
both these products.
A number of telecommunications service providers act as distribution channels
for net.com product sales to enterprise customers and service providers
worldwide. net.com has joint marketing, system integration, resale and other
agreements with service providers such as Concert-British Telecom, GlobalOne,
MCI WorldCom, Bell Atlantic, US West, Bell South, Unisource Business Networks,
Tele Danmark and Hanwha Corporation. None of these agreements has a required
sales commitment and all come up for renewal on a periodic basis. While a
failure to renew any one of these agreements would not have a significant impact
on net.com's financial results, failure to renew a significant number of these
agreements on favorable terms and conditions could have a material impact on our
financial results.
N.E.T. Federal supports sales to the U.S. government's defense and civilian
sectors. Sales to Federal customers are almost entirely direct. Federal is,
however, a subcontractor on a number of government contracts and resells third
party product to the Federal government.
net.com's business is not seasonal in nature and sales are generated throughout
the year.
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BACKLOG
net.com manufactures its products based upon its forecast of customer demand and
typically builds finished products in advance of receiving firm orders from its
customers. Orders for net.com's products are generally placed by customers on an
as-needed basis and we have typically been able to ship these products within
30-90 days after the customer submits a firm purchase order. Because of the
possibility of customer changes in delivery schedules or cancellation of orders,
net.com's backlog as of any particular date may not be indicative of sales in
any future period. See discussion in Business Risk Factors on page 13 of this
Form 10-K.
CUSTOMER SERVICE
The markets, customers and complex challenges of the networking industry
described above require not only hardware and software based solutions, but also
significant support, service and other assistance in the development, operation
and expansion of a customer network. Since its inception, net.com has viewed
customer service and support as a key element of its overall strategy and a
critical component of its long-term relationship with customers. Customers
around the world turn to net.com not only for the reliability and performance of
our products, but also for our comprehensive support services that optimizes the
value of those products. Customers rely on net.com to help maintain the highest
possible availability for their mission-critical networks.
net.com's SCREAM Care service offerings provide a wide range of service and
support options to customers and resellers of net.com products. Service
offerings includes product installation, a choice of different hardware and
software maintenance programs to meet the varying needs of our customers, parts
repair, remote and on-site technical assistance and customer training. In
addition, net.com provides web-based customer support services through our
Electronic Support Center. Services available over the web include first-line
troubleshooting information for net.com products, technical information such as
trouble shooting guides and frequently asked questions, and a web-based
interface to net.com's Technical Assistance Center ("TAC") through an Online
Case Management system.
TAC is staffed 24 hours a day seven days a week by engineers trained in
networking products. TAC assists customers remotely over the telephone and has
language facility in many languages including Spanish, Chinese, French and
German. TAC engineers have the ability to replicate customer problems and test
proposed solutions prior to implementation. As part of net.com's January, 2000
restructuring, net.com consolidated its TAC services worldwide into its Ashburn,
Virginia facility. net.com continues to invest in its TAC operations, adding
tools, equipment and capabilities to enhance its support services. Maintenance
support from net.com's TAC, whether provided over the web or over the telephone,
is fee based under either an annual fee contract or on a time and materials
basis.
Customer training on net.com products is provided to both end-users and
resellers worldwide. net.com has training facilities at its Fremont headquarters
facility, in Ashburn, Virginia, Crawley, England and Singapore. In addition,
net.com trainers travel to customer and reseller facilities to provide training.
net.com training services can be customized to meet the special requirements of
its customers. Customers are charged per person per class for net.com training.
In addition, certain net.com resellers provide training to net.com end-users on
behalf of net.com.
Over the years, net.com has developed expertise in certain professional services
such as staging, system integration and managed network services. These services
assist customers in optimizing their network investments, allow them to
outsource selected network operations to net.com and provide additional
expertise on a project basis. Professional services from net.com are utilized
throughout the network life cycle from planning and design to implementation.
They are generally charged on a per project basis.
A significant amount of net.com's revenue and profits are generated by its
service and support offerings. In fiscal years 2000, 1999 and 1998 service and
support offerings accounted for 48.5%, 40.4% and 35.1%, respectively, of net.com
revenue. net.com cannot guaranty that customers will continue in the future to
require service support on net.com networks to the extent that they have in the
past. In particular, maintenance contracts for older IDNX networks may not be
renewed to the extent customers replace those networks with networking products
from other vendors.
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MANUFACTURING
net.com has one manufacturing facility located at its Fremont, California
facility. Assembly of printed circuit boards and circuit testing of net.com
designed products are outsourced to a single subcontractor, Solectron. Final
assembly, quality control and final testing are performed in the Fremont
manufacturing facility. In addition, net.com maintains control over parts
procurement, design, documentation and selection of approved suppliers. We have
a multi-year contract with Solectron that requires them to meet defined
performance specifications. Because Solectron is a sole source vendor, any
interruption in Solectron's manufacturing processes or a failure to renew our
contract could have a material adverse effect on our financial results and
operations.
Currently, several key components of our Promina and SCREAM products are
available only from a single source including certain ASICs and power supplies.
In addition, some components are in short supply generally throughout the
industry. Depending upon the component, there may or may not be alternative
sources or substitutes. Some of these components are purchased through purchase
orders without an underlying long-term supply contract. Any delay or
difficulties in obtaining needed components could seriously impact our ability
to ship products.
We maintain sufficient inventory to ship products quickly, normally within 15 to
60 days after receipt of an order. Scheduling of production and inventory supply
is based on internal sales forecasts. Generally, our customer contracts allow
the customers to reschedule delivery dates or cancel orders within certain time
frames before shipment without penalty and outside those time frames, with a
penalty. Because of these and other factors, there are risks of excess or
inadequate inventory that could materially impact expenses, revenue and
earnings.
net.com is focused on continually enhancing the quality of products and services
delivered to customers worldwide. This includes improving the quality of
supplied components, subassemblies and internal processes. As part of this
continuing process, net.com is ISO 9002 certified.
RESEARCH AND DEVELOPMENT
We believe that our long-term success depends on our ability to maintain product
and technology leadership. The networking equipment industry is characterized by
rapid technological change, evolving industry standards, frequent new product
introductions, enhancements to products currently in the market and constantly
changing customer requirements. To compete effectively, net.com must be able to
bring new products to market in a timely and cost effective manner and enhance
existing products to extend their useful life. Along with making continued
investments in our internal research and development, we will also consider
strategic acquisitions where appropriate to provide needed technology and
resources.
net.com continually monitors relevant markets, its customers' businesses and
technology developments in order to develop products that proactively address
customer needs. Net.com's new SCREAM products were designed with an open
architecture to facilitate the development by third parties of products that
will enhance its capability. Further, we design to industry standards and
support industry standards bodies in their endeavors. Despite our efforts,
however, there is no guaranty that we will be able to successfully develop new
products or that our customers or our targeted markets will accept any products
we develop.
As of March 31, 2000, we had an engineering staff of 156 engineers working on
our SCREAM, Promina or SHOUTip products. The majority of our research and
development activity is focused on the SCREAM product line and on our new voice
over IP solution, SHOUTip. We continue, however, to provide engineering support
to Promina and to provide feature enhancements required to maintain viability.
While most product development activity is undertaken in-house, external
development organizations are used to shorten time to market.
In fiscal 2000, 1999 and 1998, net.com's research and development expenditures
were $42.1 million, $45.8 million, and $43.4 million, respectively. net.com
expensed in-process research and development of $879,000 in fiscal year 2000 as
a result of the FlowWise acquisition. No in-process research and development
costs were expensed in fiscal years 1999 and 1998.
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INTELLECTUAL PROPERTY
Our ability to invent and develop new technologies and then to protect these
technologies from abuse by others outside our company is an important part of
our success. We use all available means to protect our proprietary technology
including patents, trade secrets, and copyrights. All our employees sign
Confidentiality and Invention Disclosure agreements and anyone outside our
company receiving information either signs a Non-Disclosure Agreement prior to
receiving information or is a net.com licensee. To foster disclosure of
patentable inventions, we provide financial incentives to employees. We believe
that ownership of patents, copyrights and trade secrets is important to our
ability to compete and to defend ourselves against patent infringement
allegations. However, we believe that other factors impact our future success to
an equal or greater degree. These include the innovative skill and technical
competence of our employees, our ability to understand and stay abreast of the
market for our products, and the timely introduction of new products.
Over the past 17 years, a number of patents have been issued to net.com in the
United States, Europe and Japan. These include some very early basic ATM
inventions that comport with ATM Forum standards. In the last fiscal year, we
began a highly focused effort to identify and patent our proprietary SCREAM
technology. We expect to continue filing patent applications as our development
process for SCREAM moves forward. In addition, as part of our acquisition of
FlowWise Networks in December 1999, we became the successor to several filed
patent applications relating to the FlowWise product. We are also working to
file patent applications for inventions obtained as part of the purchase of the
assets of Convergence Equipment Company.
Although we have a number of patent applications pending, we cannot guaranty
that any one will result in the issuance of a patent. Even if issued, the patent
may later be found to be invalid or may be infringed without our knowledge. It
is difficult to monitor use of our technology by others. Despite all the
precautions we take, competitors or others outside net.com may obtain our
proprietary information through independent development or other means. If we do
not effectively protect our intellectual property, it could have a material
adverse effect on our competitive position and sales of our products.
In June 2000, net.com entered into its first patent cross-licensing agreement.
The agreement is with Lucent Technologies whereby net.com and Lucent licensed
patents to the other. Under the terms of the cross-licensing agreement, each
company will receive a license under all patents related to their product
markets. net.com's portfolio includes patents in basic networking and ATM
technologies supported by the ATM Standards Forum and other standard setting
bodies. The cross-license has a five-year term.
RESTRUCTURINGS
During fiscal year 2000, we engaged in two restructurings, both of which
involved realignment of our corporate structure and reductions in our work
force. These restructurings were in addition to the March 1999 reduction in
force. In July 1999, we announced a restructuring intended to streamline our
corporate organizational structure and to bring expenses in line with projected
revenues. The streamlining reduced the structure ofto five functional areas;
Marketing, Sales and Service, Product Development, Operations and Finance. All
these department heads along with the General Counsel report directly to the
CEO. Implementation of the reorganization included employee reductions at all
levels of net.com and in all functional areas, other than Marketing and Field
Sales. net.com reduced its workforce by approximately 7% worldwide. Expenses
related to the restructuring were recognized in the second quarter of fiscal
year 2000. See Note 4 to the Notes to the Consolidated Financial Statements on
page 33.
In January 2000, we reorganized around our two product lines: circuit switched
or "narrowband" products and packet based or "broadband" products. We split our
marketing and product development departments between the narrowband and
broadband businesses so that each of these new business units will include
marketing and engineering focused on the respective product line. The former
Vice President of Product Development heads the Broadband business unit as its
General Manager and the Vice President of Marketing heads the Narrowband
business unit as its General Manager. Both General Managers report directly to
the CEO.
As part of the reorganization, we consolidated sales and service in Virginia
with support from small field sales offices worldwide. To facilitate the
reorganization and reduce expenses, we reduced our workforce by approximately
30% worldwide and closed a number of offices worldwide. All departments were
impacted by this reduction. A substantial portion of the expenses related to the
restructuring were recognized in the fourth quarter of
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fiscal year 2000. See Note 4 in Notes to Consolidated Financial Statements on
page 33 and Management's Discussion and Analysis on page 13 of this Form 10-K.
Item 2. Properties
net.com is headquartered in Fremont, California. In April 1998, we entered into
a twelve year lease for three buildings totaling 290,000 square feet of office,
R&D and manufacturing space in an industrial park. In May 2000, we consolidated
into two buildings, the R&D building and the manufacturing building. We returned
the third building to the landlord who has since leased that building to another
tenant. This consolidation resulted from 1) the January 2000 restructuring and
2) the settlement of the ground water intrusion problem affecting all three
buildings. In March 2000, an agreement was reached with the landlord and our
insurance carrier to move net.com to a new build-to-suit facility next door to
the current facility. The new facility will be approximately 185,000 square feet
and will be leased to net.com for 10 years under the same economic terms as our
existing lease. The move is scheduled to take place in late summer 2001. net.com
believes that substantially all the costs associated with the move and the build
out of the new facility will be covered by insurance.
net.com and its subsidiaries also lease sales and service offices at other
locations in the U.S., England, France, Germany, Mexico, Singapore, Uruguay,
Brazil, China and Hong Kong. As a result of the January 2000 restructuring,
net.com is currently attempting to sublease its Crawley, England facility and
relocate to a smaller facility in the Crawley area. We have also relocated to
smaller facilities in several U.S. locations and plan on closing our office in
Mexico City.
Item 3. Legal Proceedings
net.com is unaware of any material pending or threatened legal proceedings. From
time to time net.com may be involved in employment or other litigation or in
activities including litigation needed to collect past due receivables.
Generally we do not consider these litigation matters and or collection
activities to be material.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5. Market for net.com's Common Equity and Related Stockholder Matters
See Note 8 in the "Notes to Consolidated Financial Statements" on page 36. At
June 9, 2000, there were 580 stockholders of record of net.com.
MARKET PRICE
Net.com's Common Stock is traded on the New York Stock Exchange under the symbol
NWK. The following table sets forth, for the quarterly periods indicated, the
high and low sale prices:
Fiscal 2000 High Low
---------------------------------------------------------
First quarter $11.00 $ 7.31
Second quarter 11.63 8.19
Third quarter 14.81 8.88
Fourth quarter 12.50 9.25
---------------------------------------------------------
Fiscal 1999 High Low
---------------------------------------------------------
First quarter $20.63 $13.94
Second quarter 17.00 8.94
Third quarter 13.69 8.00
Fourth quarter 10.88 7.88
---------------------------------------------------------
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net.com has never declared or paid dividends on its capital stock and does not
intend to pay dividends in the foreseeable future.
In addition, the Company's 7 1/4% convertible subordinated debentures trade in
the over-the-counter market.
Item 6. Selected Financial Data
Five year financial summary:
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Years ended March 31, 2000 1999 1998 1997 1996
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenue $ 225,686 $ 263,835 $ 308,721 $ 324,438 $ 338,899
Income (loss) from continuing operations (40,070) (7,054) 14,350 23,302 31,350
Diluted earnings (loss) per share (1.86) (.32) .65 1.08 1.50
7 1/4% convertible subordinated debentures 24,706 24,706 25,821 25,821 33,526
Total assets 259,994 313,112 334,557 301,653 281,957
</TABLE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the Consolidated
Financial Statements and the accompanying notes starting on page 24 of this Form
10-K. The discussion contains forward-looking statements that involve risk and
uncertainties. These statements relate to future events or our future financial
results. Forward-looking statements can often be identified by words such as
"may", "will", "should", "expect", "anticipate", "believe", "estimate" or words
of similar import. Our actual results may differ significantly from those
anticipated by any forward-looking statement as a result of a number of factors,
trends, and risks - many beyond our control. These factors and risks are
discussed further within Business Environment and Risk Factors below and
elsewhere in this Form 10-K.
ACQUISITIONS
In the third quarter of fiscal 2000, net.com completed the acquisition of
FlowWise Networks, Inc. ("FlowWise") based in San Jose, California. The
acquisition brings to net.com Internet Protocol expertise, which is a major
component of net.com's broadband strategy. The acquisition was accounted for as
a purchase for approximately $16.2 million in cash. net.com recorded a one-time
charge of $879,000 in the third quarter of fiscal 2000 for purchased in-process
technology that has not reached technological feasibility and had no alternative
future use. In addition, the remaining portion of the purchase price that
exceeded the net assets of FlowWise, a total of $16.0 million, was recorded as
goodwill and other intangible assets which will be amortized on a straight line
basis over five years. See discussion in Business Environment and Risk Factors
("Business Risk Factors") on page 20 and Note 15 of Notes to Consolidated
Financial Statements on page 40 of this Form 10-K.
Subsequent to the end of fiscal year 2000, net.com acquired the assets of
privately held Convergence Equipment Company from Global Communication
Technologies, Inc. for $1.5 million cash. The acquisition will be accounted for
as a purchase. Convergence Equipment Company designs and manufactures next
generation IP (internet protocol) telephony platforms. Included in the deal are
the Convergence Equipment Company's engineering team, intellectual property, and
a full-featured IP voice switch.
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RESULTS OF OPERATIONS
The following table depicts data derived from the Consolidated Statements of
Operations expressed as a percentage of revenue for each of the three years in
the period ended March 31.
Percent of Revenue 2000 1999 1998
---- ---- ----
Product revenue 51.5% 59.6% 64.8%
Service and other revenue 48.5 40.4 35.2
----- ----- -----
Total revenue 100.0 100.0 100.0
===== ===== =====
Product gross margin 55.3 59.2 60.8
Service and other revenue gross margin 35.2 34.8 38.0
----- ----- -----
Total gross margin 45.6 49.3 52.8
===== ===== =====
Sales and marketing 31.1 33.0 28.3
Research and development 18.6 17.3 14.1
General and administrative 5.6 4.7 3.8
Facility relocation costs 0.0 0.1 1.1
Other operating expense 0.8 0.0 0.0
Restructuring costs 6.7 1.8 0.0
----- ----- -----
Total operating expenses 62.8 56.9 47.3
===== ===== =====
Income (loss) from operations (17.3) (7.6) 5.5
Interest income 3.2 2.5 2.2
Interest expense (1.0) (0.8) (0.6)
Other 3.0 0.3 (0.3)
----- ----- -----
Income (loss) before income taxes (12.1) (5.6) 6.8
Income tax provision (benefit) 5.7 (2.9) 2.2
Extraordinary gain 0.0 0.1 0.0
----- ----- -----
Net income (loss) (17.8%) (2.6)% 4.6%
===== ===== =====
COMPARISON OF 2000, 1999 & 1998
Revenue Total revenue decreased 14.4% to $225.7 million in fiscal 2000 as
compared to $263.8 million in fiscal 1999. Fiscal 1999 was a decrease of 14.5%
compared to the $308.7 million in fiscal 1998. Product revenue decreased 26.1%
to $116.1 million in fiscal 2000 as compared to $157.1 million in fiscal 1999.
Fiscal 1999 was a decrease of 21.5% compared to the $200.2 million in fiscal
1998. The decrease in product revenue is primarily the result of lower sales of
our circuit switched or "narrowband" product line, Promina, which accounts for
the majority of the product sales worldwide. Promina sales decreased as part of
a general decline in the overall market for circuit switched products and an
increase in the market for packet switched or "broadband" products. Product
revenue for the North America sales channel decreased 57.2% to $21.6 million in
fiscal 2000 compared to $50.5 million in fiscal 1999. Fiscal 1999 was flat to
the $50.7 million in fiscal 1998. Product revenue for the European sales channel
decreased 39.4% to $27.0 million in fiscal 2000 compared to $44.6 million in
fiscal 1999. Fiscal 1999 was a decrease of 18.7% compared to the $54.9 million
in fiscal 1998. Promina sales have decreased in the North America & European
sales channels as a result of the movement to broadband discussed above, which
is occurring more quickly in these areas. Partially offsetting the decline in
product sales for the North America and European sales channels was an increase
in product sales for the U.S. Federal channel, which includes sales to the U.S.
government and U.S. government contractors. Product revenue for the U.S. Federal
sales channel increased 13.8% to $50.6 million in fiscal 2000 compared to $44.3
million in fiscal 1999. Fiscal 1999 was a decrease of 12.6% compared to the
$50.7 million in fiscal 1998. The increase in product sales from the U.S.
Federal channel resulted
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from sales of upgrades to support Y2K compliance in U.S. government networks.
The overall migration towards broadband technology is expected to occur more
slowly in the federal markets than in the commercial markets.
Service and other revenue, which includes OEM product sales, increased 2.7% to
$109.5 million in fiscal 2000 as compared to $106.7 million in fiscal 1999.
Fiscal 1999 was a decrease of 1.7% compared to the $108.5 million in fiscal
1998. The increase resulted from other revenue, primarily systems integration
services in support of product sales to the U.S. government. Other revenue sales
in fiscal 2000 increased 24.1% to $43.7 million in fiscal 2000 as compared to
$34.8 million in fiscal 1999. Fiscal 1999 was flat to the $34.1 million in
fiscal 1998. Partially offsetting the increases in other revenue has been a
decrease in service revenues. Service revenue decreased 7.2% to $65.9 million in
fiscal 2000 as compared to $71.9 million in fiscal 1999. Fiscal 1999 was a
decrease of 3.3% compared to the $74.4 million in fiscal 1998. The decrease in
service revenue is a result of customers reducing their service level
requirements as their networks prove to be reliable and well functioning.
In response to the likely continuing decline in the sales for our Promina
products, we are implementing a migration strategy that includes aggressively
developing and marketing broadband products. As part of the broadband strategy,
we are developing new service creation solutions that we expect to expand our
service offerings.
Gross Margin Total gross margin, comprised of product and service margin,
decreased as a percentage of total revenue to 45.6% in fiscal 2000 compared to
49.3% in fiscal 1999 and 52.8% in fiscal 1998. The decrease in total gross
margin is primarily the result of the following:
1) lower product gross margin. Product gross margin decreased to 55.3% in fiscal
2000, compared to 59.2% in fiscal 1999 and 60.8% in fiscal 1998. The decrease in
product gross margin is primarily the result of unfavorable manufacturing
variances that resulted from lower product revenues. In addition, a charge of
$1.2 million for inventory reserves in connection with the obsolescence of
non-year 2000 compliant inventory was taken in fiscal 2000. Partially offsetting
the variances in fiscal 2000 were reductions in manufacturing costs as a result
of the two restructurings.
2) lower product revenue as a percent of total revenue for fiscal 2000 as
compared to fiscal 1999 and 1998. Gross margins are higher for product revenue
than for service revenue. As product revenue decreases, service revenue becomes
a larger component of total revenue. As a result, this change in the mix in
product revenue versus service and other revenue impacted total gross margin.
Service and other revenue gross margin increased to 35.2% in fiscal 2000,
compared to 34.8 % in fiscal 1999. Fiscal 1999 gross margin decreased compared
with fiscal 1998 gross margin of 38.0%. The increase in service and other
revenue gross margin in fiscal 2000 is primarily the result of lower expenses,
which resulted from reduced headcount for service support. The gross margin
decline in fiscal 1999 compared to fiscal 1998 resulted primarily from a
decrease in gross margin for systems integration services due to changes in the
mix of OEM products (included in other revenue) and services.
Operating Expenses Operating expenses in fiscal 2000 decreased $8.4 million to
$141.8 million compared to $150.2 million in fiscal 1999. Fiscal 1999 operating
expenses increased $4.4 million, compared to $145.8 million in fiscal 1998.
Operating expenses as a percentage of total revenue increased to 62.9% in fiscal
2000, compared to 56.9% in fiscal 1999 and 47.2% in fiscal 1998. In the second
quarter of fiscal 2000, we completed a restructuring that included a reduction
in our workforce. This reduction contributed to lower operating expenses in
future quarters. See Item 1, Restructurings and Note 4 of Notes to Consolidated
Financial Statements on page 33 of this Form 10-K). An additional restructuring
occurred in the fourth quarter of fiscal 2000. This restructuring divided
net.com into two business units, one dedicated to developing and delivering our
new broadband products and the other to managing the existing narrowband
business. See Item 1, Restructurings and Note 4 of Notes to Consolidated
Financial Statements on page 33 of this Form 10-K. These actions resulted in a
charge of $12.2 million in the fourth quarter of fiscal 2000 to provide for a
reduction in headcount and the closure of field offices worldwide. Excluding
these two restructuring charges, operating expenses would have decreased $24.0
million to $126.2 million in fiscal 2000.
Sales and marketing expenses in fiscal 2000 decreased $16.8 million to $70.2
million compared to $87.0 million in fiscal 1999 and $87.3 million in fiscal
1998. Sales and marketing expenses as a percentage of total revenue decreased to
31.1% in fiscal 2000, compared to 33.0% in fiscal 1999. In fiscal 1999, Sales
and Marketing expenses increased 28.3% from fiscal 1998. The decrease in fiscal
2000 spending resulted from reduced headcount, continued focus on cost control
and lower sales related expenses. As a result of the restructuring actions that
took
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place in fiscal 1999 and fiscal 2000, management expects sales and marketing
expenses to decline in fiscal 2001 compared to fiscal 2000.
Research and development expenses in fiscal 2000 decreased $3.7 million to $42.1
million, compared to $45.8 million in fiscal 1999. Fiscal 1999 research and
development expense increased $2.3 million from $43.4 million in fiscal 1998.
The decrease in expenses in fiscal 2000 compared to fiscal 1999 is primarily the
result of: 1) reduced headcount following the restructuring activities; and 2)
reduction in the cost for capital equipment purchases in fiscal 2000 as compared
to fiscal 1999. In fiscal 1999, the cost for capital equipment purchases
increased compared to fiscal 1998. In fiscal 2001, we intend to focus research
and development resources on development and release of our broadband technology
offerings. We expect research and development spending to be flat or slightly
below fiscal 2000 levels.
General and administrative expense in fiscal 2000 increased $250,000 to $12.6
million, compared to $12.4 million in fiscal 1999 and $11.8 million in fiscal
1998. The increase in fiscal 2000 is primarily the result of outside consulting
and legal expenses partially offset by lower salary and benefit expenses. Legal
expenses increased in fiscal 2000 as a result of activities related to the
defense of patent infringement claims made by Lucent. See discussion in Business
Environment and Risk Factors section on page 20 of this Form 10-K. We expect
general and administrative expense in fiscal 2001 to decline compared to fiscal
2000 as a result of the restructuring actions conducted in fiscal 2000 and the
cross licensing of patents with Lucent.
A charge of $879,000 was recorded in fiscal 2000 for purchased in-process
technology that arose from the acquisition of FlowWise. Amortization of goodwill
and intangibles related to the FlowWise acquisition totaled $801,000 in fiscal
year 2000. See discussion in Business Risk Factors on page 20, Note 15 of Notes
to the Consolidated Financial Statements on page 40 and Management's Discussion
and Analysis on page 14 of this Form 10-K.
Non-Operating Items Interest income, primarily related to cash investments,
increased $726,000 to $7.3 million in fiscal 2000 compared to $6.6 million in
fiscal 1999 and $6.7 million in fiscal 1998. The increase in interest income is
primarily the result of a shift in the investment portfolio from tax-exempt
securities to taxable securities.
Interest expense, primarily related to the 7 1/4% convertible subordinated
debentures, for fiscal 2000 increased $306,000 to $2.3 million, compared to $2.0
million in fiscal 1999 and $2.0 million in fiscal 1998. The increase in interest
expense is primarily related to debt obligations assumed by net.com as part of
acquisition of FlowWise. We are in the process of retiring the debt obligations
and we do not expect an increase in interest expense in fiscal 2001.
Other income in fiscal 2000 increased $6.0 million to $6.7 million, compared to
$738,000 in fiscal 1999 and an expense of $797,000 in fiscal 1998. Other income
in fiscal years 2000 and 1999 includes gains of $7.2 million and $1.0 million
respectively, mostly from the sale of all of the equity securities held in a
publicly traded company.
Fiscal 2000 included a tax provision of $12.8 million as compared to tax benefit
of $7.6 million in fiscal 1999 and a tax provision of $6.8 million in fiscal
1998. In fiscal 2000, we evaluated the positive and negative evidence bearing
upon the realization of its deferred tax assets. Under the applicable accounting
standards, we considered the history of losses and concluded that it was
appropriate to fully reserve our deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2000, cash, cash equivalents and temporary investments were
$124.9 million, as compared to $154.6 million at the end of fiscal 1999 and
$161.5 million at the end of fiscal 1998. Cash used by operations was $2.2
million in fiscal 2000, compared to cash provided by operations of $19.0 million
and $53.7 million in fiscal 1999 and 1998, respectively. The decrease primarily
resulted from a net loss in fiscal 2000 along with decreases in accounts payable
and accrued liabilities. Partially offsetting the reductions in fiscal 2000 was
a decrease in deferred income taxes.
Net cash provided from investment activities was $16.9 million in fiscal 2000,
compared to a net use of $63.2 million and $37.9 million in fiscal 1999 and
fiscal 1998 respectively. Net cash provided by investment activities consisted
primarily of the proceeds from maturing temporary cash investments of $152.1
million, which was
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partially offset by $113.5 million in purchases of temporary cash investments
and the net use of $15.4 million cash for the acquisition of FlowWise (net of
cash acquired).
Net cash provided by financing activities was $286,000 in fiscal 2000, compared
to net cash of $1.3 million used in fiscal 1999 and net cash of $4.5 million
provided in fiscal 1998. In fiscal 2000, cash provided by financing activities
was $4.1 million from the sale of common stock, which was partially offset by
the use of $3.8 million in cash for the repurchase of common stock.
During fiscal 2000, a secured line of credit of $10.0 million was available for
net.com's use. The security for this line of credit is $10.0 million identified
on the balance sheet as restricted cash. This line of credit was terminated by
net.com as of May 2000. At March 31, 2000, there were no outstanding borrowings
under this line. In addition, as of March 31, 2000, the balance sheet identified
an additional $3.1 million in restricted cash. This cash is identified for an
escrow account held for future payouts to FlowWise employees. See Note 15 of
Notes to Consolidated Financial Statements of this Form 10-K.
The Board of Directors reauthorized a share repurchase program in October of
1999. During fiscal 2000, 437,700 common shares at an average price of $8.62 per
common share were repurchased. We intend to continue the share repurchase
program in fiscal 2001 and from time to time will reenter the market to
repurchase shares.
We believe that our existing current cash and cash equivalents, temporary cash
investments and cash flows from operations will be sufficient to fund
operations, purchases of capital equipment and research and development programs
currently planned at least through the next 12 months.
BUSINESS ENVIRONMENT AND RISK FACTORS
net.com's business is subject to the risks below. Although we have tried to
identify the material risks to our business, this not an all inclusive list.
There may be additional risks not listed because either they have not yet been
identified or they are not material now, although they could become material in
the future. Any one of the risks identified below could materially impact our
business, results of operation or financial condition.
NET.COM HAS LOST MONEY FOR THE PAST THREE QUARTERS AND COULD INCUR LOSSES IN
FUTURE QUARTERS
While we have been profitable in the past, for the past three quarters and for
five out of the last six quarters we have had losses. Our net loss totaled $40.1
million for fiscal year 2000. We will continue to incur large research and
development, marketing and sales expenses to release our new SCREAM product
line. Although we have taken a number of measures to reduce expenditures, our
SCREAM expenditures mean we need to generate significant revenues to achieve
profitability. Since we do not foresee revenue growth from our existing Promina
product line, profitability will need to come from the growth in revenue
associated with the introduction of new products including those recently
acquired. Even if we do achieve profitability in a future quarter, we cannot
guaranty that that profitability will be sustainable.
CASH RESERVES MAY CONTINUE TO DECREASE IF LOSSES CONTINUE
Because of our recent losses, we have had to use portions of our cash reserves
to fund operations. In fiscal year 2000, we expended $2.2 million of our cash
reserves for this purpose. Until we become profitable, a further decline in our
cash reserves may be required in order to fund operations. Further depletion of
our cash reserves could negatively effect our stock price.
OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE THEREBY AFFECTING OUR STOCK PRICE
Our operating results may be subject to quarterly fluctuations as a result of
many different factors. Some of those factors include:
1) General economic conditions in the United States and abroad that can affect
capital spending decisions of our customers.
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2) Decreased demand for our Promina circuit switched products due to a decline
in the markets for our technologies. We expect that in the future, our net sales
of Promina will remain below what we experienced in previous years. The market
for circuit switched networking products appears to be decreasing, possibly
substantially, as commercial customers in the United States initially and
worldwide thereafter increasingly adopt packet or "broadband" technologies. We
cannot predict the speed at which the transition from circuit to packet
technologies will occur. The transition may occur more rapidly than we have
anticipated, which would cause quarterly fluctuations in product sales to
increase and could have other adverse effects on our financial results.
3) Market conditions including increased competition from our competitors' new
or enhanced products or the entry of new competitors in the markets we target.
4) Increases or decreases in our operating expense. Most of our expenses are
fixed, rather than variable. As a result, any shortfall in revenue for a quarter
may materially impact our financial condition and results of operations.
5) Delays in introducing our new products to the market.
6) Our inability to ship products as ordered. This could be due to many factors
such as a shortage or delay in receiving component parts or other failures by
third party suppliers, or customers canceling orders or postponing shipments.
Our customers, including resellers, have the contractual right to delay
scheduled order delivery dates with minimal penalties and to cancel orders
within specified time frames with no penalty. Delays or cancellations make it
difficult to predict when an order may actually ship.
7) Our lack of backlogged product orders at the beginning of each quarter.
Historically, the majority of our revenue in each quarter has resulted from
orders received and shipped in that quarter. In the past fiscal year, we have
not started a quarter with a sufficient amount of backlogged orders to meet the
sales forecast for that quarter. Because many smaller networking equipment
companies have the same ordering patterns yet still see increased revenue
growth, we do not believe that backlog is necessarily indicative of future
revenue levels. Without a backlog, we have been forced to schedule production
and certain expenses based more upon forecasts of sales, which are difficult to
predict. Forecasting sales during a quarter is difficult in part because a large
portion of our orders historically have been received and filled in the last
month of the quarter. This ordering pattern creates a significant risk of too
much or too little inventory if orders do not match forecast. Furthermore, if
large orders do not close when forecasted or if near-term demand weakens for the
products we have available to ship, our operating results for that or subsequent
quarters would be adversely affected.
While it would be impossible to list all the factors that can affect revenues in
a quarter or a fiscal year, the factors listed can have a significant effect.
Because of possible fluctuations resulting from these various factors, results
of operations in any one-quarter do not necessarily indicate what results can be
expected in future quarters. Future declines in networking product sales for any
reason could have a materially adverse effect on our business, financial
condition or results of operations. Additionally, to the extent that we do not
achieve profitability in any given quarter or that our forecasted revenue is
below the expectations of the publicly traded markets, the price of our common
stock could fall, perhaps a significant amount.
WE ARE DEPENDENT IN LARGE PART ON THE PROMINA PRODUCT LINE UNTIL INTRODUCTION OF
NET.COM'S SCREAM PRODUCT LINE IN FULL
Currently, we derive the majority of our product revenue from our Promina
product line, a circuit-based technology that will eventually be replaced
entirely by our packet based product line, net.com's SCREAM. We believe that
circuit-based technology generally is becoming obsolete, but we cannot foresee
when this obsolescence will become complete. While we work to develop our SCREAM
product line, we are dependent upon our Promina products to generate the bulk of
our revenue. Upon introduction of SCREAM, it will take time to develop the
market for this product. Our ability to complete development of net.com's SCREAM
product line and to successfully introduce that product to the technology market
could materially affect our financial condition and results of operation.
The move from circuit to packet based products appears to be happening more
quickly in the commercial markets in the United States than elsewhere in the
world. As our largest market has traditionally been the United States, this is
where we have seen the largest drop-off in commercial product sales.
Consequently, international sales will continue to account for a significant
portion of our Promina sales in future periods. International sales tend to have
risks that are difficult to foresee and plan for including political and
economic stability, regulatory changes, currency exchange rates, tax rates and
structures, and collection of accounts receivable. Unforeseen events in various
areas of
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the globe may have an adverse impact on us such as the recent economic
difficulties in Asia and Latin America. Further, our international markets are
served primarily by non-exclusive resellers who themselves may be severely
impacted by economic or market changes within a particular country or region.
Unforeseen or unpredictable changes in international markets could have an
adverse effect on our business, results of operations and financial condition.
INCREASED COMPETITION IS LIKELY IN THE FUTURE
The market for networking products is extremely competitive. Our specific
market, telecommunication equipment, is a highly competitive and dynamic market
characterized by the easy entrance of new start-up companies, rapid changes,
converging technologies and a worldwide migration from existing circuit
technology to the new packet based technologies. We compete directly both
internationally and domestically with many different companies, some of which
are large, established suppliers of end-to-end solutions such as Cisco, Lucent,
Nortel and others which are new start-up ventures. Many of the large suppliers
have greater financial, marketing and technical resources and offer a wider
range of networking products than we have. They are often able to devote greater
resources to the development, marketing and sale of their products and to use
large market capitalizations or significant cash to acquire other companies with
technology and/or products that are competitive with ours. They often can
compete favorably on price because their large product selection allows them to
decrease the price for any individual product without impacting their overall
product margins. Small start-up ventures are better able to devote all their
resources to a particular product development unencumbered by the requirements
to support an existing product line. As a result of the market's favorable
reaction to recent initial public offerings by technology companies, start-ups
also often have large market capitalizations allowing them easy access to
capital which could be used for various growth activities including funding
competitive acquisitions. Through these acquisitions, competitors can obtain
strategic advantages that may adversely affect our business, financial condition
or results of operations.
To remain competitive, we need to develop new products that meet the
ever-changing needs of the networking market but that can be purchased at a
competitive price. We also must enhance our current products to provide needed
features that increase the overall value proposition for the customer while
keeping the price competitive. Due to the competitive nature of the market, we
may not be able to maintain prices for our products at levels that will sustain
profitability over the short or long term.
A SIGNIFICANT PORTION OF OUR REVENUE IS GENERATED FROM SALES TO THE FEDERAL
GOVERNMENT
A significant portion of our revenue from both product and services comes from
contracts with the U.S. government, most of which do not include purchase
commitments. While the transition from circuit to packet technology is slower in
the Federal market than in the commercial market, orders from the U.S.
government may not continue at historical levels, and it is possible that we
will not be able to obtain orders from new commercial customers to make up any
shortfall. The Federal market is characterized by rapid consolidation of
companies serving this market. As our federal contracts come up for renewal, the
government is tending to favor larger companies that can assume the role we
currently hold as primary contractor making us a subcontractor to a prime. If we
cannot find larger federal companies to partner with us on renewal of our
federal contracts, we could see a decrease in U.S. government orders and
resulting revenue. In addition, as a subcontractor, we often cannot offer the
same array of products and services at the prices we have in the past. This
could lead to a decrease in sales and related gross margin on those sales.
Should U.S. government orders substantially decline, it could have a material
adverse effect on our business, results of operations and financial condition.
OUR INABILITY TO SIGN COMPETITIVE RESALE PARTNERS INTERNATIONALLY COULD
SIGNIFICANTLY AFFECT FUTURE PRODUCT AND SERVICE REVENUE
Because the transition from circuit to packet technology is slower outside the
United States, we expect international sales will continue to account for a
significant portion of our Promina product sales in future periods. Resellers
whose territory corresponds to a particular geographic region that is not
exclusive to that reseller generate most international sales. Resellers do not
have minimum purchase requirements that they must meet. While we require our
resellers to use their best efforts to resell our products, because our product
line is small, our resellers must often resell product lines from other
networking companies including our competitors such as Cisco, in order to
sustain a profit. Because of Cisco's size and dominant position in the network
equipment market, it is difficult to find a
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<PAGE>
reseller who does not resell Cisco products. Due to the difficulty of signing up
resellers without pre-existing competitive relationships, our resellers are not
always successful in promoting our products impacting the sustainability of our
international product sales. If we cannot develop relationships with resellers
that can effectively market and sell our products and services, we will not be
able to meet our forecasted sales and revenue in future quarters.
OUR LATIN AMERICA SALES MAY CONTINUE AT DEPRESSED LEVELS
Sales in Latin America have largely been through strategic international resale
partners, primarily IBM and Ericsson Networks, rather than through local
resellers. Our reseller relationship with IBM ended in late 1997. In Latin
America, Ericsson Networks has focused on marketing and selling its own
internally developed products. The decline of these two relationships has
significantly impacted product revenue in Latin America. If we cannot find other
resale channels, our Latin American sales may continue at current or decreased
levels thereby impacting our business, results of operations and financial
condition.
GROWTH IN REVENUE IS PREDICATED UPON TIMELY RELEASE AND MARKET ACCEPTANCE OF OUR
SCREAM BROADBAND PRODUCT LINE
Although we believe the circuit switched product market to be declining, we
believe there is significant opportunity for growth in the packet switched
product market. That is why we have focused our research and development
activities on our new SCREAM broadband product line. We cannot guarantee,
however, that broadband product markets will grow as fast as we expect nor can
we guarantee that the market will readily adopt our product. If we fail to
release our broadband products on time, if our products do not have the features
and capabilities that the broadband market is looking for, or if our products
can not be competitively priced then our broadband product line may not generate
the revenue that we currently expect. That failure could materially adversely
affect our business, results of operations and financial condition.
OUR CUSTOMERS MUST FOCUS ON SERVICE CREATION AND DELIVERY FOR OUR NEW SCREAM
PRODUCT TO GAIN ACCEPTANCE IN THE BROADBAND ACCESS MARKET
net.com's new SCREAM product focuses on allowing our customers to deliver
services to their customers. Service creation is a concept that is only just now
being seriously studied by our customers. While early indications are that this
is a significant product feature, if the move by our customers to adopt the
service creation model is slow or if our customers ultimately reject this as an
unneeded technology feature, then our SCREAM product may not be accepted or may
be accepted slowly by the broadband access market. In either case, a lack of
acceptance or a slower than anticipated acceptance could impact our forecasted
revenue.
IF WE ARE UNABLE TO HIRE QUALIFIED NEW EMPLOYEES OR TO RETAIN EXISTING
EMPLOYEES, THEN WE MAY NOT BE ABLE TO SUCCESSFULLY MANAGE OUR BUSINESS
As with all technology companies, our success is dependent on being able to
attract and retain highly skilled engineers, managers and other key employees.
In particular, we have seen a large turnover in our direct sales force in North
America. This turnover has impacted our ability to sell products in the United
States. The current tight job market has made competition for employees very
intense for all employers. The large job growth in the San Francisco Bay Area
and the competition for employees from companies able to offer greater
compensation incentives through either stock options for stock with a perceived
higher growth value than net.com, or offering a large equity interest in a
pre-IPO start-up company has made it difficult for many departments in net.com
including Marketing and Engineering to attract and recruit new employees in a
timely manner. While we have put additional focus and resources into our
recruitment activities and have taken steps including compensation and other
incentives that we hope will mitigate these competitive advantages, we cannot
say that in the current economy, our increased efforts will substantially
improve the recruitment and retention issues faced by our company at this time.
Our inability to attract, recruit and retain key personnel, particularly
engineers, sales and marketing employees, could impact our ability to meet
important company objectives such as product delivery deadlines and sales
targets. That in turn could significantly impact our business, results of
operations and financial condition.
We recently experienced the departure of our Vice President of WorldWide Sales
and Service. For the present, the Vice Presidents of the geographic sales units
and the Vice President of Worldwide Service are assuming her duties
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<PAGE>
and responsibilities. We are in the process of analyzing the appropriate
long-term solution for replacement of her position.
OUR NEED TO OBSOLETE OUR STM PRODUCT LINE COULD IMPACT REVENUE IN FUTURE PERIODS
Due to an inability to find parts needed to manufacture our STM product line, we
will be working with our customers to end of life this product line effective at
the end of fiscal year 2001. In fiscal 2000, STM accounted for 6.4% of our
product revenue. We are not planning on replacing the STM with another product
line for that market. If revenue generated from our new products is not
sufficient to compensate for revenues lost from STM product sales, the phase out
of the STM product could impact our results of operations and financial
condition in future periods.
WE RELY ON A NUMBER OF SOLE SOURCE SUPPLIERS FOR OUR COMPONENT PARTS
For both net.com's Promina and new SCREAM product lines, we purchase key
components from single source suppliers. In particular, our back planes, ASICS
and power supplies come from single source suppliers. If one of these suppliers
were no longer able to supply a required component, it could result in our
having to significantly reengineer the affected product. Further, due to
increased demand and a shortage of capacity in the semiconductor industry, lead
times for ordering parts have increased. If we encounter shortages or delays in
receiving ordered components or if we are not able to accurately forecast our
ordering requirements, this could adversely impact our ability to ship ordered
products and could ultimately negatively impact our results of operations and
financial condition.
WE SINGLE SOURCE OUR MANUFACTURING PROCESS SO THAT A FAILURE OR DELAY BY THAT
VENDOR COULD IMPACT OUR ABILITY TO TIMELY SHIP OUR PRODUCTS
We currently subcontract some testing and all product manufacturing to one
company, Solectron. Final test and assembly is generally performed at our
Fremont, California facility. While subcontracting creates substantial cost
efficiencies in the manufacturing process, it also exposes us to delays in
product shipments should Solectron be unable to perform under our contract. In
addition, should Solectron in some future period decide not to renew our
contract with them, it would be difficult for us to quickly transfer our
manufacturing requirements to another vendor likely causing substantial delays
in customer product shipments and impacting revenue and our results of
operations.
OUR PRODUCTS HAVE LONG SALES CYCLES MAKING IT DIFFICULT TO PREDICT WHEN A
CUSTOMER WILL PLACE AN ORDER AND WHEN TO FORECAST REVENUE FROM THE RELATED SALE
Our products are very complex pieces of networking equipment and represent a
significant capital expenditure to our customers. The purchase of our products
can have a significant impact on how a customer designs its network and provides
services either within its own organization or to an external customer.
Consequently, our customers often engage in extensive testing and evaluation of
products before purchase. There are also numerous financial and budget
considerations and approvals that often must be obtained before a customer will
issue a purchase order. As a result, the length of our sales cycle can be quite
long, up to a year in some cases. While customers may tell us that they are
planning to purchase our products, to ensure a purchase order is placed, we
often must incur substantial sales and marketing expense. If the order is not
placed in the quarter forecasted because approvals took longer than anticipated
by the customer, our sales may not meet forecast and revenues may be
insufficient in that quarter to meet expenses.
TO MAINTAIN OUR COMPETITIVE ADVANTAGE, WE NEED TO PROTECT OUR INTELLECTUAL
PROPERTY FROM INFRINGEMENT BY OTHERS
Our future success is dependent upon our ability to develop new products
superior to those of our competitors. We have an aggressive program in place to
patent our intellectual property and protect it from infringement by
competitors. In addition, we take measures to protect our trade secret
information from disclosure by third parties and current and former employees.
Despite our concerted efforts in these areas, we cannot guarantee our patents
will issue or that we will be able to protect our trade secrets from disclosure.
Even if a patent does issue, we cannot
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<PAGE>
guarantee that it will not later be found invalid or infringed without our
knowledge. In particular, with the movement of employees from competitor to
competitor, it may be inevitable that trade secret information will be disclosed
at some point and used in product development. Monitoring unauthorized use of
our technology and trade secrets is extremely difficult. If our technology or
trade secret information is disclosed to a competitor, it may not be possible
for us to prove infringement or misappropriation sufficiently for a court to
take actions necessary to protect us. If a competitor gained an advantage
through infringement and/or misappropriation of our trade secrets, it could
seriously impact our competitive position in the market and ultimately our
financial condition.
WE HAVE BEEN SUBJECT, AND MAY AGAIN BE SUBJECT, TO CLAIMS THAT OUR TECHNOLOGY
INFRINGES ANOTHER'S INTELLECTUAL PROPERTY
Over the past decade, many companies have developed a business model where they
seek to increase their revenues by claiming infringement of one or more of their
patents. A number of these companies are large with extensive patent portfolios
developed because of their actual monopoly or near monopoly positions in certain
markets. These companies approach other companies and attempt to coerce them
into a licensing agreement by threatening to use their resources and patent
portfolio in never ending claims of infringement against their many patents.
While we have patents in our portfolio that we consider valuable, we do not have
an extensive enough portfolio to easily defend against these accusations of
infringement. Even if the infringement claims are without merit, defending
against these claims is time consuming and expensive especially for a small
company such as net.com and takes us away from the focus of our business. In
every case, we may not be able to successfully negotiate a licensing agreement
or the third party may institute litigation against us. In addition, if we were
required to pay royalties to an ever-increasing number of companies, it could
impact our financial condition and results of operation.
We recently entered into a cross-licensing agreement with Lucent Technologies in
settlement of our cross claims of patent infringement. We are each licensed for
use of all patents relevant to our individual businesses.
WE CANNOT GUARANTEE THAT OUR ACQUISITIONS WILL PROVE SUCCESSFUL
We completed one acquisition in the fiscal year ended March 31, 2000, FlowWise
Networks, Inc. In addition, after the close of the fiscal year, on May 2, 2000,
we acquired Convergence Equipment Company. The purchase of FlowWise provided us
with Internet Protocol or "IP" technology expertise that we consider important
for us to effectively develop competitive products for the emerging broadband
market. We are selling the FlowWise product under the net.com label and are also
considering licensing the FlowWise technology to others. See Note 15 of Notes to
Consolidated Financial Statements in this Form 10-K and Management's Discussion
and Analysis, Acquisitions, on page 11 of this Form 10-K. The purchase of
Convergence gives us voice over IP technology that can be incorporated into our
existing Promina product line. We believe that adding the voice over IP feature
will enhance the value proposition for customers of our Promina products.
While the intent of both these acquisitions is to enhance our competitive
position, we cannot be certain that either acquisition will have this result. To
be successful, we must overcome risks associated with these acquisitions
including the possible inability to integrate the FlowWise or Convergence
technologies and products with our current and future technologies and products,
the possible loss of key FlowWise or Convergence employees before products are
completed, the possible inability of net.com to successfully sell the FlowWise
products due to our inexperience in the router accelerator market and the many
strong competitors in the larger router market, our inability to successfully
sell the Convergence product as an enhanced feature due to the many competitors
in this market and the overarching migration from circuit to packet based
products, or our inability to complete development of the Convergence product
and successfully bring it to market in a timely manner. Failure to bring the
Convergence product to market in a timely manner could impact our ability to
maintain projected revenue levels for the Promina product. In addition,
competition, technology changes and other factors may force us to change our
broadband strategy and that may impact the significance of the FlowWise
acquisition. If either of these acquisitions proves unsuccessful, it could have
an adverse effect on our business, financial condition or results of operations.
OUR RECENT RESTRUCTURINGS MAY NOT HAVE THE DESIRED BENEFICIAL EFFECT ON OUR
BUSINESS GOING FORWARD
During fiscal year 2000, we engaged in two restructurings both of which involved
realignment of our corporate structure and a reduction in our work force. These
restructurings were in addition to the reduction in force in March 1999. In July
1999, we restructured in order to streamline our organizational structure and to
bring expenses in line
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<PAGE>
with projected revenues. In January 2000, we reorganized around our two product
lines, circuit switched or "narrowband" products and packet based or "broadband"
products. See Note 4 in Notes to Consolidated Financial Statements on page 33
and Item 1, Business, Restructuring, on page 9 of this Form 10-K.
The intent of both restructurings was to increase efficiency by simplifying the
organizational structure and to bring expenses in line with revenue. We cannot
guarantee, however, that the sought after efficiency will result from these
restructurings, that expenses will be reduced sufficiently to return us to
profitability, or that either or both of the restructurings will have a positive
long term effect.
In particular, while the intent of the January reorganization was to bring
increased focus on our broadband product development while maintaining support
of our existing narrowband products, there is no guarantee that the
reorganization will result in the increased focus required to release broadband
products in a timely manner and still adequately support narrowband sales.
Employees may not focus sufficiently on implementation of the broadband strategy
because of preoccupation with the effects of the restructuring. In addition, as
a result of the organizational changes, we may lose a significant number of
employees that we wanted to retain thereby impacting our ability to be
successful in the broadband market. Nor can we be certain that even if
implemented, our broadband strategy will be successful. The broadband market may
not expand as quickly as anticipated or that market may not accept our products.
WE FACE GREATER CREDIT RISK FROM SOME OF OUR NEW CUSTOMERS
Historically, our customers have tended to be large established companies who
either used our products to develop their own wide area network or were phone
companies using our products to allow their customers to access their regional
or national network. In the past two years, our customers have changed to now
include smaller start-up telecommunications companies. Because these start-up
companies typically do not have either long operating histories or significant
capitalization, traditional lending sources are often not available to them.
Since financing assistance from the manufacturer is often required to consummate
the transaction, these companies frequently make purchasing decisions in part on
the ability of an equipment manufacturer to provide financing assistance to them
in deploying their network infrastructure. We have had a leasing program
originally with Bank Boston and now with Marcap to assist these customers with
their financing requirements. This program includes a loss sharing provision
with the lessor. In addition, we entered into a loss sharing agreement with one
of our resellers wherein we share in a percentage of any loss arising from a
customer's failure to pay the reseller for our equipment. Both these programs
are for United States based companies only. Although we have not experienced
significant losses to date from customers failing to meet their obligations,
should a significant number of lessees or customers in any one loss sharing pool
or should one large lessee or customer default, it could have a material adverse
effect on our business, results of operations and financial condition.
WE EXPECT GROSS MARGINS TO DECLINE OVER FUTURE PERIODS
Due to increases in competition, material and labor costs and changes in the mix
of products we sell, we expect that our gross margins could decrease in future
quarters. Some of our new products may have lower gross margins than our Promina
product line. In addition, if product sales decrease so that service revenue
becomes a larger part of overall revenue, overall margin may decrease as service
products traditionally have lower margins. Further, to the extent we expand our
sales through product resellers, reseller sales generally result in lower gross
margins because of the need to build in a margin for the reseller. Prices for
our component parts are also increasing due to increased demand and an overall
shortage of capacity in the semiconductor industry. Any one of these factors or
all of them in combination may decrease our product margins or our margins
overall.
WE NEED TO CONTINUE TO LICENSE PRODUCTS FROM THIRD PARTIES
We license some of our technology from third party suppliers. If the relevant
licensing agreement expires or is terminated without our being able to renew
that license, that failure to renew the license could impact our ability to
market the affected product and that, in turn, could materially impact our
results of operations and financial condition.
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<PAGE>
SALES OF NET.COM'S SCREAM PRODUCT DEPENDS UPON CONTINUED GROWTH OF THE INTERNET
We expect our broadband product sales will grow in large part due to increasing
growth of the Internet. In addition, our SCREAM product is targeted at certain
markets, such as internet and application service providers, whose business
relies completely on the growth of the Internet. If the Internet does not
continue to grow, it would directly impact the market for broadband networking
equipment like SCREAM. In the future, it is possible that there will be problems
with the performance of Internet communications due to capacity limitations and
equipment or software failures. Should any of these failures be associated with
net.com equipment, our reputation as a supplier of reliable equipment would be
tarnished, whether justified or not. That could undermine our ability to sell
products into targeted markets.
DOMESTIC OR FOREIGN REGULATIONS OF TELECOMMUNICATIONS OR THE INTERNET COULD
IMPACT OUR ABILITY TO SELL OUR PRODUCTS
As a telecommunications networking equipment manufacturer, our customers
worldwide often work within a regulated environment. That in turn requires us to
develop products that meet their regulatory requirements. Regulations usually
vary to a certain extent from country to country. For example, in many
countries, our Promina products require homologation certification in order to
connect to the public networks. If we do not comply with existing or evolving
regulations or if our products fail to obtain appropriate regulatory approvals
where required, it would impact our ability to sell our products in those
markets.
In addition, there are currently few laws or regulations that govern access or
commerce on the Internet. If individual countries, or groups of countries acting
in concert began to impose regulations or standards on Internet access or
commerce including voice over IP, this could materially impact our ability to
sell our new SCREAM or SHOUTip products if the regulations or standards resulted
in decreased demand or increased costs for our products. This, in turn, could
have a material adverse effect on our business, results of operations and
financial condition.
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<PAGE>
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The following table represents the hypothetical changes in fair market values in
the financial instruments held by us at March 31, 2000 that are sensitive to
changes in interest rates. These instruments are not leveraged and are held for
purposes other than trading. The modeling technique used measures the change in
fair values arising from selected potential changes in interest rates. Market
changes reflect immediate hypothetical parallel shifts in the yield curve of
plus or minus 50 basis points (BPS), 100 BPS and 150 BPS over a six-month
horizon. Beginning fair values represent the market principal plus accrued
interest, dividends and certain interest rate sensitive securities considered
cash and equivalents for financial reporting purposes at March 31, 2000. Ending
fair values comprise the market principal and accrued interest, dividends and
reinvestment income at a six-month horizon. This table estimates the fair value
of the portfolio at a six-month time horizon:
<TABLE>
<CAPTION>
Valuation of securities No change Valuation of securities
given an interest rate in interest given an interest rate
decrease of x basis points rates increase of x basis points
----------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) (150) BPS (100) BPS (50) BPS 50 BPS 100 BPS 150 BPS
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Cash Equivalents $ 32,149 $ 32,189 $ 32,229 $ 32,269 $ 32,309 $ 32,350 $ 32,390
Treasuries/Agencies 23,822 23,747 23,673 23,599 23,526 22,774 23,381
Corporates 42,661 42,582 42,503 42,425 42,348 42,271 42,195
Asset Backed 24,737 24,298 24,099 23,806 23,528 23,943 23,012
Municipals 8,974 8,885 8,597 8,439 8,297 8,171 8,057
----------------------------------------------------------------------------------------------------------------------
Total $132,343 $131,701 $131,101 $130,538 $130,008 $129,509 $129,035
======================================================================================================================
</TABLE>
A 50 BPS move in the Federal Funds Rate has occurred in 8 of the last 10 years;
a 100 BPS move in the Federal Funds Rate has occurred in 5 of the last 10 years;
and a 150 BPS move in the Federal Funds Rate has occurred in 3 of the last 10
years.
We are exposed to foreign currency fluctuation when translating foreign
operations in the Consolidated Financial Statements. If the foreign currencies
fluctuated up to 10%, there would not be a material impact to our business,
financial condition or results of operations.
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<PAGE>
Item 8. Financial Statements and Supplementary Data
Financial Highlights:
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Highlights for years ended March 31, 2000 1999
----------------------------------------------------------------------------------------------
<S> <C> <C>
Revenue $225,686 $263,835
Operating loss (39,013) (20,039)
Net loss (40,070) (6,959)
Basic loss per share (1.86) (0.32)
Working capital 138,893 177,088
Total assets 259,994 313,112
7 1/4% convertible subordinated debentures 24,706 24,706
Stockholders' equity 185,974 233,013
Number of employees 843 1,289
----------------------------------------------------------------------------------------------
</TABLE>
Quarterly financial data (unaudited):
<TABLE>
<CAPTION>
(Dollars in thousands, except per share amounts) First Second Third Fourth
----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Fiscal quarter 2000
Revenue $62,555 $64,788 $ 51,242 $ 47,101
Gross margin 29,634 30,739 22,709 19,745
Net income (loss) 3,475 (2,913) (20,002) (20,630)
Diluted earnings (loss) per share 0.16 (0.14) (0.93) (0.96)
----------------------------------------------------------------------------------------------
Fiscal quarter 1999
Revenue $71,426 $75,354 $65,914 $51,141
Gross margin 37,947 39,558 34,010 18,680
Net income (loss) 2,948 3,529 (735) (12,701)
Diluted earnings (loss) per share 0.13 0.16 (0.03) (0.59)
----------------------------------------------------------------------------------------------
</TABLE>
Results for the fourth quarter of fiscal 1999 include a charge of $4.7 million,
or $0.10 per share, related to net.com's restructuring.
Results for the second quarter of fiscal 2000 include a charge of $3.4 million,
or $0.12 per share related to net.com's restructuring. Results for the third
quarter of fiscal 2000 include a charge for a valuation allowance against
deferred tax assets of $12.6 million and a one time charge for in-process
research and development of $879,000, totaling $0.63 per share. Results for the
fourth quarter include a charge of $11.8 million, or $0.55 per share related to
net.com's restructuring.
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<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the stockholders and board of directors of Network Equipment Technologies,
Inc.
We have audited the accompanying consolidated balance sheets of Network
Equipment Technologies, Inc. and subsidiaries as of March 31, 2000 and 1999, and
the related consolidated statements of operations and comprehensive income
(loss), stockholders' equity and cash flows for each of the three years in the
period ended March 31, 2000. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Network Equipment Technologies,
Inc. and subsidiaries at March 31, 2000 and 1999, and the results of operations
and their cash flows for each of the three years in the period ended March 31,
2000 in conformity with accounting principles generally accepted in the United
States of America.
DELOITTE & TOUCHE LLP
San Jose, California
April 18, 2000
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<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Dollars in thousands)
March 31, 2000 1999
---------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents, $13,144 restricted in 2000 $ 28,024 $ 13,720
Temporary cash investments 96,902 140,843
Accounts receivable, net of allowances of $5,350 in 2000
and $3,375 in 1999 39,317 46,381
Inventories 17,691 19,193
Deferred income taxes -- 5,510
Prepaid expenses and other assets 6,087 6,834
---------------------------------------------------------------------------------------------------
Total current assets 188,021 232,481
---------------------------------------------------------------------------------------------------
Property and equipment:
Machinery and equipment 99,007 108,230
Furniture and fixtures 8,081 9,716
Leasehold improvements 18,542 20,013
Construction in progress 141 1,451
---------------------------------------------------------------------------------------------------
125,771 139,410
Less accumulated depreciation and amortization (84,150) (83,533)
---------------------------------------------------------------------------------------------------
Property and equipment, net 41,621 55,877
Software production costs, net 4,821 6,129
Deferred income taxes -- 9,053
Goodwill and other intangible assets, net 15,220 --
Other assets 10,311 9,572
---------------------------------------------------------------------------------------------------
$ 259,994 $ 313,112
===================================================================================================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 9,009 $ 11,755
Accrued liabilities 39,980 43,638
Capital leases 139 --
---------------------------------------------------------------------------------------------------
Total current liabilities 49,128 55,393
---------------------------------------------------------------------------------------------------
Long-term liabilities:
Capital leases 186 --
7 1/4% redeemable convertible subordinated debentures 24,706 24,706
---------------------------------------------------------------------------------------------------
Total long term liabilities 24,892 24,706
---------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock, $.01 par value
Authorized: 5,000,000 shares
Outstanding: none -- --
Common stock, $.01 par value
Authorized: 50,000,000
Outstanding: 21,602,000 shares in 2000 and 21,509,000 in 1999 216 215
Additional paid in capital 181,683 180,596
Treasury stock (5,640) (4,853)
Cumulative comprehensive income (loss) (1,349) 5,921
Retained earnings 11,064 51,134
---------------------------------------------------------------------------------------------------
Total stockholders' equity 185,974 233,013
---------------------------------------------------------------------------------------------------
$ 259,994 $ 313,112
===================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
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<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
<TABLE>
<CAPTION>
(Dollars in thousands, except per share amounts)
Years ended March 31, 2000 1999 1998
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue:
Product revenue $ 116,141 $ 157,119 $ 200,199
Service and other revenue 109,545 106,716 108,522
----------------------------------------------------------------------------------------------------------------
Total revenue 225,686 263,835 308,721
----------------------------------------------------------------------------------------------------------------
Cost of sales:
Cost of product revenue 51,920 64,065 78,468
Cost of service and other revenue 70,939 69,575 67,317
----------------------------------------------------------------------------------------------------------------
Total cost of sales 122,859 133,640 145,785
----------------------------------------------------------------------------------------------------------------
Gross margin 102,827 130,195 162,936
Operating expenses:
Sales and marketing 70,243 87,025 87,248
Research and development 42,089 45,768 43,442
General and administrative 12,601 12,351 11,815
Facility relocation costs -- 395 3,289
Restructure costs 15,227 4,695 --
In process research and development costs 879 -- --
Amortization of goodwill and other intangible assets 801 -- --
----------------------------------------------------------------------------------------------------------------
Total operating costs 141,840 150,234 145,794
----------------------------------------------------------------------------------------------------------------
Income (loss) from operations (39,013) (20,039) 17,142
Interest income 7,306 6,580 6,726
Interest expense (2,281) (1,975) (1,968)
Gain on sale of equity securities 7,156 997 --
Other (467) 259 (797)
----------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (27,299) (14,696) 21,103
Income tax provision (benefit) 12,771 (7,642) 6,753
----------------------------------------------------------------------------------------------------------------
Income (loss) before extraordinary gain (40,070) (7,054) 14,350
Extraordinary gains on repurchase of debentures -- 95 --
----------------------------------------------------------------------------------------------------------------
Net income (loss) $ (40,070) $ (6,959) $ 14,350
================================================================================================================
Basic earnings (loss) per share:
Income (loss) before extraordinary gain $ (1.86) $ (0.33) $ 0.68
Net income (loss) $ (1.86) $ (0.32) $ 0.68
Diluted earnings (loss) per share:
Income (loss) before extraordinary gain $ (1.86) $ (0.33) $ 0.65
Net income (loss) $ (1.86) $ (0.32) $ 0.65
Shares used in per share computation:
Basic 21,489 21,508 21,246
Diluted 21,489 21,508 22,034
Consolidated Statements of Comprehensive Income (Loss)
Net income (loss) $ (40,070) $ (6,959) $ 14,350
Other comprehensive income (loss), net of tax:
Cumulative translation adjustments 6 (372) 54
Net unrealized gains (losses) on securities, net of taxes of
$0 in 2000, $1,564 in 1999 and $2,054 in 1998 (7,276) 2,970 3,815
Less reclassification adjustment for gains included in net income 7,442 -- --
----------------------------------------------------------------------------------------------------------------
Comprehensive income (loss) $ (39,898) $ (4,361) $ 18,219
================================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
Page 27
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Dollars in thousands)
Years ended March, 31 2000 1999 1998
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash and cash equivalents at beginning of year $ 13,720 $ 59,512 $ 39,141
--------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) (40,070) (6,959) 14,350
Adjustments required to reconcile net income (loss) to net
cash provided by (used for) operations:
Depreciation and amortization 23,416 21,685 19,206
Restructure liability 7,513 4,158 --
In process research and development costs 879 -- --
Facility relocation costs -- -- 3,289
Extraordinary gains on repurchase of debentures -- (95) --
Restricted stock compensation 15 286 401
Deferred income taxes 14,563 (8,226) (2,418)
Loss on disposition of property and equipment 405 -- --
Changes in assets and liabilities:
Accounts receivable 6,857 25,313 11,128
Inventories 1,711 506 2,953
Prepaid expenses and other assets 951 403 (594)
Accounts payable (7,546) (10,114) (1,841)
Accrued liabilities (10,879) (7,947) 7,193
--------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operations (2,185) 19,010 53,667
--------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of temporary cash investments (113,472) (131,608) (84,526)
Proceeds from maturities of temporary cash investments 152,129 104,477 82,304
Purchases of property and equipment (4,809) (32,214) (30,322)
Additions to software production costs (1,759) (3,359) (3,160)
Acquisition of company (net of cash acquired) (15,339) -- --
Other (727) (461) (2,217)
--------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities 16,023 (63,165) (37,921)
--------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Sale of common stock 4,061 5,294 4,485
Repurchase of convertible subordinated debentures -- (955) --
Repurchase of common stock (3,775) (5,617) --
--------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities 286 (1,278) 4,485
--------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 180 (359) 140
Net increase (decrease) in cash and cash equivalents 14,304 (45,792) 20,371
--------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 28,024 $ 13,720 $ 59,512
==============================================================================================================
Other cash flow information:
Cash paid (refunded) during the year:
Interest $ 2,248 $ 1,895 $ 1,932
Income taxes $ (5,974) $ 1,449 $ 5,989
Non-cash investing and financing activities:
Unrealized gain (loss) on available-for-sale securities $ (7,276) $ 2,970 $ 3,815
Income tax benefit arising from employee stock
option plans $ -- $ 808 $ 648
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
Page 28
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Additional Cumulative Total
Common Paid-in Treasury Comprehensive Retained Stockholders'
(Dollars in thousands) Stock Capital Stock Income (Loss) Earnings Equity
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances, March 31, 1997 $ 210 $ 172,038 $ (2,545) $ (546) $ 43,743 $ 212,900
------------------------------------------------------------------------------------------------------------------------------------
Sale of 242,000 shares of
Common Stock under
employee stock benefit plans 3 2,815 -- -- -- 2,818
Reissuance of 164,000 shares of
treasury stock under stock plans 2 951 1,115 -- -- 2,068
Income tax benefit arising from
employee stock option plans -- 648 -- -- -- 648
Net unrealized gain on securities -- -- -- 3,815 -- 3,815
Cumulative translation adjustment -- -- -- 54 -- 54
Net income -- -- -- -- 14,350 14,350
------------------------------------------------------------------------------------------------------------------------------------
Balances, March 31, 1998 $ 215 $ 176,452 $ (1,430) $ 3,323 $ 58,093 $ 236,653
------------------------------------------------------------------------------------------------------------------------------------
Sale of 269,000 shares of
Common Stock under
employee stock benefit plans 2 2,877 -- -- -- 2,879
Purchase of 500,000 shares of
Common Stock (5) -- (5,612) -- -- (5,617)
Reissuance of 286,000 shares of
treasury stock under stock plans 3 459 2,189 -- -- 2,651
Income tax benefit arising from
employee stock option plans -- 808 -- -- -- 808
Net unrealized gain on securities -- -- -- 2,970 -- 2,970
Cumulative translation adjustment -- -- -- (372) -- (372)
Net loss -- -- -- -- (6,959) (6,959)
------------------------------------------------------------------------------------------------------------------------------------
Balances, March 31, 1999 $ 215 $ 180,596 $ (4,853) $ 5,921 $ 51,134 $ 233,013
------------------------------------------------------------------------------------------------------------------------------------
Sale of 193,000 shares of --
Common Stock under
employee stock benefit plans 2 1,842 -- -- -- 1,844
Purchase of 438,000 shares of
Common Stock (4) -- (3,771) -- -- (3,775)
Reissuance of 338,000 shares of
treasury stock under stock plans 3 (755) 2,984 -- -- 2,232
Net unrealized gain on securities -- -- -- (7,276) -- (7,276)
Cumulative translation adjustment -- -- -- 6 -- 6
Net loss -- -- -- -- (40,070) (40,070)
------------------------------------------------------------------------------------------------------------------------------------
Balances, March 31, 2000 $ 216 $ 181,683 $ (5,640) $ (1,349) $ 11,064 $ 185,974
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
Page 29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business Network Equipment Technologies, Inc., doing business as
net.com ("net.com"), headquartered in Fremont, California, is a leading
designer, developer, manufacturer and supplier of multiservice wide area
networks and associated services used by enterprises, government organizations
and carriers worldwide.
Principles of Consolidation The Consolidated Financial Statements include the
accounts of net.com and its wholly owned subsidiaries. Intercompany accounts and
transactions have been eliminated.
Revenue Recognition net.com recognizes revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the price is fixed or determinable
and collectibility is reasonably assured. Service and other revenue includes
revenue from service contracts, which is recognized ratably over the contract
period, and revenue from other services, such as systems integration,
installation and training, which is recognized when the service is performed.
Product warranty cost are accrued when revenue is recognized.
Cash and Cash Equivalents Cash and cash equivalents include highly liquid
investments with original maturities of three months or less at the time of
acquisition.
Temporary Cash Investments Temporary cash investments are primarily composed of
highly liquid investments with original maturities of greater than three months
at the time of acquisition.
Inventories Inventories are stated at lower of cost (first-in, first-out) or
market and include material, labor and manufacturing overhead costs. Inventories
at March 31 consisted of the following:
(Dollars in thousands) 2000 1999
--------------------------------------------------------------------------------
Purchased components $ 2,866 $ 3,728
Work-in-process 13,868 13,168
Finished goods 957 2,297
--------------------------------------------------------------------------------
$17,691 $19,193
================================================================================
Property and Equipment Property and equipment are stated at cost. Depreciation
is computed using the straight-line method over estimated useful lives of
generally three to ten years. Leasehold improvements are amortized over the
shorter of the respective lease terms or estimated useful lives.
Software Production Costs Capitalization of software production costs begins
upon the establishment of technological feasibility for the products, and
amortization begins when the products are available for release to customers.
net.com assesses the recoverability of capitalized software production costs in
light of many factors, including anticipated future revenues, estimated economic
useful lives and changes in software and hardware technologies. Capitalization
of software production costs amounted to $1.8 million, $3.4 million and $3.2
million in fiscal 2000, 1999 and 1998, respectively. Software production costs
are amortized over the lives of the products, generally three years.
Amortization amounted to $3.1 million, $2.7 million and $2.3 million in fiscal
2000, 1999 and 1998, respectively. During fiscal 2000, net.com reduced fully
amortized software production costs by $792,000, which had no effect on net
balances. Accumulated amortization was $7.9 million, $5.7 million and $8.3
million at March 31, 2000, 1999 and 1998, respectively.
Goodwill and Intangibles Goodwill and intangibles represent the excess of cost
over the fair value of tangible net assets acquired and are amortized over five
years using the straight-line method. Accumulated amortization was $801,000 at
March 31, 2000.
Foreign Currency Translation The functional currency for net.com's foreign
subsidiaries is the local currency. Assets and liabilities of foreign
subsidiaries are translated into dollars at the rates of exchange in effect at
Page 30
<PAGE>
the end of the period. Revenues and expenses are translated into dollars at the
average exchange rate during the period. Gains and losses from foreign currency
translation are included in a separate account in stockholders' equity in the
Consolidated Balance Sheets or included in the Consolidated Statements of
Operations and have not been significant. net.com enters into foreign exchange
contracts to hedge certain intercompany balances and balance sheet exposures
against future movements in foreign exchange rates. Gains and losses on foreign
exchange contracts are included in other income and expense, which offset
foreign exchange gains or losses from revaluation of foreign
currency-denominated intercompany balances and balance sheet exposure items. At
March 31, 2000, net.com had no outstanding foreign exchange contracts.
Stock Based Compensation net.com accounts for employee stock-based compensation
using the intrinsic value method in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and,
accordingly, does not generally recognize compensation cost in connection with
its stock option and purchase plans.
Comprehensive Income In fiscal 1999, net.com adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which
requires an enterprise to report, by major components and as a single total, the
change in net assets during the period from non-owner sources. Statements of
comprehensive income (loss) for the years ended March 31, 2000, 1999 and 1998
have been included within the Consolidated Statement of Operations. Cumulative
comprehensive income (loss) at March 31, 2000 and 1999 is comprised of
cumulative foreign translation adjustments of ($802,000) and ($808,000),
respectively, and cumulative net unrealized gains (losses) on available-for-sale
securities of ($547,000) and $6.7 million, respectively.
Financial Statement Estimates The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Such management estimates include, but are not
limited to, the allowances for potentially uncollectible accounts receivable,
the valuation of inventory, the valuation allowance on deferred tax assets,
lease recourse obligation and certain reserves and accruals.
Credit Risks net.com's credit evaluation process and the reasonably short
collection terms help to mitigate credit risk. net.com typically does not
require collateral or other security to support accounts receivable. While
net.com does maintain allowances for potential credit losses, actual bad debt
losses have not been material or outside of management's expectations.
Recently Issued Accounting Standards In June 1998, the Financial Accounting
Standards Board adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", which requires that all derivative instruments be recorded
on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in the current earnings or other
comprehensive income, depending on whether a derivative is designed as part of a
hedge transaction and, if it is, the type of hedge transaction. This statement
is effective for net.com beginning April 1, 2001, with earlier application
permitted. net.com believes that this statement will not have a significant
impact on net.com's consolidated financial position, results of operations or
cash flows.
In December 1999, the SEC issued Staff Accounting Bulletin (SAB) No. 101,
"Revenue Recognition in Financial Statements" which summarizes certain of the
SEC staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. net.com believes that its revenue
recognition policy complies with the provisions of SAB No. 101.
Facility Relocation Costs In April 1997, net.com entered into a 12-year
operating lease agreement for the construction of a new corporate headquarters
in Fremont, California. The new facilities were built to net.com's specification
and serve as home to its marketing, engineering, manufacturing and
administrative staff. Related to the project management, design and construction
of this new facility, net.com has expended $1.2 million and $11.6 million, net
of landlord contributions, in fiscal 1999 and 1998, respectively, all of which
has been capitalized. Other than expenditures relating to the ground water
intrusion problem discussed in Note 6 to the Consolidated Financial Statements,
net.com believes that there are no further significant expenditures to be
incurred related to this project.
Page 31
<PAGE>
NOTE 2: TEMPORARY CASH INVESTMENTS
net.com classifies its temporary cash investments as available-for-sale
securities. The carrying value of such securities is adjusted to fair market
value, with unrealized gains and losses, net of deferred taxes, being excluded
from earnings and reported as a separate component of stockholders' equity.
Temporary cash investments at March 31 consisted of the following:
<TABLE>
<CAPTION>
2000
-----------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(Dollars in thousands) Cost Gains Losses Value
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. government and municipalities $ 32,148 $ -- $ (143) $ 32,005
Corporate notes and bonds 38,453 -- (192) 38,261
Equity securities -- -- -- --
Other debt securities 19,714 3 (164) 19,553
Foreign debt issues 7,088 -- (5) 7,083
--------------------------------------------------------------------------------------------
$ 97,403 $ 3 $ (504) $ 96,902
============================================================================================
<CAPTION>
1999
-----------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(Dollars in thousands) Cost Gains Losses Value
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. government and municipalities $ 75,021 $ 220 $ (12) $ 75,229
Corporate notes and bonds 21,437 38 (21) 21,454
Other debt securities 25,955 45 (5) 25,995
Foreign debt issues 6,537 8 (3) 6,542
Equity securities 1,625 9,998 -- 11,623
--------------------------------------------------------------------------------------------
$ 130,575 $ 10,309 $ (41) $ 140,843
============================================================================================
</TABLE>
At March 31, 2000, net.com held unregistered equity securities in a privately
held company which are recorded at cost of $1.1 million and are classified in
Other Assets in the Consolidated Balance Sheet.
At March 31, 2000, the estimated market value of available-for-sale securities
with maturities less than one year was $44.8 million, with maturities between
one year and five years was $50.7 million and with maturities between five years
and ten years was $1.4 million. Any gains or losses on sales of securities are
computed on a specific identification basis. In fiscal 2000 and 1999, there were
realized gains on the sale of equity securities of $7.2 million and $1.0
million, respectively. There were no material realized gains or losses from the
sale of securities in fiscal year 1998.
NOTE 3: ACCRUED LIABILITIES
Accrued liabilities at March 31 were as follows:
(Dollars in thousands) 2000 1999
--------------------------------------------------------------------------------
Accrued compensation $ 8,517 $15,113
Taxes payable 7,365 6,648
Unearned income 4,794 4,735
Restructure costs 7,513 4,158
Other 11,791 12,984
--------------------------------------------------------------------------------
$39,980 $43,638
================================================================================
Page 32
<PAGE>
NOTE 4: RESTRUCTURE COSTS
Fourth Quarter Fiscal Year 1999 Restructuring The Consolidated Statements of
Operations for fiscal 1999 included a charge of $4.7 million, consisting of $4.6
million for employee severance and other related costs and $135,000 for office
closures. A restructuring provision of $1.0 million remains as of March 31,
2000. net.com expects the provision will be paid in its entirety during fiscal
2001.
Restructure Paid Remaining
Charge To Date Charge
Compensation $ 3,964 $ 2,964 $ 1,000
Outplacement 97 597 --
Office closures 135 135 --
------- ------- -------
Totals $ 4,696 $ 3,696 $ 1,000
======= ======= =======
Second Quarter Fiscal Year 2000 Restructuring The Consolidated Statements of
Operations for fiscal 2000 included a charge of $3.4 million, consisting of $3.2
million for employee severance and other related costs and $174,000 for office
closures. A restructuring provision of $484,000 remains as of March 31, 2000.
net.com expects the provision will be paid in its entirety during fiscal 2001.
Restructure Paid Remaining
Charge To Date Charge
Compensation $ 2,912 $ 2,462 $ 450
Outplacement 266 266 --
Office closures 174 140 34
------- ------- -------
Totals $ 3,352 $ 2,868 $ 484
======= ======= =======
Fourth Quarter Fiscal Year 2000 Restructuring The Consolidated Statements of
Operations for fiscal 2000 included a charge of $12.2 million, consisting of
$7.3 million for employee severance and other related costs and $4.9 million for
office closures and other related costs. A restructuring provision of $6.0
million remains as of March 31, 2000. net.com expects the provision will be
substantially paid in its entirety during fiscal 2001.
Restructure Paid Remaining
Charge To Date Charge
Compensation $ 6,710 $ 4,973 $ 1,737
Outplacement 636 217 419
Office closures 4,869 996 3,873
------- ------- -------
Totals $12,215 $ 6,186 $ 6,029
======= ======= =======
In March 2000, net.com reversed $340,000 relating to prior restructuring charges
for the European operation.
NOTE 5: FINANCING ARRANGEMENTS
In fiscal year 2000 net.com maintained a secured $10.0 million line of credit.
Borrowings under this committed facility were available through May 2000 and
bear interest at the bank's base rate (which approximates prime). The terms of
the agreement require that net.com maintain $10.0 million on deposit with the
bank which has been presented as restricted cash in the Consolidated Balance
Sheets at March 31, 2000. There were no outstanding borrowings under the line of
credit agreement at March 31, 2000.
BancBoston Leasing and net.com have an agreement under which BancBoston Leasing
will provide lease financing to net.com's customers, with limited recourse of a
minimum of $5.0 million or 20% of the outstanding lease balance, whichever is
greater. In fiscal 2000 and 1999, net.com recognized $3.2 million and $5.0
million, respectively, as revenue related to sales to customers who obtained
financing from BancBoston Leasing. Although
Page 33
<PAGE>
the outstanding lease payments to BancBoston at March 31, 2000 totaled $6.9
million, net.com's recourse is limited to $5.0 million as discussed above.
NOTE 6: COMMITMENTS AND CONTINGENCIES
net.com leases its facilities under operating leases and certain equipment under
capital leases. The minimum future lease commitments under these leases as of
March 31, 2000, were as follows:
(Dollars in thousands) Operating Leases Capital Leases
--------------------------------------------------------------------------------
2001 $ 6,790 $ 154
2002 4,755 154
2003 3,936 50
2004 3,557 --
2005 3,557 --
After 2005 20,865 --
--------------------------------------------------------------------------------
Total 43,460 358
Less amount representing interest 33
--------------------------------------------------------------------------------
Present value of net minimum lease payments 325
Less current portion 139
--------------------------------------------------------------------------------
Long term portion 186
--------------------------------------------------------------------------------
Rental expense under operating leases was $7.2 million, $7.6 million and $7.9
million for fiscal years 2000, 1999 and 1998, respectively. In April 1997,
net.com entered into a 12-year operating lease agreement for a new headquarters
facility, in Fremont California.
In March 2000, net.com reached a settlement with its landlord and insurance
carrier over ground water intrusion problems in its Fremont headquarters
facility. Under the terms of this settlement, net.com will enter into a lease
with the current landlord for a new build-to-suit headquarters facility adjacent
to its current facility. As a result of the settlement of a ground water
intrusion problem in the Fremont facility, net.com will be leasing approximately
100,000 square feet less in Fremont beginning June 1, 2000; obligations relating
to the 100,000 square feet being evacuated have been excluded from the table
presented above. net.com believes substantially all of the costs of tenant
improvements and moving will be covered by the insurance proceeds.
NOTE 7: REDEEMABLE CONVERTIBLE SUBORDINATED DEBENTURES
In May 1989, net.com issued $75.0 million of 7 1/4% convertible subordinated
debentures due May 15, 2014, in an underwritten public offering, with net
proceeds of $72.8 million. Each debenture is convertible at the option of the
holder into Common Stock at $31.50 per share and is redeemable at the option of
net.com. The debentures are entitled to a sinking fund beginning May 15, 2000,
of $3.8 million annually, calculated to retire 70% of the debentures prior to
maturity. Any redemption or conversion of debentures prior to the date of the
sinking fund payment will reduce those payments. Previous redemptions have
satisfied the sinking fund requirement through May 15, 2012.
In fiscal 1991, net.com repurchased debentures in the face amount of $6.4
million. During fiscal 1996, net.com completed a partial call of its outstanding
debentures, reducing debenture principal by $35.1 million, of which $9.8 million
was redeemed and an additional $25.3 million was converted into shares of Common
Stock at a conversion price of $31.50 per share. In fiscal 1997, net.com
repurchased debentures in the face amount of $7.7 million.
In fiscal 1999, net.com repurchased debentures in the face amount of $1.1
million at a cost of $983,000 plus accrued taxes. Accordingly, net.com recorded
a $ 95,000 gain, net of taxes ($0.01 per diluted share), as an extraordinary
gain in the Consolidated Statements of Operations.
NOTE 8: CAPITAL STOCK
Stockholders' Rights Plan On July 12, 1999, the Board of Directors of net.com
voted to extend net.com's existing Stockholder Rights Plan for an additional 10
years. In addition, the Board voted to amend the Plan: 1) to
Page 34
<PAGE>
adjust the exercise price to $80.00 per one-one hundredth of a share of Series A
Preferred Stock; and 2) to adopt a Three Year Independent Director Evaluation
Provision or "TIDE provision" whereby a committee of independent directors of
net.com will review and evaluate the Rights Plan at least once every three years
to determine if it continues to be in the best interests of net.com and its
stockholders to maintain the Rights Plan in effect.
Under the plan, as amended, a preferred share purchase right ("Right") is
attached to each share of Common Stock. The Rights are exercisable only after a
person or group acquires beneficial ownership of 15% or more of net.com's Common
Stock or commences a tender or exchange offer that would result in 20% or more
of Common Stock ownership. Each Right initially entitles stockholders to buy one
one-hundredth (1/100) of a share of a new series of participating Preferred
Stock at an exercise price of $80.00. If net.com is acquired in a merger or
other transaction with a person or group, or sells 50% or more of its assets or
earning power to such a person or group, each Right not owned by such acquiring
person will entitle its holder to obtain on exercise of the Right a number of
the acquiring company's common shares having a market value at the time of twice
the Right's then-current exercise price. If a person or group acquires 15% or
more of net.com's outstanding Common Stock, each Right will entitle its holder
to obtain on exercise of the Right a number of shares of Common Stock (or
equivalent) having a market value of twice the Right's then-current exercise
price. After a person or group has acquired 15% of the outstanding shares of
Common Stock but before their acquisition of 50% or more of the Common Stock,
the Board of Directors may exchange one share of Common Stock or equivalent
fractions of Preferred Stock for each Right. net.com can redeem the Rights at
$.01 per Right at any time until the tenth day following the acquisition by a
person or group of 15% of net.com Common Stock. The Rights are also redeemable
thereafter in certain circumstances. The Rights expire on August 24, 2009,
unless earlier redeemed or exchanged.
Preferred Stock net.com has authorized 5,000,000 shares of $.01 par value
Preferred Stock. This stock, if issued, will carry liquidation preferences and
other rights, as determined by the Board of Directors. As of March 31, 2000, no
preferred shares were outstanding.
Reserved Stock As of March 31, 2000, net.com had reserved shares of its Common
Stock for the following purposes:
Reserved
--------------------------------------------------------------------------------
Stock option plans:
Outstanding (at $5.25 to $35.75 per share) 6,280,357
Available for grant 3,827,481
Convertible subordinated debentures 784,317
Employee Stock Purchase Plan 1,029,118
--------------------------------------------------------------------------------
Employee Stock Purchase Plan Under the Employee Stock Purchase Plan, net.com's
employees, subject to certain restrictions, may purchase shares of Common Stock
at a price equal to at least 85% of the lower of the fair market value of the
Common Stock at the beginning of the offering period or the end of each four
month period. During fiscal 2000, 1999 and 1998, 338,000, 285,000 and 163,000
shares were issued under this Plan, at weighted average prices of $6.60, $9.30
and $12.64 per share, respectively. During fiscal 1998, a new Employee Stock
Purchase Plan was approved, which replaced the prior plan. The offering period
under the new plan began May 1, 1998 and purchases will be made every four
months under the same terms previously in effect.
Stock Option And Restricted Stock net.com grants options to purchase shares of
its Common Stock and is authorized to award restricted shares of Common Stock
pursuant to the terms of its 1993 Stock Option Plan and 1997 Stock Option
Program (collectively "option plans"). Stock options generally become
exercisable ratably over a four-year period and expire after seven to ten years.
Options may be granted to officers, employees, directors and independent
contractors to purchase Common Stock at a price not less than 100% of the fair
market value at the date of grant. No restricted stock was awarded in fiscal
2000, 1999 or 1998. Previously issued restricted stock carries certain
restrictions on transferability, which lapse over the vesting period (generally
two to four years). As of March 31, 2000, 239,500 restricted shares at $.01 per
share have been awarded and issued, and net.com had the right to repurchase
1,750 shares from certain officers and employees at the original purchase price
of $.01 per share. Such rights expire ratably over the respective vesting
period. Related compensation expense totaled $15,000, $286,000 and $401,000 for
the years ended March 31, 2000, 1999 and 1998, respectively.
Page 35
<PAGE>
Activity in net.com's option plans is summarized below:
<TABLE>
<CAPTION>
Weighted Weighted
Average Number Average
Shares Exercise Price Exercisable Exercise Price
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Options outstanding at March 31, 1997 3,577,247 $12.00 1,149,338 $ 9.46
-------------------------------------------------------------------------------------------------------------------
Granted 1,835,059 13.87
Exercised (242,185) 9.55
Cancelled (473,652) 13.46
-------------------------------------------------------------------------------------------------------------------
Options outstanding at March 31, 1998 4,696,469 12.68 1,861,651 11.11
-------------------------------------------------------------------------------------------------------------------
Granted 2,970,007 12.72
Exercised (273,845) 9.50
Cancelled (2,445,751) 15.88
-------------------------------------------------------------------------------------------------------------------
Options outstanding at March 31, 1999 4,946,880 11.28 2,180,545 11.62
-------------------------------------------------------------------------------------------------------------------
Granted 3,528,151 9.36
Exercised (193,835) 9.05
Cancelled (2,000,839) 10.54
-------------------------------------------------------------------------------------------------------------------
Options outstanding at March 31, 2000 6,280,357 10.51 2,697,106 11.49
-------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table summarizes information concerning options outstanding and
exercisable as of March 31, 2000
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------------- ---------------------------------
Weighted
Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 5.25 - $8.81 1,362,371 7.25 $ 8.04 533,324 $ 7.61
$ 8.88 - $9.94 1,286,814 8.87 $ 9.64 135,602 $ 9.43
$10.00 - $10.25 1,677,073 9.22 $10.20 407,698 $10.25
$10.38 - $12.38 1,630,102 6.55 $11.91 1,367,187 $11.98
$12.75 - $35.75 323,997 6.81 $18.93 253,295 $20.13
------------------------------------------------------------------------------------------------------------------
$5.25 - $35.75 6,280,357 7.90 $10.51 2,697,106 $11.49
==================================================================================================================
</TABLE>
During the third quarter of fiscal 1999, net.com approved a cancellation and
regrant program for outstanding options under net.com's stock option plans.
Under the program, holders of outstanding options granted after July 24, 1996,
with exercise prices in excess of $10.25 per share were given the choice of
retaining these options or of obtaining in substitution repriced options for the
same number of shares. The repriced options are exercisable at a price of $10.25
per share, the fair market value of the Common Stock on the regrant date. The
repriced options have a vesting schedule identical to the cancelled options, but
beginning anew on the date of regrant.
Stock Based Compensation As discussed in Note 1 to the Consolidated Financial
Statements, net.com continues to account for its stock-based compensation using
the intrinsic value method in accordance with APB 25 and, accordingly, does not
recognize compensation expense for employee stock plans as they are granted at
fair market value. However, SFAS 123, "Accounting for Stock Based Compensation"
requires disclosure of pro forma net income and earnings per share had net.com
adopted the fair value method as prescribed by SFAS 123. Under SFAS 123, the
fair value of stock-based awards is calculated through the use of option pricing
models, even though such models were developed to estimate the fair value of
freely tradable, fully transferable options without vesting restrictions, which
significantly differ from net.com's stock-based awards. These models also
require subjective assumptions, including future stock price volatility and
expected time to exercise, which greatly affect the calculated values. As
net.com's employee stock-based compensation plans have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate,
net.com believes that the existing option valuation models do not necessarily
provide a reliable measure of the fair value of awards from those plans.
Page 36
<PAGE>
If the computed fair values of the awards had been amortized to expense over the
vesting period of the awards, pro forma net income (loss) and earnings (loss)
per share would have been ($44.8) million (($2.08) per diluted share), ($12.8)
million (($0.27) per diluted share) and $8.0 million ($0.36 per diluted share)
in fiscal 2000, 1999 and 1998, respectively.
net.com's calculations for option grants were made using the Black-Scholes
option pricing model with the following weighted average assumptions for fiscal
2000, 1999 and 1998, respectively: risk free rates of 6.4%, 5.3% and 6.1%; stock
price volatility factors of 56%, 56% and 50%; expected option lives of three
months, four months and three months following vesting; and no dividends during
the expected term. net.com's calculations are based on a multiple option
valuation approach and forfeitures are recognized as they occur. The weighted
average fair value of options granted during fiscal 2000, 1999 and 1998 was
approximately $3.63, $4.86 and $5.08, respectively. The fair value of the
employee purchase rights under the Employee Stock Purchase Plan was estimated
using the same model, but with the following weighted average assumptions for
fiscal 2000, 1999 and 1998, respectively: risk free rate of 6.0%, 5.1% and 5.5%;
stock price volatility factor of 60%, 60% and 48%; and expected option life of
four months, four months and six months. The weighted average fair value of
purchase rights granted in fiscal 2000, 1999 and 1998 was approximately $2.82,
$3.69 and $4.76, respectively.
NOTE 9: INCOME TAXES
net.com accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109, which prescribes an asset and liability method of
income tax accounting.
Income before income taxes and the provision (benefit) for income taxes consist
of the following:
<TABLE>
<CAPTION>
(Dollars in thousands) 2000 1999 1998
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income (loss) before income taxes:
Domestic $ (18,835) $ (13,217) $ 16,135
Foreign (8,464) (1,479) 4,968
-------------------------------------------------------------------------------------------------------------------
$ (27,299) $ (14,696) $ 21,103
===================================================================================================================
Provision (benefit) for income taxes:
Current:
Federal $ (2,045) $ 1,067 $ 6,310
State 3 (144) 1,760
Foreign 250 (338) 1,101
-------------------------------------------------------------------------------------------------------------------
(1,792) 585 9,171
-------------------------------------------------------------------------------------------------------------------
Deferred:
Federal 10,749 (4,286) (1,591)
State 3,814 (3,941) (827)
Foreign -- -- --
-------------------------------------------------------------------------------------------------------------------
14,563 (8,227) (2,418)
--------------------------------------------------------------------------------------------------------------------
$ 12,771 $ (7,642) $ 6,753
===================================================================================================================
</TABLE>
The provision (benefit) for income taxes reconciles to the amount computed by
applying the statutory U.S. federal rate of 35% to income before income taxes as
follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 2000 1999 1998
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory federal tax provision $ (9,555) $ (5,144) $ 7,386
State taxes net of federal income tax benefit (3) (284) 823
Goodwill 588 -- --
Research and Development credit (968) -- --
Change in valuation allowance 24,153 -- (1,044)
Foreign sales corporation benefit -- (316) (913)
Exempt interest income (336) (1,260) (745)
Other (1,108) (638) 1,246
-------------------------------------------------------------------------------------------------------------------
Provision (benefit) for income taxes $ 12,771 $ (7,642) $ 6,753
===================================================================================================================
</TABLE>
Page 37
<PAGE>
Deferred tax assets (liabilities) are comprised of the following at March 31:
(Dollars in thousands) 2000 1999
--------------------------------------------------------------------------------
Gross deferred tax assets:
Reserves not currently deductible for tax purposes $ 8,937 $ 9,009
Loss carryforwards 9,696 292
Credit carryforwards 14,384 13,771
--------------------------------------------------------------------------------
Gross deferred tax assets 33,017 23,072
Gross deferred tax liabilities:
Depreciation (7,041) (884)
Capitalized software production costs (1,823) (4,126)
Unrealized gain on securities -- (3,499)
--------------------------------------------------------------------------------
Gross deferred tax liabilities (8,864) (8,509)
Valuation allowance (24,153) --
--------------------------------------------------------------------------------
Net deferred tax assets $ -- $ 14,563
================================================================================
The valuation allowance increased $24.2 million in fiscal 2000. The increase
resulted from management's evaluation of the positive and negative evidence
bearing upon the realization of its deferred tax assets. Under the applicable
accounting standards, management considered the history of losses and concluded
that it was appropriate to fully reserve the deferred tax assets.
As of March 31, 2000, net.com has available federal research and development tax
credit carryforwards of $6.0 million expiring in years 2006 through 2021, and
alternative minimum tax credit carryforwards of $3.6 million available
indefinitely. Also available at March 31, 2000 are state research and
development tax credit carryforwards of $4.8 million, also available
indefinitely.
As of March 31, 2000 net.com has available Net Operating Loss ("NOL")
carryforwards of $6.25 million expiring in year 2020. In addition, net.com has
available California NOL carryforwards of $0.9 million expiring in year 2020.
net.com has NOL carryforwards of $1.9 million for its U.K. subsidiary available
indefinitely, also we have NOL carryforwards of $0.6 million for our French
subsidiary expiring in year 2005.
NOTE 10: EARNINGS (LOSS) PER SHARE
Basic earnings per share ("EPS") excludes dilution and is computed based upon
the weighted average number of common shares outstanding for the periods
presented. Diluted earnings per share reflects the potential dilution that could
occur if Common Stock options were exercised. Potentially dilutive common shares
in the diluted EPS computation are excluded in net loss periods as their effect
would be antidilutive. Such outstanding securities totaled 6,280,357 at March
31, 2000. Additionally, there were 784,000 shares of Common Stock issuable upon
conversion of debentures. These shares, and the related effect of accrued
interest expense on the debentures, were not included in the calculation of
diluted earnings per share for any of the years presented, as their inclusion
would have been antidilutive.
Page 38
<PAGE>
2000 1999 1998
--------------------------------------------------------------------------------
Numerator:
Income (loss) before extraordinary gain $(40,070) $ (7,054) $ 14,350
Net income (loss) $(40,070) $ (6,959) $ 14,350
Denominator:
Weighted average shares outstanding--basic 21,489 21,508 21,246
Dilutive effect of options -- -- 788
--------------------------------------------------------------------------------
Total Diluted 21,489 21,508 22,034
Basic earnings (loss) per share:
Income (loss) before extraordinary gain $ (1.86) $ (0.33) $ 0.68
Net income (loss) $ (1.86) $ (0.32) $ 0.68
Diluted earnings (loss) per share:
Income (loss) before extraordinary gain $ (1.86) $ (0.33) $ 0.65
Net income (loss) $ (1.86) $ (0.32) $ 0.65
NOTE 11: SIGNIFICANT CUSTOMERS
Sales to the U.S. government and its agencies amounted to 50%, 38% and 33% of
revenue for fiscal years 2000, 1999 and 1998, respectively. These amounts
include sales, which amounted to 39%, 24% and 30% of revenue for fiscal years
2000, 1999 and 1998, respectively, under contracts with the Department of
Defense ("DoD"). Under these DoD contracts various government agencies both
inside and outside the DoD can order products, installation and service from
net.com. net.com had no other customers that accounted for more than 10% of
revenue during these same periods.
NOTE 12: SEGMENT INFORMATION
net.com operates in one segment: the design, development, manufacture and sale
of multiservice wide area networks and associated services used by enterprises,
government organizations and carriers worldwide. net.com follows the
requirements of SFAS 131, "Disclosures about Segments of an Enterprise and
Related Information". In January 2000, net.com reorganized its business around
two product lines; narrowband and broadband products. Operating results of these
two product lines have been aggregated as there have been no revenues generated
from the broadband products as of March 31, 2000. Following is operating
information by geographic territory for fiscal 2000, 1999 and 1998:
(DOLLARS IN THOUSANDS)
United United Other
2000 States Kingdom International Eliminations Totals
--------------------------------------------------------------------------------
Product $ 72,195 $13,989 $33,223 $ (3,266) $116,141
Service and other 92,251 12,132 4,974 188 109,545
------------------------------------------------------------
Total revenue $164,446 $26,121 $38,197 $ (3,078) $225,686
Long-lived assets $ 82,097 $ 2,558 $ 561 $(13,243) $ 71,973
--------------------------------------------------------------------------------
United United Other
1999 States Kingdom International Eliminations Totals
--------------------------------------------------------------------------------
Product $ 94,833 $26,416 $39,660 $ (3,790) $157,119
Service and other 88,071 14,244 4,563 (162) 106,716
------------------------------------------------------------
Total revenue $182,904 $40,660 $44,223 $ (3,952) $263,835
Long-lived assets $ 87,644 $ 4,885 $ 1,058 $(12,956) $ 80,631
--------------------------------------------------------------------------------
Page 39
<PAGE>
United United Other
1998 States Kingdom International Eliminations Totals
--------------------------------------------------------------------------------
Product $101,398 $31,832 $64,545 $ 2,424 $200,199
Service and other 90,168 16,429 2,265 (340) 108,522
------------------------------------------------------------
Total revenue $191,566 $48,261 $66,810 $ 2,084 $308,721
Long-lived assets $ 71,111 $ 5,758 $ 287 $(12,618) $ 64,538
--------------------------------------------------------------------------------
Total revenues are based on the country from which customers are invoiced.
NOTE 13: EMPLOYEE BENEFIT PLAN
net.com has established a 401(k) tax-deferred savings plan, whereby eligible
employees may contribute a percentage of their eligible compensation (presently
from 1% to 17% to a maximum of $10,000 per year). Company contributions are
discretionary and were $1.3 million, $1.1 million and $961,000 for fiscal 2000,
1999 and 1998, respectively.
NOTE 14: FINANCIAL INSTRUMENTS FAIR VALUE DISCLOSURE
The estimated fair values of net.com's financial instruments at March 31 were as
follows:
<TABLE>
<CAPTION>
2000 1999
-------------------- ----------------------
Carrying Estimated Carrying Estimated
(Dollars in thousands) Amount Fair Value Amount Fair Value
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets
Cash and cash equivalents $28,024 $28,024 $ 13,720 $ 13,720
Temporary cash investments $96,902 $96,902 $140,843 $140,843
Equity securities $ 1,103 $ 1,103 $ 1,103 $ 1,103
Liabilities
Convertible subordinated debentures $24,706 $17,294 $ 24,706 $ 19,765
------------------------------------------------------------------------------------------
</TABLE>
The following methods and assumptions were used in estimating the fair values of
financial instruments:
Cash and cash equivalents--the carrying amounts reported in the balance sheets
for cash and cash equivalents approximate their estimated fair values due to
their short maturities.
Temporary cash investments and convertible subordinated debentures--fair values
are based on quoted market prices.
The equity instrument held is in a privately held company. Due to there being no
stated market value for the equity, it is being held and recorded at cost.
Management at this time believes there to be no impairment to this asset.
NOTE 15: ACQUISITION OF FLOWWISE NETWORKS, INC.
In December 1999, net.com completed the acquisition of FlowWise Networks, Inc.
("FlowWise"). The acquisition was accounted for as a purchase. net.com paid
approximately $15.4 million in cash for all FlowWise common and preferred shares
outstanding plus investment banking, accounting and legal fees of approximately
$800,000. net.com also placed $6.6 million in an escrow account for payments to
FlowWise employees who agree to remain as net.com employees for a period of two
years beginning January 2000. These amounts will be paid out and recorded as
compensation expense over the course of the two years. net.com recorded a one
time charge of $879,000 in the third quarter of fiscal year 2000 for purchased
in-process technology that had not reached technological feasibility and had no
alternative future use. The remaining portion of the purchase price that
exceeded the net assets of
Page 40
<PAGE>
FlowWise, a total of $16 million, was recorded as goodwill and other intangibles
that will be amortized on a straight line basis over five years.
The operating results of FlowWise have been included in the consolidated
statements of operations since the date of acquisition. Had the acquisition
taken place at the beginning of fiscal year 1999, the unaudited pro forma
results of operations would have been as follows for fiscal years 2000 and 1999
(in thousands except for per share data):
Years ended Mar 31,
2000 1999
-----------------------------
Net revenues $ 226,086 $ 263,983
Net loss $ (51,929) $ (20,836)
Basic and diluted loss per share $ (2.42) $ (0.97)
The pro forma results of operations give effect to certain adjustments,
including amortization of purchased intangibles, interest associated with
funding the acquisition and amortization of the amount placed in escrow for
payment to FlowWise employees. The $879,000 charge for purchased in-process
technology has been excluded from the pro forma results, as it is a material
non-recurring charge.
In determining the fair value of the assets and liabilities acquired from
FlowWise, management has made estimates and assumptions that affect the reported
amounts of FlowWise assets, liabilities and expenses. Actual results could
differ from these amounts.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
Page 41
<PAGE>
PART III
Certain information required by Part III is omitted from this Form 10-K because
net.com will file its definitive proxy statement (the "Proxy Statement")
pursuant to Regulation 14A within 120 days after the end of its fiscal year
covered by this Report, and certain information included in the Proxy Statement
is incorporated by reference into this Part III.
Item 10. Directors and Executive Officers of Registrant
Information regarding net.com's Directors and Executive Officers is contained in
the sections captioned "Election of Directors: Directors" in the Proxy Statement
is incorporated herein by reference.
Executive Officers of the Company
The Executive Officers of net.com and their ages at June 1, 2000 are as follows:
Name Age Position
Hubert A.J. Whyte 49 President and Chief Executive Officer
John C. Batty 45 Senior Vice President and Chief Financial Officer
Mary Ann Moran 43 Vice President, General Counsel and Corporate Secretary
Hans Kramer 38 Vice President and General Manager, Broadband
Craig W. Forbes 38 Vice President Marketing and General Manager, Narrowband
Hubert A.J. Whyte joined net.com as President and Chief Executive Officer on
June 1, 1999. From 1994 until he joined net.com, Mr. Whyte served as President
and CEO of Advanced Computer Communications ("ACC"), where he created a new
vision and strategy for the company, successfully restructured the organization
and almost doubled annual revenues before initiating the acquisition of ACC by
Ericsson for approximately $290 million. Prior to joining ACC, Mr. Whyte served
as Vice President and General Manager of the Access Products unit of Newbridge
Networks Corporation. Earlier in his career, Mr. Whyte gained industry
experience with British Telecom, Ericsson, Shell Oil, Business Intelligence
Services, Mitel and Siemens.
John C. Batty joined net.com in December 1999 as Vice President and Chief
Financial Officer. He has a 20-year background in high-technology, including
strong experience in telecommunications, specifically in wide area networks,
net.com's core business. Prior to joining net.com, Batty was Vice President of
Finance and Chief Financial Officer of Verilink. Prior to Verilink, Mr. Batty
spent eleven years at VLSI as Controller, Director of Corporate Financial
Planning and finally as Vice President and Treasurer prior to its acquisition by
Phillips Semiconductor. He earned his B.A. in Economics at the University of New
Hampshire and his M.B.A. at the University of Chicago School of Business. He
began his career with Intel.
Mary Ann Moran has been with net.com since March 1996. In July 1999, she was
promoted to her current position of Vice President, General Counsel and
Corporate Secretary. Before joining net.com, Ms. Moran was General Counsel of
West Coast Video, now known as MediaCopy, a company in the home video industry
where she was responsible for negotiating deals with major movie studios. She
received her undergraduate degree Summa Cum Laude from the University of San
Francisco, and her degree in law Cum Laude from the University of California's
Hastings College of Law, in San Francisco, where she was on the Law Review.
Hans Kramer joined net.com in 1988 and became Vice President of Product
Development in 1999. Mr. Kramer was appointed Vice President and General Manager
of the Broadband Business Unit in January 2000. He joined net.com after working
for a series of start-up companies in the communications industry, including
Macom LinkABit, now a part of the Hughes Network, where he was the project
leader for a VSAT product. Mr. Kramer received his B.A. in Computer Science from
the University of California at San Diego, with dual minors in Economics and
Queuing Systems.
Page 42
<PAGE>
Craig W. Forbes joined N.E.T. Federal, Inc., a wholly owned subsidiary of
net.com, in 1988. He was appointed to the position of Vice President of
Marketing in July 1999, taking an active role in the new management team's
effort to revitalize and redirect the company, with a focus on opportunities in
emerging technologies, without abandoning its core customer base worldwide. In
January 2000, he was appointed to the position of Vice President Marketing and
General Manager, Narrowband and now directs net.com's overall marketing efforts
while leading the company's narrowband business in support of its existing
customer base. Mr. Forbes has a Bachelor of Science degree in Electrical
Engineering from Bucknell University. From 1984 until he joined N.E.T. in 1988,
he was an officer in the United States Air Force.
Item 11. Executive and Director Compensation
Information regarding compensation of net.com's Directors and Executive Officers
is contained in the sections captioned "Election of Directors: Board Committees,
Meetings, and Remuneration" and "Executive Compensation and Related Information"
in the Proxy Statement, which sections are incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information regarding security ownership of certain beneficial owners and
management from the section captioned "Stock Ownership of Five Percent
Stockholders, Directors, and Corporate Officers" in the Proxy Statement is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
Information regarding transactions with net.com's Directors and Executive
Officers from the sections captioned "Election of Directors: Board Committees,
Meetings, and Remuneration" in the Proxy Statement and "Executive Compensation
and Related Information" in the Proxy Statement is incorporated herein by
reference.
Page 43
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description Note
----------- ----------- ----
<S> <C> <C>
3.1 Registrant's Restated Certificate of Incorporation, as amended. 1
3.2 Registrant's Bylaws, as amended. 1
4.1 Indenture dated as of May 15, 1989 between Registrant and Morgan Guaranty 2
Trust Company of New York.
4.2 Rights Agreement dated as of August 15, 1989 between Registrant and The First 3
National Bank of Boston, as amended.
4.3 Certificate of Designations of Series A Junior Participating Preferred Stock 4
filed with the Secretary of State of Delaware on August 24, 1989 (Exhibit 4.1
in the Registrant's Form S-8 Registration Statement).
10.1 Headquarters Facilities Lease Agreements between Sobrato Interests III and 5
Network Equipment Technologies, Inc. dated April 9, 1997.
10.2 Officer Employment and Continuation Agreement between Registrant and Joseph 6
J. Francesconi.
10.3 Officer Employment and Continuation Agreement between Registrant and G. 6
Michael Schumacher.
10.4 Officer Employment and Continuation Agreement between Registrant and Raymond 6
E. Peverell.
10.5 Officer Employment and Continuation Agreement between Registrant and Roger A. 6
Barney.
10.6 Officer Employment and Continuation Agreement between Registrant and Hubert 6
A. Whyte.
10.7 General Release of All Claims, Covenant Not to Sue, and Confidentiality 6
Agreement between Registrant and Joseph J. Francesconi.
10.8 Employment Agreement between Registrant and Walter J. Gill. 7
10.9 Change of Control Agreement between Registrant and John C. Batty.
10.10 Change of Control Agreement between Registrant and Craig W. Forbes.
10.11 Change of Control Agreement between Registrant and Hans Kramer.
10.12 Change of Control Agreement between Registrant and Mary Ann Moran.
10.13 Change of Control Agreement between Registrant and Hubert A.J. Whyte
</TABLE>
Page 44
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
10.14 Form of Officer Employment and Continuation Agreement as signed by all other 7
Executive Officers and Registrant.
10.15 Form of Director Indemnification Agreement as signed by all Directors of the 7
Company.
10.16 Form of Officer Indemnification Agreement as signed by all Executive Officers 7
of the Company.
10.17 Corporate Director Compensation Deferral Election Program and 1996 Deferral 7
Form.
10.18 Corporate Officer Compensation Deferral Election Program and 1996 Deferral 7
Form.
10.19 Corporate Officers Long-Term Variable Compensation Program. 7
10.20 Agreement and Plan of Merger dated as of December 14, 1999 by and among 8
Network Equipment Technologies, Inc., IPNow, Inc., and FlowWise Networks,
Inc.
13 Portions of 2000 Annual Report to Stockholders.
21.1 Subsidiaries of Registrant as of June 29, 2000.
23.1 Independent Auditors' Consent.
27 Financial Data Schedule.
99.1 Registrant's 1983 Stock Option Plan, as amended. 9
99.2 Registrant's 1988 Restricted Stock Award Plan. 10
99.3 Registrant's 1990 Employee Stock Purchase Plan, as amended. 11
99.4 Registrant's 1993 Stock Option Plan, as amended (Exhibit 99.3). 12
99.5 Registrant's 1997 Stock Option Program, as amended (Exhibit 99.2). 12
99.6 Registrant's 1998 Employee Stock Purchase Plan (Exhibit 99.1). 12
</TABLE>
Page 45
<PAGE>
NOTES
(1) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Form 10-Q (Commission File No. 0-15323) for the fiscal
quarter ended December 24, 1995, originally filed with the Securities and
Exchange Commission on February 7, 1996.
(2) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Form 8 Amendment No. 1 to Annual Report on Form 10-K
(Commission File No. 0-15323) for the fiscal year ended March 31, 1989,
filed with the Securities and Exchange Commission on July 25, 1989.
(3) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Annual Report on Form 10-K (Commission File No. 0-15323) for
the fiscal year ended March 31, 1990, filed with the Securities and
Exchange Commission on June 29, 1990.
(4) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Registration Statement on Form S-8 (Nos. 33-33013 and
33-33063), filed with the Securities and Exchange Commission on January
19, 1990.
(5) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Registration Statement on Form 10-K (Commission File No.
0-15323) for the fiscal year ended March 31, 1997, originally filed with
the Securities and Exchange Commission on June 23, 1997.
(6) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Annual Report on Form 10-K (Commission File No. 0-15323) for
the fiscal year ended March 31, 1999, filed with the Securities and
Exchange Commission on June 29, 1999.
(7) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Annual Report on Form 10-K (Commission file No. 0-15323) for
the fiscal year ended March 31, 1996, filed with the Securities and
Exchange Commission on June 21, 1996.
(8) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Current Report on Form 8-K (Commission file No. 0-15323),
filed with the Securities and Exchange Commission on January 10, 2000.
(9) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Annual Report on Form 10-K (Commission File No. 0-15323) for
the fiscal year ended March 31, 1993, filed with the Securities and
Exchange Commission on June 25, 1993.
(10) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Annual Report on form 10-K (Commission File No. 0-15323) for
the fiscal year ended March 31, 1991, filed with the Securities and
Exchange commission on June 28, 1991.
(11) Incorporated by reference from the corresponding Exhibit (or the Exhibit
identified in parentheses) previously filed as an Exhibit in the
Registrant's Registration Statement on Form S-8 (No. 33-68860), filed with
the Securities and Exchange Commission on September 15, 1993.
(12) Incorporated by reference from the corresponding Exhibit (or the
Exhibit identified in parentheses) previously filed as an Exhibit in
the Registrant's Registration Statement on Form S-8 (No. 333-49837),
filed with the Securities and Exchange Commission on April 10, 1998.
Page 46
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NETWORK EQUIPMENT TECHNOLOGIES, INC.
(Registrant)
Date: June 29, 2000 By: /s/ Hubert A.J. Whyte
Hubert A.J. Whyte
President, Chief Executive
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ John Batty Chief Financial Officer June 29, 2000
--------------------------- (Principal Financial Officer and
John Batty Principal Accounting Officer)
/s/ Dixon R. Doll Director June 29, 2000
---------------------------
Dixon R. Doll
/s/ James K. Dutton Director June 29, 2000
---------------------------
James K. Dutton
/s/ Walter J. Gill Director June 29, 2000
---------------------------
Walter J. Gill
/s/ Peter Sommerer Director June 29, 2000
---------------------------
Peter Sommerer
/s/ George M. Scalise Director June 29, 2000
---------------------------
George M. Scalise
/s/ Hubert A.J. Whyte President, Chief Executive June 29, 2000
--------------------------- Officer and Director
Hubert A.J. Whyte (Principal Executive Officer)
/s/ Hans A. Wolf Chairman of the Board June 29, 2000
---------------------------
Hans A. Wolf
Page 47
<PAGE>
INDEX TO FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
FINANCIAL STATEMENTS
Page in 2000
Form 10-K
---------
Independent Auditors' Report 25
Consolidated Balance Sheets as of March 31, 2000 and 1999 26
Consolidated Statements of Operations for the years ended
March 31, 2000, 1999 and 1998 27
Consolidated Statements of Comprehensive Income (Loss) for the
years ended March 31, 2000, 1999 and 1998 27
Consolidated Statements of Cash Flows for the years ended
March 31, 2000, 1999 and 1998 28
Consolidated Statements of Stockholders' Equity for the years
ended March 31, 2000, 1999 and 1998 29
Notes to Consolidated Financial Statements 30
----------
FINANCIAL STATEMENT SCHEDULE
Page in 2000 Form 10-K
----------------------
Independent Auditors' Report 49
Schedule II - Valuation and Qualifying Accounts 50
All other schedules are omitted because they are not required, are not
applicable, or the information is included in the Consolidated Financial
Statements or Notes thereto.
Separate financial statements of the Registrant are omitted because the
Registrant is primarily an operating company and all subsidiaries included in
the Consolidated Financial Statements filed, in the aggregate, do not have a
minority equity interest and/or long-term indebtedness to any person outside the
consolidated group in an amount which together exceeds 5% of total consolidated
assets at March 31, 2000.
Page 48
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Network Equipment Technologies, Inc.:
We have audited the consolidated financial statements of Network Equipment
Technologies, Inc. and subsidiaries as of March 31, 2000 and 1999, and for each
of the three years in the period ended March 31, 2000, and have issued our
report thereon dated April 18, 2000. Our audits also included the financial
statement schedule of Network Equipment Technologies, Inc. listed in the
accompanying index to financial statements and financial statement schedule. The
financial statement schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion based on our audits. In our opinion,
such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
San Jose, California
April 18, 2000
Page 49
<PAGE>
NETWORK EQUIPMENT TECHNOLOGIES, INC.
SCHEDULE II
Valuation and Qualifying Accounts
(in thousands)
<TABLE>
<CAPTION>
Balance at Charged to Charged Balance
beginning costs and to other Deduction/ at end
Description of period expenses accounts(1) write off of period
----------- --------- -------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
For the year ended
March 31, 1998:
Accounts receivable
allowances $3,910 -- $2,082 $(2,066) $3,926
For the year ended
March 31, 1999:
Accounts receivable
allowances $3,926 -- $4,679 $(5,230) $3,375
For the year ended
March 31, 2000:
Accounts receivable
allowances $3,375 -- $5,690 $(3,715) $5,350
</TABLE>
----------
(1) Amount represents additions to accounts receivable allowances that were
charged primarily to revenue.
Page 50
