SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
Amendment No. 1
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly period ended October 3, 1998
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition period from to
------ ------
Commission File Number 000-24918
---------
SHIVA CORPORATION
(Exact name of registrant as specified in its charter)
Massachusetts 04-2889151
------------------------------ ---------------------------------
State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
28 Crosby Drive, Bedford, MA 01730
(Address of principal executive offices, including Zip Code)
(781) 687-1000
(Registrant's telephone number, including area code)
____________________________
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES /X/ NO
The number of shares outstanding of the registrant's Common Stock
as of November 4, 1998 was 30,422,850
1
<PAGE>
RESTATEMENT OF FINANCIAL STATEMENTS AND CHANGES TO CERTAIN
INFORMATION
While responding to a comment letter received from the staff of
the Securities and Exchange Commission (the "SEC"), the Company
reviewed staff guidance issued on September 15, 1998 with respect
to the method used to value acquired in-process R&D associated
with the Company's acquisition of Isolation Systems Limited
("Isolation") in the first quarter of 1998. As a result of this
review, the Company has modified the method used to value such
acquired in-process R&D. Initial calculations to value the
acquired in-process R&D were based upon a methodology that
focused on the after-tax cash flows attributable to the
technology on an overall basis, without regard to the stage of
completion of individual projects, and the selection of an
appropriate rate of return to reflect the risk associated with
the stage of completion of the technology. Revised calculations
were based upon the methodology set forth in the SEC's September
1998 letter to the AICPA that requires consideration of the stage
of completion of the individual in-process R&D projects at the
date of acquisition. As a result of applying the revised
calculations, the Company has restated its financial statements
for the quarters ended April 4, July 4, and October 3, 1998 (See
Note 10 to the Company's consolidated financial statements).
This Quarterly Report on Form 10Q/A amends and restates items 1
and 2 of Part I and item 6 of Part II of the Company's Quarterly
Report on Form 10-Q previously filed for the quarter ended
October 3, 1998.
2
<PAGE>
<TABLE>
SHIVA CORPORATION
Consolidated Balance Sheet
(in thousands, except share related data)
<CAPTION>
October 3, January 3,
1998 1998
------------- ------------
(unaudited)
(As Restated-
See Note 10)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 28,662 $ 58,915
Short-term investments 39,353 36,868
Accounts receivable, net of allowances
of $8,718 at October 3, 1998 and
$8,037 at January 3, 1998 15,978 23,169
Inventories 12,694 14,058
Deferred income taxes 8,684 8,683
Prepaid expenses and other current assets 1,667 2,369
-------- --------
Total current assets 107,038 144,062
Property, plant and equipment, net 19,703 26,093
Deferred income taxes 15,046 8,840
Goodwill, net 29,090 -
Other assets 4,791 3,251
-------- --------
Total assets $175,668 $182,246
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 6,017 $ 9,376
Accrued expenses 29,300 22,304
Deferred revenue 4,969 4,068
-------- --------
Total current liabilities 40,286 35,748
-------- --------
Deferred income taxes 575 554
-------- --------
Total liabilities 40,861 36,302
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value;
1,000,000 shares authorized,
none issued - -
Common stock, $.01 par value;
100,000,000 shares authorized,
30,527,765 and 29,605,848 shares
issued at October 3, 1998 and
January 3, 1998, respectively 305 296
Additional paid-in capital 155,076 153,036
Treasury stock at cost, 106,115 shares
at October 3, 1998 (1,307) -
Unrealized gain on investments 227 110
Cumulative translation adjustment (200) (308)
Accumulated deficit (19,294) (7,190)
--------- ---------
Total stockholders' equity 134,807 145,944
--------- ---------
Total liabilities and stockholders'
equity $175,668 $182,246
======== =========
<FN>
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
SHIVA CORPORATION
Consolidated Statement of Operations
(in thousands, except per share data)
(unaudited)
<CAPTION>
Three months ended Nine months ended
-------------------------- --------------------------
October 3, September 27, October 3, September 27,
1998 1997 1998 1997
------------ ------------- ---------- -------------
(As Restated- (As Restated-
See Note 10) See Note 10)
<S> <C> <C> <C> <C>
Revenues:
Product $ 22,594 $ 29,117 $ 80,089 $ 88,083
Service 2,578 1,965 19,211 5,134
Licenses, royalties
and other 6,520 4,499 8,717 13,261
-------- -------- -------- --------
Total revenues 31,692 35,581 108,017 106,478
Cost of revenues:
Product 10,746 13,609 36,625 47,952
Service 1,343 1,710 11,575 4,955
-------- -------- -------- --------
Total cost of
revenues 12,089 15,319 48,200 52,907
-------- -------- -------- --------
Gross profit 19,603 20,262 59,817 53,571
-------- -------- -------- --------
Operating expenses:
Research and
development 6,402 6,937 15,623 18,676
Selling, general and
administrative 14,927 17,622 44,729 55,929
In-process research
and development - - 2,100 -
Goodwill amortization 2,911 - 5,819 -
Restructuring expenses 2,235 - 13,300 -
-------- -------- -------- --------
Total operating
expenses 26,475 24,559 81,571 74,605
-------- -------- -------- --------
Loss from operations (6,872) (4,297) (21,754) (21,034)
Interest income 810 887 2,824 2,787
Interest and other income
(expense), net 715 (26) 1,130 (294)
-------- --------- --------- ---------
Loss before income taxes (5,347) (3,436) (17,800) (18,541)
Income tax benefit (1,711) (1,306) (5,696) (7,045)
--------- --------- --------- ---------
Net loss $ (3,636) $ (2,130) $(12,104) $(11,496)
========= ========= ========= =========
Net loss per share -
basic and diluted $ (0.12) $ (0.07) $ (0.40) $ (0.39)
========= ========= ========= =========
Shares used in computing
net loss per share -
basic and diluted 30,394 29,387 30,175 29,165
========= ========= ========= =========
<FN>
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
SHIVA CORPORATION
Consolidated Statement of Cash Flows
Increase (Decrease) in Cash and Cash Equivalents
(in thousands)
(unaudited)
<CAPTION>
Nine Months Ended
-------------------------------
October 3, September 27,
1998 1997
------------ -------------
(As Restated -
See Note 10)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (12,104) $ (11,496)
Adjustments to reconcile net loss
to net cash provided by
operating activities:
In-process research and development 2,100 -
Depreciation and amortization 14,424 7,430
Non-cash restructuring charge 3,570 -
Deferred income taxes (5,759) (8,123)
Changes in assets and liabilities,
net of effects of acquisition:
Accounts receivable 8,066 14,633
Inventories 1,467 658
Prepaid expenses and other current
assets 768 (89)
Accounts payable (3,947) (3,285)
Accrued expenses 6,627 851
Deferred revenue 881 1,061
Other long-term liabilities - (17)
--------- ---------
Net cash provided by operating
activities 16,093 1,623
--------- --------
Cash flows from investing activities:
Purchases of property, plant and
equipment (3,529) (8,788)
Payments for acquisition (39,925) -
Capitalized software development costs (320) (889)
Purchases of short-term investments (32,367) (23,104)
Proceeds from maturity and sales of
short-term investments 29,999 16,309
Change in other assets (556) (2,176)
---------- ----------
Net cash used by investing activities (46,698) (18,648)
---------- ----------
Cash flows from financing activities:
Principal payments on long-term debt
and capital lease obligations (119) (344)
Purchases of treasury stock (1,307) -
Proceeds from exercise of stock options 1,601 2,014
---------- ----------
Net cash provided by financing
activities 175 1,670
---------- ----------
Effects of exchange rate changes on
cash and cash equivalents 177 223
---------- ----------
Net decrease in cash and cash
equivalents (30,253) (15,132)
Cash and cash equivalents, beginning
of period 58,915 72,067
---------- ----------
Cash and cash equivalents, end of
period $ 28,662 $ 56,935
========== ==========
<FN>
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
5
<PAGE>
SHIVA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements
include the accounts of the Company and its wholly-owned
subsidiaries, and have been prepared by the Company in accordance
with generally accepted accounting principles. In the opinion of
management, these unaudited consolidated financial statements
contain all adjustments necessary for a fair presentation of the
Company's financial position, results of operations and cash
flows at the dates and for the periods indicated. Such
adjustments are of a normal recurring nature, except for the
restructuring charges incurred during the three-month and nine-
month periods ended October 3, 1998 and the in-process R&D
charges incurred during the nine-month period ended October 3,
1998. While the Company believes that the disclosures presented
are adequate to make the information not misleading, these
consolidated financial statements should be read in conjunction
with the consolidated financial statements and related notes
included in the Company's Annual Report on Form 10-K for the
fiscal year ended January 3, 1998.
The results of operations for the three-month and nine-month
periods ended October 3, 1998 are not necessarily indicative of
the results expected for the full fiscal year.
2. EARNINGS PER SHARE:
The Company has adopted Statement of Financial Accounting
Standards (SFAS) No. 128, "Earnings per Share," and has restated
earnings per share amounts for all periods presented herein.
<TABLE>
<CAPTION>
Three months ended Nine months ended
------------------------- ---------------------------
October 3, September 27, October 3, September 27,
1998 1997 1998 1997
---------- ------------- ---------- -------------
(As Restated- (As Restated-
See Note 10) See Note 10)
<S> <C> <C> <C> <C>
Net loss ($3,636,000) ($2,130,000) ($12,104,000) ($11,496,000)
============ ============ ============= =============
Weighted average
shares outstanding 30,394,028 29,387,230 30,174,813 29,165,388
Common-equivalent
shares outstanding - - - -
------------ ------------ ------------- -------------
Weighted average and
common equivalent
shares outstanding 30,394,028 29,387,230 30,174,813 29,165,388
------------ ------------ ------------- -------------
Basic and diluted
net loss per share ($0.12) ($0.07) ($0.40) ($0.39)
============ ============ ============= =============
</TABLE>
3. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS:
At October 3, 1998, the Company had cash and cash equivalents of
$28,662,000 and short-term investments of $39,353,000, including
an unrealized gain of $227,000 recorded as a separate component
of stockholders' equity. The Company's short-term investments at
October 3, 1998, classified as available-for-sale, consist of
municipal securities, corporate debt securities and U.S. Treasury
securities, with various maturity dates through August 2000.
6
<PAGE>
4. INVENTORIES:
<TABLE>
<CAPTION>
Inventories consist of the following:
October 3, January 3,
(in thousands) 1998 1998
---------- ----------
<S> <C> <C>
Raw materials $ 6,424 $ 7,199
Work-in-process 61 57
Finished goods 6,209 6,802
------- -------
$12,694 $14,058
======= =======
</TABLE>
5. COMPREHENSIVE LOSS:
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130 ("FAS 130"),
"Reporting Comprehensive Income." The Company adopted FAS 130 on
January 4, 1998, which establishes standards for reporting
comprehensive income and its components in the consolidated
financial statements. Comprehensive loss, as restated, for the
three-month and nine-month periods ended October 3, 1998 was
$3,473,000 and $11,951,000, respectively, and includes the after-
tax effect of foreign currency translation adjustments and
unrealized holding gains on its cash and short-term investments
arising during the periods.
6. ACQUISITION:
On March 26, 1998, the Company acquired Isolation, a leading
developer of virtual private networking ("VPN") hardware and
software solutions based in Toronto, Ontario in exchange for cash
paid by the Company from its existing cash and short-term
investment balances. The acquisition was accounted for as a
purchase. Accordingly, the purchase price of approximately
$39,925,000 was allocated to the underlying assets and
liabilities based on their respective fair values at the date of
closing. The fair value of the net assets acquired was $617,000,
and $2,100,000 of the purchase price was allocated to in-process
R&D. The amount allocated to in-process R&D was determined based
upon the methodology set forth in the SEC's September 1998 letter
to the AICPA that requires consideration of the stage of
completion of the individual in-process R&D projects at the date
of acquisition. The in-process R&D was expensed upon
acquisition, as it was determined that technological feasibility
had not been established and no alternative uses existed. The
excess of the purchase price over the net assets acquired,
excluding the in-process R&D charge recorded in the first quarter
of 1998, is being amortized on a straight-line basis over three
years. This excess approximated $38,208,000, and consisted of
$35,908,000 recorded as goodwill, while the remaining amount,
which has been included in other assets in the accompanying
financial statements, consisted of $2,000,000 related to
developed technology and $300,000 related to an assembled
workforce.
Pursuant to an indemnification agreement with Isolation, the
Company has a contingent liability up to a maximum of
approximately $6,500,000 in relation to certain foreign tax
liabilities and associated interest. The obligations of Shiva
only arise if Isolation is assessed or reassessed on the basis
that a portion of the property sold is of a particular nature.
The purpose of the agreement was to ensure that Isolation and its
shareholders were not subject to adverse tax consequences as a
result of the terms of the Company's agreement to acquire
Isolation.
7
<PAGE>
The following summary, prepared on an unaudited pro forma basis,
combines the results of operations as if Isolation had been
acquired as of December 29, 1996; however, the one-time charge of
$2,100,000 as a result of the purchase price allocated to in-
process R&D has been excluded due to its non-recurring nature.
The pro forma results have been adjusted in each of the periods
presented below to reflect the loss of interest income as a
result of the cash used in the acquisition as well as the
amortization of goodwill resulting from the transaction.
<TABLE>
<CAPTION>
Three months ended Nine months ended
---------------------------- --------------------------
October 3, September 27, October 3, September 27,
(in thousands) 1998 1997 1998 1997
------------- ------------- ------------- -------------
(As Restated- (As Restated-
See Note 10) See Note 10)
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Total revenues $ 31,692 $ 36,120 $ 109,275 $ 107,396
Operating loss (6,872) (8,070) (22,773) (32,484)
Net loss (3,636) (4,710) (13,028) (19,299)
========== ========== =========== ===========
Net loss per share -
basic and diluted ($0.12) ($0.16) ($0.43) ($0.66)
========== ========== =========== ===========
</TABLE>
The unaudited pro forma results are not necessarily indicative of
what actually would have occurred if the acquisition had been in
effect for the entire periods presented. In addition, they are
not intended to be a projection of future results and do not
reflect any synergies that might be achieved from combined
operations.
7. RESTRUCTURING EXPENSES:
During the second quarter of fiscal 1998, the Company approved
and implemented a restructuring program to align its financial
model with its strategic focus on providing remote access
solutions for business. The plan included a reduction of the
Company's worldwide workforce by approximately 130 employees,
most of whom were based in Europe, with the remainder in the
United States. A majority of these employees identified were
terminated on July 13, 1998 and the remaining terminations were
completed on October 15, 1998. The Company recorded restructuring
expenses of $2,235,000 in the three-month period ended October 3,
1998, which included $1,176,000 for severance, benefits and other
personnel-related expenses, $456,000 of advertising and marketing
costs, and $416,000 of transition and other costs.
The Company also recorded restructuring expenses of $9,435,000 in
the three-month period ended July 4, 1998, which included
$4,585,000 for severance, benefits and other personnel-related
expenses, $3,570,000 in non-cash expenses for fixed asset write-
downs, $647,000 in advertising and marketing, and $633,000 in
transition and other costs.
In addition, the Company recorded $1,630,000 of restructuring
expenses during the first quarter of fiscal 1998. These
expenses, comprised of severance-related costs of $1,482,000 and
$148,000 of transition and other costs, were the result of the
restructuring of the Company's sales and marketing operations.
As of October 3, 1998, $5,155,000 of severance, benefits and
other personnel-related costs, $279,000 of advertising and
marketing costs, and $901,000 of transition and other costs had
been paid, and approximately $3,395,000 remained as an accrued
liability.
8
<PAGE>
8. RECENTLY ENACTED ACCOUNTING PRONOUNCEMENTS:
In June 1998, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities
("FAS 133"). FAS 133 is effective for all fiscal quarters of all
fiscal years beginning after June 15, 1999. FAS 133 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 current earnings or other
comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction and, if it is, the type
of hedge transaction. For fair-value hedge transactions in which
the Company is hedging changes in an asset's, liability's, or
firm commitment's fair value, changes in the fair value of the
derivative instrument will generally be offset in the income
statement by changes in the hedged item's fair value. For cash-
flow hedge transactions, in which the Company is hedging the
variability of cash flows related to a variable-rate asset,
liability, or a forecasted transaction, changes in the fair value
of the derivative instrument will be reported in other
comprehensive income. The gains and losses on the derivative
instrument that are reported in other comprehensive income will
be reclassified as earnings in the periods in which earnings are
impacted by the variability of the cash flows of the hedged item.
The ineffective portion of all hedges will be recognized in
current-period earnings.
The Company has not yet determined the impact that the adoption
of FAS 133 will have on its earnings or statement of financial
position.
9. SUBSEQUENT EVENT:
On October 19, 1998, Shiva Corporation and Intel Corporation
("Intel") entered into a definitive merger agreement. Under the
merger agreement, if the proposed merger is consummated, Shiva
will become a wholly-owned subsidiary of Intel. In the merger,
each share of Shiva stock, other than shares held by stockholders
who exercise statutory appraisal rights, would be converted into
the right to receive $6 per share in cash. The transaction is
subject to approval by Shiva stockholders, regulatory approval
and other conditions.
10. RESTATEMENT:
While responding to a comment letter received from the staff of
the SEC, the Company reviewed staff guidance issued on September
15, 1998 with respect to the method used to value acquired in-
process R&D associated with the Company's acquisition of
Isolation in the first quarter of 1998. As a result of this
review, the Company has modified the method used to value such
acquired in-process R&D. Initial calculations to value the
acquired in-process R&D were based upon a methodology that
focused on the after-tax cash flows attributable to the
technology on an overall basis, without regard to the stage of
completion of individual projects, and the selection of an
appropriate rate of return to reflect the risk associated with
the stage of completion of the technology. Revised calculations
were based upon the methodology set forth in the SEC's September
1998 letter to the AICPA that requires consideration of the stage
of completion of the individual in-process R&D projects at the
date of acquisition. After applying the revised calculations,
the Company has restated its financial statements for the
quarters ended April 4, 1998, July 4, 1998 and October 3, 1998
and has decreased the amount of the purchase price allocated to
acquired in-process R&D associated with the Isolation acquisition
from $34,500,000 to $2,100,000 and increased goodwill by
$32,400,000. Goodwill is being amortized over a three year
period. The Company has also stated the amount of goodwill
amortization as a separate line item in the consolidated
statement of operations; goodwill amortization had been included
in the Company's selling, general and administrative expenses
prior to the restatement for the three-month and nine-month
periods ended October 3, 1998. A summary of the significant
effects of the restatement are as follows (in thousands):
9
<PAGE>
<TABLE>
<CAPTION>
Statement of Operations:
Three months Nine months
Ended Ended
October 3, October 3,
1998 1998
------------ -----------
<S> <C> <C>
Operating expenses:
As previously reported $23,775 $108,571
Adjustment related to
in-process R&D and goodwill
amortization 2,700 (27,000)
--------- -----------
Restated 26,475 81,571
========= ===========
Loss before income taxes:
As previously reported (2,647) (44,800)
Adjustment related to
in-process R&D and goodwill
amortization (2,700) 27,000
---------- -----------
Restated (5,347) (17,800)
========== ===========
Income tax benefit:
As previously reported (847) (14,336)
Adjustment related to
in-process R&D and goodwill
amortization (864) 8,640
---------- -----------
Restated (1,711) (5,696)
========== ===========
Net loss:
As previously reported (1,800) (30,464)
Adjustment related to
in-process R&D and goodwill
amortization (1,836) 18,360
---------- -----------
Restated (3,636) (12,104)
========== ===========
Net loss per share - basic
and diluted:
As previously reported (0.06) (1.01)
Adjustment related to
in-process R&D and goodwill
amortization (0.06) 0.61
---------- -----------
Restated $(0.12) $(0.40)
========== ==========
Balance Sheet:
October 3, 1998
----------------------------
As Previously
Reported As Restated
------------- -----------
Goodwill, net (1) $ - $ 29,090
Other assets (1) 6,881 4,791
Long-term deferred income taxes 23,686 15,046
Total assets 157,308 175,668
Total stockholders' equity 116,447 134,807
<FN>
(1) Goodwill, net, in the amount of $2,090 was included in
other assets prior to restatement.
</TABLE>
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Restatement
While responding to a comment letter received from the staff of
the SEC, the Company reviewed staff guidance issued on September
15, 1998 with respect to the method used to value acquired in-
process research and development associated with the Company's
acquisition of Isolation in the first quarter of 1998. As a
result of this review, the Company has modified the method used
to value such acquired in-process R&D. Initial calculations to
value the acquired in-process R&D were based upon a methodology
that focused on the after-tax cash flows attributable to the
technology on an overall basis, without regard to the stage of
completion of individual projects, and the selection of an
appropriate rate of return to reflect the risk associated with
the stage of completion of the technology. Revised calculations
were based upon the methodology set forth in the SEC's September
1998 letter to the AICPA that requires consideration of the stage
of completion of the individual in-process R&D projects at the
date of acquisition. After applying the revised calculations,
the Company has restated its financial statements for the
quarters ended April 4, 1998, July 4, 1998 and October 3, 1998
and has decreased the amount of the purchase price allocated to
acquired in-process R&D associated with the Isolation acquisition
from $34,500,000 to $2,100,000 and increased goodwill by
$32,400,000. Goodwill is being amortized over a three year
period. The Company has also stated the amount of goodwill
amortization as a separate line item in the consolidated
statement of operations; goodwill amortization had been included
in the Company's selling, general and administrative expenses
prior to the restatement for the three-month and nine-month
periods ended October 3, 1998.
Results of Operations
Nortel Agreements. The Company has been party to a strategic
relationship with Northern Telecom, Inc. ("Nortel") since 1995
which has evolved over time. On September 28, 1998, the Company
signed an amended agreement with Nortel (the "1998 Amendment")
under which the Company will receive a revenue stream of
$20,000,000, with little or no direct cost, over the contract
term which began in the three-month period ended October 3, 1998
and expires in the fourth quarter of fiscal 1999. The financial
terms of the 1998 Amendment provide the Company with a comparable
level of gross profit, and supersedes the terms of, the OEM
agreement (the "1998 Agreement") signed on February 28, 1998,
under which Nortel was to issue purchase orders for a minimum of
$5,000,000 per quarter to purchase the Company's products with a
minimum aggregate amount of $40,000,000 over the term of the
contract, which began in the three-month period ended April 4,
1998. These OEM purchases from Nortel had replaced the minimum
royalty arrangement with the Company that was in effect during
fiscal 1997. In the first two quarters of fiscal 1998, the
Company also received total professional services revenue of
$12,000,000 from Nortel related to the development of carrier
class remote access technology. The OEM purchases and
professional services in the first two quarters of 1998 had
resulted in higher revenues from Nortel through such period,
which carried lower gross margins than those achieved in 1997.
Beginning in the three-month period ended October 3, 1998,
however, gross margins as a percentage of revenues from Nortel
are expected to increase, as a significant portion of the
revenues from Nortel will consist of the revenue stream provided
under the terms of the 1998 Amendment, which carry little or no
direct cost.
On April 23, 1998, Nortel exercised its option under the 1998
Agreement to license certain Shiva technology. Pursuant to the
terms of the agreement, Shiva will record a total of $26,000,000
ratably over ten quarters, or $2,600,000 per quarter, which began
in the second quarter of fiscal 1998, for the license and other
items related to intellectual property. Proceeds from this
license agreement are being accounted for as $2,000,000 in
LanRover Access Switch revenue and $600,000 in other income per
quarter over the license term.
11
<PAGE>
Revenues. Revenues in the three-month and nine-month periods
ended October 3, 1998 were $31,692,000 and $108,017,000,
respectively, compared to $35,581,000 and $106,478,000 in the
comparable periods in fiscal 1997, respectively. The 11%
decrease in revenues in the three-month period ended October 3,
1998 was primarily due to lower revenues from the Company's
LanRover and LanRover Access Switch products, partially offset by
increased revenues from other remote access products. Revenues
increased slightly in the nine-month period ended October 3, 1998
compared to the corresponding period in fiscal 1997 principally
due to higher service revenues, which increased to $19,211,000 in
the nine-month period ended October 3, 1998 from $5,134,000
during the comparable period in fiscal 1997. This increase was
primarily due to $12,000,000 in professional services revenue
from Nortel related to the development of carrier class remote
access technology pursuant to the 1998 Agreement. This increase
in service revenues was partially offset by lower revenues from
the Company's LanRover product line due to lower volume
shipments, as well as decreased license, royalty and other
revenues, primarily related to the LanRover Access Switch
products as discussed below. Revenues in the nine-month period
ended September 27, 1997 were negatively impacted by price
protection provisions of $6,700,000, of which $3,900,000 related
to the LanRover and $2,800,000 related to the LanRover Access
Switch, due to increased price competition and price reductions
on the V.34 modem card due to the availability of 56K modem
technology in the access concentrator market. Price protection
rights require the Company to grant retroactive price adjustments
for inventories of the Company's products held by distribution
partners if the Company lowers its prices for such products.
Revenues from the LanRover Access Switch in the three-month and
nine-month periods ended October 3, 1998 decreased to $11,413,000
and $40,930,000, respectively, from $14,700,000 and $45,947,000
in the comparable periods in fiscal 1997, primarily due to lower
license and royalty revenues from Nortel, and lower volume
shipments. Revenues from the LanRover Access Switch in fiscal
1997 included minimum royalty revenues from Nortel, which will
not recur in fiscal 1998 (as described above) that were based on
sales of the Nortel Rapport 112, an OEM version of the LanRover
Access Switch. The loss of these royalty revenues was partially
offset by license revenues from Nortel as part of the 1998
Agreement recorded in the second and third quarters of fiscal
1998, and by the price protection provisions of $2,800,000
recorded in the first quarter of fiscal 1997 as described above.
Revenues from the LanRover product line in the three-month and
nine-month periods ended October 3, 1998 decreased to $7,396,000
and $25,534,000, respectively, from $13,475,000 and $39,238,000
in the comparable periods in fiscal 1997, primarily due to lower
volume shipments. LanRover revenues in the nine-month period
ended September 27, 1997 were negatively impacted by price
protection provisions of $3,900,000.
Revenues from the Company's other remote access products
increased to $9,517,000 and $18,696,000, respectively, in the
three-month and nine-month periods ended October 3, 1998 from
$3,984,000 and $11,016,000 in the comparable periods in fiscal
1997. The increase in the three-month and nine-month periods
ended October 3, 1998 was primarily related to revenues recorded
in accordance with the 1998 Amendment with Nortel, increased
revenues from the Company's AccessPort product, and the
introduction of the LanRover VPN Gateway product as a result of
the acquisition of Isolation on March 26, 1998, partially offset
by decreased revenues from certain other products.
The Company provides its distributors and resellers with product
return rights for stock balancing and product evaluation.
Revenues were reduced by provisions for product returns of
$2,125,000 and $7,441,000, or 6% of gross revenues, in the three-
month and nine-month periods ended October 3, 1998, respectively.
Provisions for product returns were $2,439,000, or 6% of gross
revenues, and $13,784,000, or 11% of gross revenues in the
corresponding periods in fiscal 1997. Provisions for product
returns were higher in the nine-month period ended September 27,
1997 compared to the nine-month period ended October 3, 1998
primarily a result of provisions recorded in the first quarter of
fiscal 1997 to account for slow-moving and discontinued products
in the Company's North American distribution channels.
Revenues from OEM customers represented 21% and 29% of revenues
in the three-month and nine-month periods ended October 3, 1998,
respectively, compared to 26% and 25% in the comparable periods
in fiscal 1997. The decrease in the three-month period ended
October 3, 1998 was primarily due to decreased OEM purchases from
Nortel and IBM, partially offset by increased revenues from
Nortel related to the 1998 Amendment. The increase in the nine-
month period ended October 3, 1998 was primarily due to the
$12,000,000 in professional services revenue received from Nortel
in the first two quarters of 1998. The Company anticipates that
OEM revenues will decline in future periods.
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International revenues accounted for 41% and 37% of revenues in
the three-month and nine-month periods ended October 3, 1998,
respectively, compared with 43% and 50% in the corresponding
periods in fiscal 1997. International revenues were lower in the
three-month and nine-month periods ended October 3, 1998 due to
decreased sales in the Pacific Rim and Europe. In addition,
international revenues represented a significantly higher
proportion of total revenues in the nine-month period ended
September 27, 1997 due to the impact of the return provisions and
price protection provisions that significantly reduced revenues
from the Company's North American distribution channels in 1997.
Gross Profit. Gross profit was $19,603,000 and $59,817,000, for
the three-month and nine-month periods ended October 3, 1998,
respectively, compared to $20,262,000 and $53,571,000 for the
comparable periods in fiscal 1997. This represented 62% and 55%
of revenues in the three-month and nine-month periods ended
October 3, 1998, respectively, compared to 57% and 50% in the
corresponding periods in 1997. Gross profit as a percentage of
revenues increased in the three-month period ended October 3,
1998 due to the increase in license, royalty and other revenues,
which carry little or no direct cost. Gross profit in the nine-
month period ended September 27, 1997 included the negative
impact of price protection provisions of $6,700,000, as
previously described, and provisions for slow-moving inventories.
The provisions for slow-moving inventories increased cost of
revenues by $6,463,000, and related to V.34 modem cards, for
which demand had decreased due to the availability of 56K modem
technology, and certain other products. Excluding the impact of
these provisions, gross profit as a percentage of revenues would
have been 59% in the nine-month period ended September 27, 1997.
Gross profit as a percentage of revenues was negatively impacted
in the nine-month periods ended October 3, 1998 due to the
professional services revenue and OEM product (non-license and
royalty) revenues from Nortel. Each of these revenue streams from
Nortel carried lower gross profit percentages than the Company's
non-Nortel product revenues, and significantly lower gross profit
percentages than the Nortel royalty revenues recorded in the year
earlier period. In the future, the Company's gross margins may
be affected by several factors, including but not limited to the
competitive pricing environment, product mix, the level of
license and royalty revenues as a percentage of total revenue,
the distribution channels used, changes in component costs and
the introduction of new products.
Research and Development. Research and development expenses
during the nine-month period ended October 3, 1998 primarily
related to the development of new and existing remote access
products, including products which incorporate technology to
support virtual private networking. Research and development
expenses decreased to $6,402,000 and $15,623,000 in the three-
month and nine-month periods ended October 3, 1998 from
$6,937,000 and $18,676,000 during the comparable periods in
fiscal 1997. The decrease in research and development expenses
for the three-month period ended October 3, 1998 compared to the
three-month period ended September 27, 1997 was primarily due to
restructuring actions as the Company discontinued operations at
the Edinburgh, Scotland, facility. The Edinburgh facility was
primarily focused on jointly funded engineering activities with
Nortel. The decrease in these expenses for the nine-month
period ended October 3, 1998 compared to the nine-month period
ended September 27, 1997 was primarily due to the restructuring
of the Company's relationship with Nortel in fiscal 1998 under
which Nortel had previously contracted with the Company for the
development of carrier class remote access technology. Under the
terms of the 1998 Agreement, the Company recognized a total of
$12,000,000 in professional services revenue in the nine-month
period ended October 3, 1998 as work was performed. Accordingly,
expenses related to these development efforts of $7,422,000 in
the nine-month period ended October 3, 1998, have been included
in cost of service revenues in the accompanying statement of
operations. This decrease in research and development expenses
associated with the 1998 Agreement was partially offset by a
reduction in capitalized software development costs, as well as a
decrease in customer-funded development fees, which are recorded
as an offset to research and development expenses. There were no
such fees recorded in the three-month and nine-month periods
ended October 3, 1998, compared to $1,500,000 and $4,954,000 in
the three-month and nine-month periods ended September 27, 1997.
Capitalized software development costs were $233,000 and $320,000
for the three-month and nine-month periods ended October 3, 1998,
compared with $488,000 and $888,000 in the comparable periods in
fiscal 1997. Gross research and development expenses decreased
to $6,635,000 and $23,365,000, respectively, in the three-month
and nine-month periods ended October 3, 1998 from $8,925,000 and
$24,518,000 in the comparable periods in fiscal 1997. The
Company anticipates continued significant investment in research
and development primarily focused on providing remote access
solutions for the business access market.
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Selling, General and Administrative. Selling, general and
administrative expenses decreased to $14,927,000 and $44,729,000
in the three-month and nine-month periods ended October 3, 1998
from $17,622,000 and $55,929,000 in the comparable periods in
fiscal 1997. These expenses represented 47% and 41% of revenues
in the three-month and nine-month periods ended October 3, 1998,
respectively, compared to 50% and 53% in the corresponding
periods in 1997. The decrease in gross expenses was due to
several factors, including lower personnel costs due to the
restructuring of the Company's sales and marketing organization
as discussed below, as well as decreased costs incurred for
travel, channel and marketing programs, trade shows, recruiting,
temporary help and various facilities related expenses. These
decreases were partially offset by increased bad debt expense.
Selling, general and administrative expenses in the three-month
and nine-month periods ended September 27, 1997 are net of
expenses reimbursed by Nortel of $1,623,000 and $3,831,000,
respectively, related to Shiva's Service Provider Group (SPG), a
worldwide business unit comprised of technical sales and support
personnel that had been dedicated to marketing Nortel's remote
access equipment to carriers and service providers through the
first quarter of fiscal 1998. Expenses reimbursed by Nortel in
the first quarter of 1998 were $1,018,000. Nortel no longer
funds the SPG unit.
In-Process Research and Development. In connection with the
acquisition of Isolation in the first quarter of fiscal 1998, the
Company allocated $2,100,000 of the purchase price to in-process
R&D. This allocation represented the estimated fair value based
on risk-adjusted cash flows related to the incomplete research
and development projects. At the date of acquisition, the
development of these projects had not yet reached technological
feasibility and the research and development in progress had no
alternative future uses. Accordingly, these costs were expensed
as of the acquisition date.
At the acquisition date, the nature of the acquired in-process
R&D principally related to redesign of the technology and
software operating system to develop next-generation VPN software
technology that would be compliant with evolving industry
standards. The remaining efforts included the completion of
certain design, coding, prototyping, and testing activities that
were necessary to establish that the proposed VPN technologies
met their design specifications, including functional, technical,
and economic performance requirements. This product would become
the basis for the Company's future integrated VPN / remote access
products. The Company anticipates incurring total costs of
approximately $1,000,000 to $2,000,000 over the next several
quarters, at which time the Company expects to begin selling such
products.
Management believes the Company has a reasonable chance of
successfully completing the in-process R&D; however, there is
risk associated with the completion of the projects and there can
be no assurance that the developed products will meet with either
technological or commercial success. Failure to successfully
complete the projects and/or market the resulting products would
have a material adverse effect on the results of operations and
financial condition of the Company in future periods.
The value assigned to purchased in-process R&D was determined by
estimating the costs to develop the purchased in-process R&D into
commercially viable products, estimating the stage of completion,
estimating the resulting net cash flows from the projects and
discounting the net cash flows to their present value. The
revenue projection used to value the in-process R&D was based on
estimates of relevant market sizes and growth factors, expected
trends in technology and the nature and expected timing of new
product introductions by the Company and its competitors.
The estimated revenues for the in-process R&D assumed compound
annual growth rates of 90% in the five years following
introduction, assuming the successful completion and market
acceptance of the products. The estimated revenues for the in-
process R&D products were expected to peak within four to five
years and then decline sharply as other new products and
technologies entered the market.
Gross margins and operating expenses were estimated based on
historical results and management beliefs regarding anticipated
factors affecting profit margins. The Company anticipated that
gross margins as a percentage of revenues would decline over time
as new competitors and competing technologies entered the
marketplace. Additionally, the Company anticipated that
operating expenses as a percentage of revenues would decline over
time due to purchasing power increases and general economies of
scale.
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The rates utilized to discount the net cash flows to their
present value were based on cost of capital calculations. Due to
the nature of the forecast and the risks associated with the
projected growth, profitability and developmental projects, a
discount rate of 30 percent was deemed appropriate for the in-
process R&D. This discount rate was commensurate with
Isolation's stage of development and the uncertainties in the
economic estimates as described above.
The Company believed that the foregoing assumptions used in
Isolation's in-process R&D analysis were reasonable at the time
of the acquisition. No assurance can be given, however, that the
underlying assumptions used to estimate product sales,
development costs or profitability, or the events associated with
such projects, will transpire as estimated. Actual revenues with
respect to acquired in-process R&D have been lower than previous
estimates. The Company believes that expenses incurred to date
associated with the development of the in-process R&D projects
have been higher than the Company's previous estimates.
The Company has completed many components of the original in-
process R&D project, and continues to work towards its
completion. There have been delays in the project due to changes
in technological and market requirements for VPN systems and
changes in the Company's research and development staff. In
addition, factors such as changing development priorities to meet
evolving customer requirements have delayed the development
process as well. The risks associated with these efforts are
still considered high and no assurance can be made that the
products resulting from in-process R&D will meet with market
acceptance. In addition, delays in the introduction of such
products may have an adverse impact on the Company's results of
operations and financial condition in future periods.
Goodwill Amortization. The Company recorded amortization expense
of $2,911,000 and $5,819,000 in the three-month and nine-month
periods ended October 3, 1998 related to its acquisition of
Isolation. At October 3, 1998, the Company had net goodwill of
$29,090,000 remaining to amortize over three years from the date
of acquisition of Isolation.
Restructuring Expenses. The Company recorded restructuring
expenses of $2,235,000 and $13,300,000 in the three-month and
nine-month periods ended October 3, 1998, respectively.
Restructuring expenses in the three-month period ended October 3,
1998 consisted of $1,176,000 of severance, benefits and other
personnel-related expenses $456,000 of advertising and marketing
costs, and $603,000 of transition and other costs. Restructuring
expenses for the nine-month period ended October 3, 1998
consisted of $7,243,000 in severance, benefits and other
personnel-related expenses, $3,570,000 in non-cash expenses for
fixed asset write-downs, $1,103,000 of advertising and marketing
costs, and $1,384,000 of transition and other costs. These
restructuring expenses were primarily a result of the
restructuring of the Company's sales and marketing operations as
well as a formal plan announced by the Company on April 15, 1998
to restructure its worldwide operations and align its financial
model with the strategic focus on providing remote access
solutions for business. Specifically, Shiva discontinued
operations at the Edinburgh, Scotland, facility and has relocated
certain technical support staff to the Wokingham, United Kingdom,
facility. The Edinburgh facility was primarily focused on
jointly funded engineering activities with Nortel. The Company
anticipates that substantially all of the cash restructuring
charges will be paid out from the Company's cash and short-term
investment balances by the end of fiscal 1998.
Interest Income and Expense. Interest income decreased during
the three-month period ended October 3, 1998 over the
corresponding period in fiscal 1997 primarily as a result of the
cash used in the acquisition of Isolation. Interest income
increased during the nine-month period ended October 3, 1998 over
the corresponding period in fiscal 1997 primarily due to the
Company's shift from federal tax-exempt securities into taxable
securities, which resulted in a higher overall yield on its
investments. Interest and other income for the three-month period
ended October 3, 1998 was $715,000 compared with interest and
other expense of $26,000 for the period ended September 27, 1997.
This change is primarily due to the inclusion of $600,000 of
income resulting from the option exercised by Nortel under the
1998 Agreement to license certain Shiva technology.
Income Tax Benefit. The Company's effective tax rate in each of
the three-month and nine-month periods ended October 3, 1998 was
32%, down from 38% in each of the three-month and nine-month
periods ended September 27, 1997, primarily due to the impact of
nondeductible restructuring charges.
15
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Foreign Currency Fluctuations and Conversion to Euro
Foreign currency fluctuations did not have a significant impact
on the results of operations in the three-month and nine-month
periods ended October 3, 1998 as compared with those of the
comparable periods in fiscal 1997. However, the Company's
international operations will continue to be exposed to adverse
movements in foreign currency exchange rates which may have a
material adverse impact on the Company's financial results. The
Company enters into forward exchange contracts to hedge those
currency exposures related to certain assets and liabilities
denominated in non-functional currencies and does not generally
hedge anticipated foreign currency cash flows.
Certain of the member countries of the European Union have agreed
to adopt a new currency, the Euro, as their common legal
currency. On January 1, 1999, the countries will establish fixed
conversion rates between their existing currencies and the Euro.
The Company has not yet completed its analysis of the potential
impact the conversion to the Euro may have on its business or
results of operations.
Year 2000
The Company recognizes that it must ensure that its products and
operations will not be adversely impacted by Year 2000 software
failures (the "Year 2000 issue"), which can arise in certain time-
sensitive software applications that utilize a field of two
digits to define the applicable year. In such applications, a
date using "00" as the year may be recognized as the year 1900
rather than the year 2000.
The Company is in the process of assessing its exposure to the
Year 2000 issue. The Company has divided the assessment into
multiple projects which are currently being undertaken by Company
employees in applicable functions. The Company may consider the
use of independent consultants or other external resources if
major incremental Year 2000 issues are found as a result of the
Company's internal Year 2000 assessment. The assessment project
includes the Company's product compliance testing (and related
engineering remedial work), internal systems assessment and third
party supplier assessment. All Year 2000 activity has been
funded from operating cash flows, and the Company has not
separately accounted for these costs. The Company's total cost
relating to all of these activities (excluding replacement
systems) has not been, and management anticipates that such costs
are not expected to be material to the Company's financial
position, results of operations or cash flows. The Company
currently estimates that it will not spend in excess of $600,000
for its internal Year 2000 issues, and $250,000 for product-
related Year 2000 issues.
The Company has developed an extensive Year 2000 product test
suite which is based on various industry standard Year 2000
tests. The test suite can be found on the Company's web site at
www.shiva.com. The Company has tested approximately fifty
percent of its products against the suite, and has published the
test results on the Company's web site. The web site is updated
weekly with test results as the testing is completed. The
Company anticipates that all of its products will have been
tested by the end of 1998.
To date, the Company is aware that the SpiderManager and certain
Shiva Access Manager products are not Year 2000 compliant. The
SpiderManager product will display the year number in the
activity log date field as three digits. The Company believes
that this characteristic does not have any system operational
implications for the product, therefore, the Company does not
anticipate undertaking additional research and development or
remediation efforts to change this display characteristic. The
Shiva Access Manager NT 1.0 product uses only two digits to store
year information. The system interprets these two digits as
being in the twentieth century before year 2000, and will
interpret the two digits as being in the twenty-first century
after year 2000. The Company believes that this date calculation
methodology could reactivate previously terminated user accounts
and may produce incorrect log files if both twentieth and twenty-
first century dates are involved. This Year 2000 issue has been
16
<PAGE>
corrected in Shiva Access Manager NT at version 2.0 and higher
versions. The Company has strongly recommended that its
customers implement the suggested upgrade to correct the problem.
The Company does not anticipate undertaking additional research
and development or remediation efforts incurring additional
expenses to correct this Year 2000 issue. Shiva Access Manager
version 2.x and 3.x support Vasco Data Security, Inc.'s
("Vasco's") time-based hard tokens. After the change of century,
any Vasco time-based hard tokens will fail to authenticate a user
which will cause an authorized user to be denied access to the
system. This Year 2000 issue has been corrected in Shiva Access
Manager 4.0 which incorporates new token libraries from Vasco.
The Company has strongly recommended that its customers using
Vasco time-based hard tokens upgrade to version 4.0 or higher
versions to correct the problem. All users of a Vasco time-based
hard token must also have their hard tokens reprogrammed by Vasco
in order to correct the Year 2000 issue. The Company does not
anticipate undertaking additional research and development or
remediation efforts for this Year 2000 issue. The Shiva Access
Manager Accountant cannot allow entry of full Year 2000 compliant
dates into some of data entry screens. This does not affect the
operation of the software but may cause some resulting reports to
be incorrect. This Year 2000 issue has been corrected and will
be released in the next revision of the product, which is due to
be released in the last quarter of 1998 or first quarter of 1999.
The Company has strongly recommended that customers using Shiva
Access Manager Accountant upgrade to the new release when
available. The Company does not anticipate undertaking
additional research and development or remediation efforts or
incurring additional expenses for this Year 2000 issue. To
assist customers who have Shiva Access Manager products that are
not Year 2000 compliant, the Company plans to launch a special
upgrade program within the next six months to ensure the Year
2000 compliant versions are in place by the century change. The
Company does not expect the cost of the upgrade program to be
material to the results of the Company.
Even after extensive testing, there can be no guarantee that one
or more current Company products do not contain Year 2000 issues
that may result in material costs to remedy. The Company's risk
of being subjected to lawsuits relating to Year 2000 issues with
its software products is likely to be greater than other
industries. Since computer systems may involve various hardware,
software and firmware components from different manufacturers, it
may be difficult to determine which component in a computer
system may cause a Year 2000 issue. As a result, the Company may
be subjected to Year 2000-related lawsuits independent of whether
its products or services are Year 2000 compliant. The possibility
and outcome of any such lawsuits and the potential impact on the
Company cannot be determined at this time.
The Company has completed its initial audit of the Company's
major information technology ("IT") systems. The Company
replaced its North American finance and manufacturing system in
the third quarter of fiscal 1998 with a Year 2000 compliant
system. The Company is planning to complete all necessary Year
2000 upgrades of its major systems in 1999, and is currently
identifying and developing compliance strategies for its
remaining systems that may be impacted by the Year 2000 issue.
The Company is also assessing its non-IT systems for Year 2000
non-compliance. The initial assessment of non-IT systems is
scheduled to be completed in the first quarter of 1999.
The Company is in process of developing a Year 2000 plan with
each of the Company's manufacturing contractors. The plans are
targeted to be completed by the end of 1998. The plans will
address manufacturing process, component and supplier Year 2000
readiness/compliance and the Company does not expect the cost of
such plans to be material. The Company has begun to initiate
formal communications and projects with its significant suppliers
and service providers to determine the extent to which the
Company is vulnerable to those third parties' failure to remedy
their Year 2000 issues. The Company has received some assurances
regarding the status of Year 2000 issues from its vendors;
however, there is no guarantee that third party systems will be
compliant, and such non-compliance, could have an adverse effect
on the Company. For example, if some of the Company's component
vendors are not Year 2000 compliant it could adversely impact the
Company's Year 2000 compliance program.
If the Company does not become Year 2000 compliant in a timely
manner, the Year 2000 issue could have a material impact on the
business, financial condition and results of operations. Delays
in Year 2000 compliance could also adversely affect the Company's
reputation and competitive position and impair its ability to
process customer transactions and orders and payments of supplier
merchandise. The most reasonably likely worst case scenarios
would include (1) corruption of data contained in the Company's
internal information systems, (2) hardware failure and (3) the
failure of infrastructure services provided by third parties
(e.g. electricity, phone service, etc.). The Company is in the
process of completing its contingency planning for high risk
areas at this time and is scheduled to commence contigency
planning for medium to low risk areas beginning in 1999. The
Company expects its contingency plans to include, among other
things, manual "work-arounds" for software and hardware failures,
as well as substitutions of systems, if necessary.
17
<PAGE>
The foregoing shall be considered a Year 2000 readiness
disclosure to the maximum extent allowed under the Year 2000
Information and Readiness Disclosure Act.
Liquidity and Capital Resources
As of October 3, 1998, the Company had $28,662,000 of cash and
cash equivalents and $39,353,000 of short-term investments.
Working capital decreased by 38% to $66,752,000 at October 3,
1998 from $108,314,000 at January 3, 1998, primarily due to cash
used to acquire Isolation.
Net cash provided by operations totaled $16,093,000 for the nine-
month period ended October 3, 1998 compared with $1,623,000
during the comparable period in fiscal 1997. Net cash provided
by operations in the nine-month period ended October 3, 1998
resulted primarily from the net loss adjusted for non-cash
expenses including in-process R&D, as well as the decrease in
accounts receivable and inventories and the increase in accrued
expenses, partially offset by a decrease in accounts payable.
The decrease in accounts receivable is primarily due to lower
revenues and increased collection activities. The decrease in
inventories is due to decreased inventory requirements as a
result of lower revenue levels. The increase in accrued expenses
is primarily due to increases in accrued sales, marketing and
manufacturing expenses, and the accrued severance and other costs
related to the Company's restructuring efforts. Net cash
provided by operations in the nine-month period ended September
27, 1997 resulted primarily from the decrease in accounts
receivable, partially offset by the net loss adjusted for non-
cash expenses and the increase in deferred income taxes. The
decrease in accounts receivable was due to decreased revenue
levels and the previously mentioned increase in product return
and price protection provisions, as well as increased collection
activity.
Net cash used by investing activities totaled $46,698,000 for the
nine-month period ended October 3, 1998, compared to $18,648,000
during the comparable period in fiscal 1997. Investment activity
in the nine-month period ended October 3, 1998 consisted
primarily of payments related to the purchase of Isolation, as
well as the net purchase of short-term investments and fixed
assets. Investment activity in the nine-month period ended
September 27, 1997 consisted primarily of purchases of short-term
investments and fixed assets, partially offset by proceeds from
short-term investments upon maturity or sale.
Net cash provided by financing activities totaled $175,000 for
the nine-month period ended October 3, 1998, compared to
$1,670,000 during the comparable period in fiscal 1997. Net cash
provided by financing activities for the nine-month period ended
October 3, 1998 primarily consisted of proceeds from stock option
exercises, partially offset by the purchase of treasury stock.
Net cash provided by financing activities in the nine-month
period ended September 27, 1997 consisted of proceeds from stock
option exercises and purchases of stock under the Company's stock
purchase plan, partially offset by principal payments on long-
term debt and capital lease obligations.
The Company has a $5,000,000 unsecured revolving credit facility
with a bank which expires in March 1999. The terms of the credit
facility require the Company to comply with certain restrictive
financial covenants. Borrowings under this facility bear
interest at the bank's prime rate. At October 3, 1998, available
borrowings were reduced by outstanding letters of credit of
$842,000 which expire at various dates in 1998. The Company had
no borrowings outstanding under this line at October 3, 1998. The
Company also has a foreign credit facility of approximately
$2,720,000, all of which was available at October 3, 1998.
Available borrowings under this facility are decreased by
guarantees on certain foreign currency transactions. The terms
of the foreign credit facility require the Company to comply with
certain restrictive financial covenants. There were no
borrowings outstanding under this foreign credit facility at
October 3, 1998.
18
<PAGE>
The Company enters into forward exchange contracts to hedge
against certain foreign currency transactions for periods
consistent with the terms of the underlying transactions. The
forward exchange contracts have maturities that do not exceed one
year. At October 3, 1998, the Company had outstanding forward
exchange contracts to purchase $7,093,000 and to sell $1,016,000
in various currencies which mature on various dates through
February 26, 1999.
The Company believes that its existing cash and short-term
investment balances, together with borrowings available under the
Company's bank credit facilities, will be sufficient to meet the
Company's cash requirements for at least the next twelve months.
Certain Factors That May Affect Future Results
Certain information contained herein, and information provided by
the Company or statements made by its employees may, from time to
time, contain "forward-looking" information which involve risks
and uncertainties. Any statements contained in the Management's
Discussion and Analysis of Financial Condition and Results of
Operations and elsewhere herein that are not historical facts may
be "forward-looking" statements. Certain information contained
herein concerning the Company's anticipated plans and strategies
for its business, available cash and cash equivalents and sources
of financing, research and development and other expenditures,
effects of the restructuring actions, ability to achieve Year
2000 compliance, and effects of the 1998 Agreement and the 1998
Amendment with Nortel consists of forward-looking statements.
Without limiting the foregoing, the words "believes," "expects,"
"anticipates," "plans," and similar expressions are intended to
identify forward-looking statements. The Company's actual future
results may differ significantly from those stated in any forward-
looking statements. Factors that may cause such differences
include, but are not limited to, the factors discussed below.
The Company's quarterly operating results may vary significantly
from quarter to quarter depending on factors such as the timing
of significant orders and shipments of its products, changes and
delays in product development, new product introductions by the
Company and its competitors, the mix of distribution channels
through which the Company's products are sold and seasonal
customer buying patterns. There can be no assurance that the
Company will be able to achieve future revenue growth and
profitability on a quarterly or annual basis. Revenues can be
difficult to forecast due to the fact that the Company's sales
cycle varies substantially depending upon market, distribution
mechanism and end-user customer. The Company's expense levels
are based, in part, on its expectations as to future revenues.
If revenue levels are below expectations, operating results may
be adversely affected. In addition, the Company's distribution
partners typically stock significant levels of inventory, and the
Company's revenues may fluctuate based on the level of partner
inventories in any particular quarter.
The Company's LanRover and LanRover Access Switch products are
experiencing increased market competition which has caused the
Company to take pricing actions and may require the Company to
take future pricing actions. The Company provides most of its
distribution partners with product return rights for stock
balancing or product evaluation and price protection rights.
Stock balancing rights permit a return of products to the Company
for credit against future product purchases, within specified
limits. Product evaluation rights permit end-users to return
products to the Company through the distribution partner from
whom such products were purchased, within 30 days of purchase if
such end-user is not fully satisfied. Price protection rights
require the Company to grant retroactive price adjustments for
inventories of the Company's products held by distribution
partners if the Company lowers its prices for such products.
These price protection provisions have adversely affected and may
continue to adversely affect revenues and profitability in the
future. There can be no assurance that the Company will not
experience significant returns or price protection adjustments in
the future or that the Company's reserves will be adequate to
cover such returns and price reductions.
The Company operates in a highly competitive market that is
characterized by an increasing number of well-funded competitors
from diverse industry sectors, including but not limited to
suppliers of software, modems, terminal servers, routers, hubs,
data communications products and companies offering remote access
solutions based on emerging technologies, such as switched
digital telephone services, remote access service offerings by
telephony providers via telephone networks and other providers
through public networks such as the Internet. In particular, the
rapid entry of large telecommunications and service provider
19
<PAGE>
competitors, such as Lucent and Nortel, to the remote access
market, in addition to large traditional networking vendors, such
as Cisco and 3Com, has resulted in increased competition. In
addition, customers increasingly view remote access offerings as
a component of an end-to-end solution that is most effectively
provided by very large-scale companies, which have significantly
greater resources than the Company and which customers may
perceive as best suited to address a variety of their needs over
a long period of time. Increased competition has resulted and
may continue to result in price reductions and loss of market
share, which has and may continue to adversely affect the
Company's revenues and profitability. There can be no assurance
that the Company will be able to continue to compete successfully
with new or existing competitors.
The Company currently relies on sales of the LanRover Access
Switch to achieve its revenue and profitability objectives.
Sales of other communications products and other remote access
products, including the LanRover product, decreased in the first
nine months of fiscal 1998 and fiscal 1997, due in part to
increased competition. There can be no assurance that the
Company will be successful in modifying current product offerings
to increase sales of its products.
The Company depends on third party distributors and value-added
resellers for a significant portion of the Company's revenues.
The loss of certain of these distributors and resellers could
have a material adverse impact on the Company's results of
operations. Moreover, many of these distributors and resellers
also act as resellers of competitive products. Therefore, there
is risk that these distributors and resellers may focus their
efforts on marketing products other than those sold by the
Company. This may require the Company to offer various
incentives to such distributors and resellers, which may
adversely impact the Company's results of operations.
The market for remote access products has changed dramatically in
recent years. Computer users have increasingly utilized the
Internet for remote access. A number of factors contributed to
this transition, including cost, ease of use and the increasing
public awareness, use and acceptance of the Internet. In order
to address the changing needs of this market, the Company has
recently revised its strategic focus, seeking to decrease its
reliance on its traditional products and on its relationship with
Nortel while devoting additional resources to products that
increase the security of remote access conducted on the Internet
and allowing the establishment of virtual private networks
("VPNs"). The introduction of new products and the Company's new
strategic focus will require the Company to successfully manage
the transition from traditional product offerings in order to
minimize the impact on customer ordering patterns, avoid
excessive levels of obsolete inventories and ensure that adequate
supplies of both new and traditional products are available to
meet customer demand. The new Internet-based products
represented less than 10% of the Company's sales in the third
quarter of 1998, and there can be no assurance the Company's new
products will achieve increased market acceptance. The Company's
future success will depend upon its ability to implement the
transition to Internet-based and VPN products and to meet and
adapt to changing customer requirements and emerging
technologies. There can be no assurance the Company will be
successful in its new strategic focus.
The Company's success in accomplishing development objectives
depends in large part upon its ability to attract and retain
highly skilled technical personnel including, in particular,
management personnel in the areas of research and development and
technical support. Competition for such personnel is intense.
There can be no assurance that the Company will be successful in
attracting and retaining the personnel it requires to accomplish
its objectives. Delays in new product development or the failure
of new products to achieve market acceptance, could have a
material adverse effect on the Company's operating results. In
addition, there can be no assurance that the Company will be
successful in identifying, developing, manufacturing or marketing
new product or service offerings or enhancing its existing
offerings.
The Company does business worldwide, both directly and via sales
to United States-based original equipment manufacturers, who sell
such products internationally. The Company expects that
international revenues will continue to account for a significant
portion of its total revenues. Although most of the Company's
sales are denominated in US Dollars, exchange rate fluctuations
could cause the Company's products to become relatively more
expensive to customers in a particular country, causing a decline
in revenues and profitability in that country. In addition,
international sales, particularly in Europe, are typically
adversely affected in the third quarter due to a reduction in
business activities during the summer months. Furthermore, global
20
<PAGE>
and/or regional economic factors and potential changes in laws
and regulations affecting the Company's business, including
without limitation, communications regulatory standards, safety
and emissions control standards, difficulty in staffing and
managing foreign operations, longer payment cycles and difficulty
in collecting foreign receivables, currency exchange rate
fluctuations, changes in monetary and tax policies, tariffs,
difficulties in enforcement of intellectual property rights and
political uncertainties, could have an adverse impact on the
Company's financial condition or future results of operations.
Some of the Company's products incorporate encryption, or
scrambling, features to protect the security, confidentiality,
and integrity of text or data transmissions. Products with
encryption features are subject to export restrictions under the
laws of the U.S., Canada, and other countries. In countries
other than the U.S. and Canada, encryption products may also be
subject to import and/or use restrictions. These restrictions
may require the Company or its customers to obtain licenses; may
require technical modifications to products; and may prohibit
sales of some products to certain destinations or customers. In
light of these restrictions, the Company's products available
abroad may contain significantly weaker encryption capabilities
than those available in the U.S. and Canada, and there can be no
assurance that the Company will continue to be able to export its
products to destinations outside of the U.S. and Canada.
Accordingly, these restrictions could potentially have an adverse
effect on the Company's business, financial conditions, or
results of operations.
The Company is exposed to potential credit risks as a result of
accounts receivable from distributors, resellers, OEM and direct
customers, with respect to which the Company does not generally
require collateral.
The Company is currently dependent on three subcontractors for
the manufacture of significant portions of its products.
Although the Company believes that there are a limited number of
other qualified subcontract manufacturers for its products, a
change in subcontractors could result in delays or reductions in
product shipments. In addition, certain components of the
Company's products are only available from a limited number of
suppliers. The inability to obtain sufficient key components as
required could also result in delays or reductions in product
shipments. Such delays or reductions could have an adverse
effect on the Company's results of operations.
The Company's proposed acquisition by Intel Corporation is
subject to a number of closing conditions, including, without
limitation, regulatory and stockholder approval. Accordingly,
there can be no assurance the proposed transaction will be
consummated. The failure of the Company to consummate the
transaction could require the Company to pay certain fees and
expenses pursuant to its agreement with Intel and could also
adversely impact the Company's relationships with current and
potential employees, customers, suppliers and others. As a
result of these and other factors, such failure could have a
material adverse effect on the Company's business, financial
condition and results of operations, including an adverse impact
on the Company's fourth quarter revenues. In addition, any
announcement concerning the actual or potential termination of
the transaction could have a material adverse effect on the
trading price of the Common Stock.
The legal proceedings discussed below under the caption "Legal
Proceedings" could have a material adverse effect on the
Company's financial condition.
See also the discussion above under the caption "Year 2000."
The market price of the Company's securities could be subject to
wide fluctuations in response to quarter-to-quarter variations in
operating results, changes in earnings estimates by analysts, and
market conditions in the industry, as well as general economic
conditions and other factors external to the Company.
Other factors that may affect future results include the accuracy
of the Company's internal estimates of revenues and operating
expense levels and the realization of the intended benefits of
the 1998 restructuring.
Because of the foregoing factors, the Company believes that
period-to-period comparisons of its financial results are not
necessarily meaningful and expects that its results of operations
may fluctuate from period to period in the future.
21
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
- ----------- ----------------------
<S> <C>
Exhibit 4.1 Amendment No. 1 to Rights Agreement dated as of
September 29, 1995 between the Company and American Stock
Transfer & Trust Company, dated as of October 19, 1998 is
incorporated herein by reference to Exhibit 4.1 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended October 3, 1998 (File No. 000-24918).
Exhibit 10.1 Amendment dated September 28, 1998 to the
Agreement dated February 27, 1998 by and between the
Company and Northern Telecom, Inc. is incorporated herein
by reference to Exhibit 10.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended October 3, 1998
(File No. 000-24918).
Exhibit 27.0 Restated Financial Data Schedule.
(b) Reports on Form 8-K: The Company filed no reports on Form 8-
K during the three-month period ended October 3, 1998.
</TABLE>
22
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
SHIVA CORPORATION
Date: January 21, 1999 by: /s/ Robert P. Cirrone
Senior Vice President, Finance and
Administration, and Chief Financial
Officer (Principal Financial and
Accounting Officer)
23
<PAGE>
EXHIBIT INDEX
-------------
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
- ----------- ----------------------
<S> <C>
Exhibit 4.1 Amendment No. 1 to Rights Agreement dated as of
September 29, 1995 between the Company and American Stock
Transfer & Trust Company, dated as of October 19, 1998 is
incorporated herein by reference to Exhibit 4.1 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended October 3, 1998 (File No. 000-24918).
Exhibit 10.1 Amendment dated September 28, 1998 to the
Agreement dated February 27, 1998 by and between the
Company and Northern Telecom, Inc. is incorporated herein
by reference to Exhibit 10.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended October 3, 1998
(File No. 000-24918).
Exhibit 27.0 Restated Financial Data Schedule.
</TABLE>
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-START> JAN-03-1998
<PERIOD-END> OCT-03-1998
<CASH> 28,662
<SECURITIES> 39,353
<RECEIVABLES> 24,696
<ALLOWANCES> 8,718
<INVENTORY> 12,694
<CURRENT-ASSETS> 107,038
<PP&E> 50,741
<DEPRECIATION> 31,038
<TOTAL-ASSETS> 175,668
<CURRENT-LIABILITIES> 40,286
<BONDS> 0
0
0
<COMMON> 305
<OTHER-SE> 134,502
<TOTAL-LIABILITY-AND-EQUITY> 175,668
<SALES> 108,017
<TOTAL-REVENUES> 108,017
<CGS> 48,200
<TOTAL-COSTS> 48,200
<OTHER-EXPENSES> 81,571
<LOSS-PROVISION> 976
<INTEREST-EXPENSE> 203
<INCOME-PRETAX> (17,800)
<INCOME-TAX> (5,696)
<INCOME-CONTINUING> (12,104)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (12,104)
<EPS-PRIMARY> (0.40)
<EPS-DILUTED> (0.40)
</TABLE>
