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 July 4, 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 July 4, 1998 was 30,330,020.
<PAGE> 1
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 research and
development ("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 9 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 July
4, 1998.
<PAGE> 2
<TABLE>
SHIVA CORPORATION
Consolidated Balance Sheet
(in thousands, except share related data)
<CAPTION>
July 4, January 3,
1998 1998
----------- -----------
(unaudited)
(As Restated-
See Note 9)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 21,113 $ 58,915
Short-term investments 45,914 36,868
Accounts receivable, net of
allowances of $8,148 at July 4,
1998 and $8,037 at January 3, 1998 19,493 23,169
Inventories 10,939 14,058
Deferred income taxes 8,683 8,683
Prepaid expenses and other current
assets 2,102 2,369
-------- --------
Total current assets 108,244 144,062
Property, plant and equipment, net 20,185 26,093
Deferred income taxes 13,311 8,840
Goodwill, net 31,987 -
Other assets 4,885 3,251
-------- --------
Total assets $178,612 $182,246
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 6,542 $ 9,376
Accrued expenses 28,692 22,304
Deferred revenue 5,002 4,068
-------- --------
Total current liabilities 40,236 35,748
Deferred income taxes 561 554
-------- --------
Total liabilities 40,797 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,
30,436,135 and 29,605,848 shares
issued and outstanding at July 4,
1998 and January 3, 1998, respectively 304 296
Additional paid-in capital 154,688 153,036
Treasury stock at cost, 106,115 shares
at July 4, 1998 (1,307) -
Unrealized gain on investments 32 110
Cumulative translation adjustment (244) (308)
Accumulated deficit (15,658) (7,190)
-------- --------
Total stockholders' equity 137,815 145,944
-------- --------
Total liabilities and stockholders'
equity $178,612 $182,246
======== ========
<FN>
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
<PAGE> 3
<TABLE>
SHIVA CORPORATION
Consolidated Statement of Operations
(in thousands, except per share data)
(unaudited)
<CAPTION>
Three months ended Six months ended
---------------------- ----------------------
July 4, June 28, July 4, June 28,
1998 1997 1998 1997
-------- -------- -------- --------
(As Restated- (As Restated-
See Note 9) See Note 9)
<S> <C> <C> <C> <C>
Revenues:
Product $27,678 $33,598 $57,494 $58,966
Service 8,460 1,628 16,634 3,169
Licenses and Royalties 2,156 4,512 2,197 8,762
------- ------- ------- -------
Total revenues 38,294 39,738 76,325 70,897
------- ------- ------- -------
Cost of revenues:
Product 12,524 14,256 25,879 34,343
Service 5,038 1,693 10,232 3,245
------- ------- ------- -------
Total cost of revenues 17,562 15,949 36,111 37,588
------- ------- ------- -------
Gross profit 20,732 23,789 40,214 33,309
------- ------- ------- -------
Operating expenses:
Research and development 4,640 5,778 9,221 11,739
Selling, general and
administrative 14,994 20,409 29,802 38,307
In-process research and
development - - 2,100 -
Goodwill amortization 2,908 - 2,908 -
Restructuring expenses 9,435 - 11,065 -
------- ------- ------- -------
Total operating expenses 31,977 26,187 55,096 50,046
------- ------- ------- -------
Loss from operations (11,245) (2,398) (14,882) (16,737)
Interest income 891 938 2,014 1,900
Interest and other income
(expense), net 614 (146) 415 (268)
-------- ------- -------- --------
Loss before income taxes (9,740) (1,606) (12,453) (15,105)
Income tax benefit (3,117) (610) (3,985) (5,739)
-------- ------- --------- --------
Net loss $(6,623) $ (996) $ (8,468) $(9,366)
======== ======== ========= ========
Net loss per share -
basic and diluted $ (0.22) $ (0.03) $ (0.28) $ (0.32)
======== ======== ========= ========
Shares used in computing
net loss per share -
basic and diluted 30,277 29,128 30,065 29,050
======== ======== ========= ========
<FN>
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
<PAGE> 4
<TABLE>
SHIVA CORPORATION
Consolidated Statement of Cash Flows
Increase (Decrease) in Cash and Cash Equivalents
(in thousands)
(unaudited)
<CAPTION>
Six Months Ended
-----------------------
July 4, June 28,
1998 1997
------- --------
(As Restated-
See Note 9)
<S> <C> <C>
Cash flows from operating activities
Net loss $ (8,468) $ (9,366)
Adjustments to reconcile net loss
to net cash provided by
operating activities:
In-process research and development 2,100 -
Depreciation and amortization 9,005 4,631
Non-cash restructuring charge 3,570 -
Deferred income taxes (4,023) (6,443)
Changes in assets and liabilities,
net of effects of acquisition:
Accounts receivable 4,531 13,640
Inventories 3,221 2,162
Prepaid expenses and other
current assets 310 19
Accounts payable (3,353) (4,239)
Accrued expenses 6,341 (420)
Deferred revenue 929 571
Other long-term liabilities - (17)
-------- --------
Net cash provided by operating
activities 14,163 538
-------- --------
Cash flows from investing activities
Purchases of property, plant and
equipment (2,257) (5,910)
Payments for acquisition (39,912) -
Capitalized software development
costs (88) (399)
Purchases of short-term investments (27,119) (10,686)
Proceeds from maturity and sales of
short-term investments 17,995 16,109
Change in other assets (330) (824)
-------- --------
Net cash used by investing
activities (51,711) (1,710)
--------- ---------
Cash flows from financing activities
Principal payments on long-term
debt and capital lease obligations (117) (229)
Purchases of treasury stock (1,307) -
Proceeds from exercise of stock
options 1,212 671
--------- ---------
Net cash provided (used) by
financing activities (212) 442
--------- ---------
Effects of exchange rate changes on
cash and cash equivalents (42) 583
--------- ---------
Net decrease in cash and cash
equivalents (37,802) (147)
Cash and cash equivalents, beginning
of period 58,915 72,067
--------- ---------
Cash and cash equivalents, end of
period $ 21,113 $ 71,920
========= =========
<FN>
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
<PAGE> 5
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 six-
month periods ended July 4, 1998 and the in-process R&D charges
incurred during the six-month period ended July 4, 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 six-month
periods ended July 4, 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 Six months ended
------------------------- ------------------------
July 4, June 28, July 4, June 28,
1998 1997 1998 1997
------------ ----------- ------------ ----------
(As Restated (As Restated
See Note 9) See Note 9)
<S> <C> <C> <C> <C>
Net Loss ($6,623,000) ($996,000) ($8,468,000) ($9,366,000)
============ =========== ============ ============
Weighted average shares
outstanding 30,276,645 29,128,123 30,065,206 29,049,872
Common-equivalent shares
outstanding - - - -
------------ ----------- ------------ ------------
Weighted average and
common-equivalent
shares outstanding 30,276,645 29,128,123 30,065,206 29,049,872
------------ ----------- ------------ ------------
Basic and diluted net
loss per share ($0.22) ($0.03) ($0.28) ($0.32)
============= =========== ============ ============
</TABLE>
3. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS:
At July 4, 1998, the Company had cash and cash equivalents of
$21,113,000 and $45,914,000 of short-term investments, including
an unrealized gain of $32,000 recorded as a separate component of
stockholders' equity. The Company's short-term investments at
July 4, 1998, classified as available-for-sale, consist of
municipal securities, corporate debt securities, certificates of
deposit, and U.S. Treasury securities, with various maturity
dates through June 2000.
<PAGE> 6
4. INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
(in thousands) July 4, January 3,
1998 1998
---- ----
<S> <C> <C>
Raw materials $ 5,150 $ 7,199
Work-in-process 126 57
Finished goods 5,663 6,802
------- -------
$10,939 $14,058
</TABLE> ======= =======
5. COMPREHENSIVE LOSS:
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130 ("SFAS 130"),
"Reporting Comprehensive Income." The Company adopted SFAS 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 six-month periods ended July 4, 1998 was
$6,733,000 and $8,478,000, respectively, and includes the after-tax
effect of foreign currency translation adjustments and unrealized
holding losses arising during the period.
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
balances. The acquisition was accounted for as a purchase.
Accordingly, the purchase price of approximately $39,912,000 was
allocated to the underlying assets and liabilities based on their
respective fair values at the date of closing. The estimated
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 and the in-process
R&D is being amortized on a straight-line basis over three
years. This excess approximated $37,195,000, and consisted of
$34,895,000 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.
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.
<PAGE> 7
<TABLE>
<CAPTION>
(in thousands)
Three-months ended Six-months ended
------------------------ ------------------------
July 4, June 28, July 4, June 28,
1998 1997 1998 1997
----------- ----------- --------- ----------
(As Restated (As Restated
See Note 9) See Note 9)
<S> <C> <C> <C> <C>
Total revenues $ 38,294 $ 39,890 $ 77,583 $ 71,276
Operating loss (11,245) (6,118) (15,901) (24,414)
Net loss (6,623) (3,538) (9,392) (14,589)
========= ========= ========= =========
Net loss per share -
basic and diluted $ (0.22) $ (0.12) $ (0.31) $ (0.50)
========= ========= ========= ========
</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:
In the three-month period ended July 4, 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 which were based in Europe and the remainder in the
United States. A majority of these employees identified were
terminated on July 13, 1998 and the remaining terminations are
expected to be substantially complete by the end of fiscal 1998.
The Company 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, and
$647,000 in advertising and marketing, and $633,000 in transition
and other costs. As of July 4, 1998, $1,186,000 of severance,
benefits and other personnel-related costs and $217,000 of
transition and other costs had been paid, and approximately
$4,462,000 remained as an accrued liability.
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
transition and other costs of $148,000, were the result of the
restructuring of the Company's sales and marketing operations.
Substantially all of these costs have been paid.
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.
<PAGE> 8
9. 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 and July 4, 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 six-month periods ended July 4, 1998. A summary
of the significant effects of the restatement are as follows (in
thousands):
<PAGE> 9
<TABLE>
<CAPTION>
Statement of Operations:
Three months Six months
Ended Ended
July 4, 1998 July 4, 1998
------------- ------------
<S> <C> <C>
Operating expenses:
As previously reported $29,277 $ 84,796
Adjustment related to
in-process R&D and goodwill
amortization 2,700 (29,700)
--------- ----------
Restated 31,977 55,096
========= ==========
Loss before income taxes:
As previously reported (7,040) (42,153)
Adjustment related to
in-process R&D and goodwill
amortization (2,700) 29,700
---------- ----------
Restated (9,740) (12,453)
========== ==========
Income tax benefit:
As previously reported (2,253) (13,489)
Adjustment related to
in-process R&D and goodwill
amortization (864) 9,504
---------- ----------
Restated (3,117) (3,985)
========== ==========
Net loss:
As previously reported (4,787) (28,664)
Adjustment related to
in-process R&D and
goodwill amortization (1,836) 20,196
---------- ----------
Restated (6,623) (8,468)
========== ==========
Net loss per share - basic and
diluted:
As previously reported (0.16) (0.95)
Adjustment related to in-process
R&D and goodwill amortization (0.06) 0.67
---------- ----------
Restated $ (0.22) $ (0.28)
========== ==========
</TABLE>
<TABLE>
<CAPTION>
Balance Sheet:
July 4, 1998
--------------------------
As Previously
Reported As Restated
------------- -----------
<S> <C> <C>
Goodwill, net (1) $ - $ 31,987
Other assets (1) 7,172 4,885
Long-term deferred income taxes 22,815 13,311
Total assets 158,416 178,612
Total stockholders' equity 117,619 137,815
<FN>
(1) Goodwill, net, in the amount of $2,287 was included in
other assets prior to restatement.
</TABLE>
<PAGE> 10
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 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 and July 4, 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 six-month periods ended July 4, 1998.
Results of Operations
Nortel Agreement. On February 27, 1998, the Company signed a new
multi-year agreement (the "1998 Agreement") with Northern Telecom
Inc. ("Nortel"). The Company and Nortel have been working
together to provide remote access equipment to service providers
since 1995. Under the new agreement, Nortel issues 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. The Company's ability to recognize
revenue related to these purchase orders, however, may be
impacted by several factors including, but not limited to, the
timing of the orders placed, the ability of the Company to ship
products in a timely fashion and product availability. These OEM
purchases from Nortel replace the minimum royalty arrangement
with the Company that was in effect during fiscal 1997. In
addition, the Company received total professional services
revenue of $12,000,000 during the first two quarters of fiscal
1998 from Nortel related to the development of carrier class
remote access technology. The OEM purchases and professional
services are expected to result in higher revenues from Nortel in
fiscal 1998 which will carry lower gross margins than achieved in
1997. Gross margins on sales to Nortel are expected to decline
in fiscal 1998 primarily due to the fact that a significant
portion of the revenues from Nortel in fiscal 1997 consisted of
royalty revenues, with little or no direct cost, related to the
Rapport 112, an OEM version of the LanRover Access Switch.
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 will be accounted for as $2,000,000 in LanRover
Access Switch revenue and $600,000 in other income per quarter
over the license term.
Revenues. Revenues in the three-month and six-month periods
ended July 4, 1998 were $38,294,000 and $76,325,000,
respectively, compared to $39,738,000 and $70,897,000 in the
comparable periods in fiscal 1997, respectively. The 4% decrease
in revenues in the three-month period ended July 4, 1998 was
primarily due to lower volume shipments of the Company's LanRover
and LanRover Access Switch products. Revenues increased 8% in
the six-month period ended July 4, 1998 compared to the
corresponding period in fiscal 1997 principally due to higher
service revenues, which increased to $16,634,000 in the six-month
period ended July 4, 1998 from $3,169,000 during the comparable
<PAGE> 11
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 product and license and
royalty revenues. Revenues in the six-month period ended June
28, 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
six-month periods ended July 4, 1998 decreased to $14,978,000 and
$29,517,000, respectively, from $19,882,000 and $31,248,000 in
the comparable periods in fiscal 1997, primarily due to lower
volume shipments. Revenues from the LanRover Access Switch in
fiscal 1997 included minimum royalty revenues from Nortel that
were based on sales of the Nortel Rapport 112, an OEM version of
the LanRover Access Switch. These royalty revenues, which will
not recur in fiscal 1998 as outlined above, were partially offset
by price protection provisions of $2,800,000 recorded in the
first quarter of fiscal 1997 as outlined above.
Revenues from the LanRover product line in the three-month and
six-month periods ended July 4, 1998 decreased to $8,392,000 and
$18,138,000, respectively, from $13,433,000 and $25,763,000 in
the comparable periods in fiscal 1997, primarily due to lower
volume shipments. LanRover revenues in the six-month period ended
June 28, 1997 were negatively impacted by price protection
provisions of $3,900,000 as previously mentioned.
Revenues from the Company's other remote access products
increased to $5,228,000 and $9,179,000, respectively, in the
three-month and six-month periods ended July 4, 1998 from
$3,035,000 and $7,032,000 in the comparable periods in fiscal
1997. The increase in the three-month and six-month periods
ended July 4, 1998 was primarily related to sales of the Shiva
AccessPort product for the small office and home office market
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
$1,993,000, or 5% of gross revenues, and $5,316,000, or 7% of
gross revenues, in the three-month and six-month periods ended
July 4, 1998, respectively. Provisions for product returns in
the corresponding periods in fiscal 1997 were $726,000, or 2% of
gross revenues, and $11,345,000, or 14% of gross revenues. The
decrease in the provision for product returns in the six-month
period ended July 4, 1998 compared to the same period in fiscal
1997 was 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 35% and 32% of revenues
in the three-month and six-month periods ended July 4, 1998,
respectively, compared to 19% and 25% in the comparable periods
in fiscal 1997. The increase in OEM revenues was primarily due
to increased revenues from Nortel, partially offset by decreased
revenues from IBM.
International revenues accounted for 32% and 36% of revenues in
the three-month and six-month periods ended July 4, 1998,
respectively, compared with 45% and 53% in the corresponding
periods in fiscal 1997. International revenues were lower in the
three-month and six-month periods ended July 4, 1998 due to
weakness in Europe and the Pacific Rim. International revenues
represented a higher proportion of total revenues in the six-
month period ended June 28, 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 $20,732,000 and $40,214,000, in
the three-month and six-month periods ended July 4, 1998,
respectively, compared to $23,789,000 and $33,309,000 in the
comparable periods in fiscal 1997. This represented 54% and 53%
of revenues in the three-month and six-month periods ended July
4, 1998, respectively, compared to 60% and 47% in the
<PAGE> 12
corresponding periods in 1997. Gross profit in the six-month
period ended June 28, 1997 included the negative impact of price
protection provisions of $6,700,000, as discussed above, 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 60% in the six-month
period ended June 28, 1997. Gross profit as a percentage of
revenues was negatively impacted in the three-month and six-month
periods ended July 4, 1998 due to the professional services
revenue and OEM product 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 periods. The lower
gross profit percentages on the professional services revenue and
the OEM product revenues from Nortel are partially offset by the
100% gross profit on the $2,000,000 LanRover Access Switch
revenue related to the previously mentioned license agreement
with Nortel. 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 distribution
channels used, changes in component costs and the introduction of
new products.
Research and Development. Research and development expenses
during the six-month period ended July 4, 1998 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
$4,640,000 and $9,221,000 in the three-month and six-month
periods ended July 4, 1998 from $5,778,000 and $11,739,000 during
the comparable periods in fiscal 1997. The decrease in these
expenses was primarily due to the restructuring of the Nortel
arrangement in fiscal 1998 under which Nortel contracted with the
Company for the development of carrier class remote access
technology. Under the terms of the 1998 Agreement, the Company
has recognized $6,000,000 in professional services revenue during
each of the first two quarters of fiscal 1998 as work was
performed. Accordingly, expenses related to these development
efforts of $3,711,000 and $7,422,000 in the three-month and six-
month periods ended July 4, 1998, respectively, have been
included in cost of service revenues in the accompanying
statement of operations. Customer funded development fees under
cost sharing relationships (including those with Nortel in fiscal
1997), which are reflected as an offset to research and
development expenses, were $1,818,000 and $3,454,000 in the three-
month and six-month periods ended June 28, 1997. There were no
such fees recorded in the three-month and six-month periods ended
July 4, 1998. There were no capitalized software development
costs in the three-month period ended July 4, 1998, compared with
$245,000 for the comparable period in fiscal 1997. Capitalized
software development costs were $88,000 for the six-month period
ended July 4, 1998, compared with $400,000 in the comparable
period in fiscal 1997. Gross research and development expenses
increased to $8,352,000 and $16,731,000, respectively, in the
three-month and six-month periods ended July 4, 1998 from
$7,840,000 and $15,593,000 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.
Selling, General and Administrative. Selling, general and
administrative expenses decreased to $14,994,000 and $29,802,000
in the three-month and six-month periods ended July 4, 1998 from
$20,409,000 and $38,307,000 in the comparable periods in fiscal
1997. These expenses represented 39% of revenues in the three-
month and six-month periods ended July 4, 1998, respectively,
compared to 51% and 54% 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 six-month periods
ended June 28, 1997 are net of expenses reimbursed by Nortel of
$1,532,000 and $2,208,000, 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
<PAGE> 13
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.
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
<PAGE> 14
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 $2,908,000 in the three-month period ended July 4, 1998
related to its acquisition of Isolation. At July 4, 1998, the
Company had net goodwill of $31,987,000 remaining to amortize
over three years from the date of acquisition of Isolation.
Restructuring Expenses. The Company recorded restructuring
expenses of $9,435,000 and $11,065,000 in the three-month and six-
month periods ended July 4, 1998, respectively. Restructuring
expenses primarily consisted of $4,585,000 in 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. These
restructuring expenses were primarily a result of a formal plan
announced by the Company on April 15, 1998 to restructure its
worldwide operations and align its financial model with the
recently announced strategic focus on providing remote access
solutions for business. Specifically, Shiva will close
operations at the Edinburgh, Scotland, facility and will relocate
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
further expects to take an additional charge of $1,000,000 to
$3,000,000 in the third quarter of 1998 to complete its
restructuring effort. This will bring total anticipated 1998
restructuring charges to $12,000,000 to $14,000,000, which
includes $1,630,000 of charges related to the restructuring of
the Company's sales and marketing operations, which were recorded
in the first quarter of 1998. The Company anticipates that
substantially all of the cash 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 July 4, 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 six-month period ended July 4, 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 (expense) for the three-month period ended July
4, 1998 increased due to the inclusion of $600,000 of income
resulting from the previously mentioned option exercised by
Nortel for certain other items related to intellectual property.
Income Tax Benefit. The Company's effective tax rate in each of
the three-month and six-month periods ended July 4, 1998 was 32%,
down from 38% in each of the three-month and six-month periods
ended June 28, 1997, primarily due to the impact of nondeductible
restructuring charges.
Foreign Currency Fluctuations
Foreign currency fluctuations did not have a significant impact
on the comparison of the results of operations in the three-month
and six-month periods ended July 4, 1998 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.
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 time-
sensitive software applications which 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
evaluating its products for Year 2000 compliance and is currently
<PAGE> 15
aware that the SpiderManager and the 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 having to undertake
additional research and development efforts or incur additional
expenses in this regard. 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 issue has been corrected in Shiva Access Manager
NT version 2.0 and greater, and the company strongly recommends
that its customers upgrade to version 2.0 to correct the problem.
The Company does not anticipate having to undertake additional
research and development efforts or incur additional expenses for
this issue. In addition, the Company recently discovered that
certain versions of its Shiva Access Manager product may contain
an additional Year 2000 issue. The Company is currently
investigating this issue, and has not yet determined the nature
and extent of this issue. Therefore, the Company can not
currently determine the extent of any additional research and
development efforts or additional expenses which may be required
to remedy this Year 2000 issue. In addition, the Company is in
the process of replacing many of its business and operating
computer systems with software which, when upgraded, will be Year
2000 compatible. The Company is planning to complete all
necessary Year 2000 upgrades of its major systems in 1998, and is
currently identifying and developing conversion strategies for
its remaining systems that may be impacted by the Year 2000
issue. While the Company does not believe that the Year 2000
issue will have a material impact on the Company, there can be no
assurance that unanticipated problems will not arise that will
have a material adverse effect on the Company's business and
results of operations.
Liquidity and Capital Resources
As of July 4, 1998, the Company had $21,113,000 of cash and cash
equivalents and $45,914,000 of short-term investments. Working
capital decreased by 37% to $68,008,000 at July 4, 1998 from
$108,314,000 at January 3, 1998.
Net cash provided by operations totaled $14,163,000 for the six-
month period ended July 4, 1998 compared with $538,000 during the
comparable period in fiscal 1997. Net cash provided by
operations in the six-month period ended July 4, 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 increased collection
activities, and the decrease in inventories is due to improved
inventory management. The increase in accrued expenses is
primarily due to accrued severance costs related to the
restructuring of the Company mentioned previously. Net cash
provided by operations in the six-month period ended June 28,
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 $51,711,000 for the
six-month period ended July 4, 1998, compared to $1,710,000
during the comparable period in fiscal 1997. Investment activity
in the six-month period ended July 4, 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 six-month period ended June 28, 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 used by financing activities totaled $212,000 for the
six-month period ended July 4, 1998, compared to net cash
provided of $442,000 in the comparable period in fiscal 1997.
Net cash used by financing activities for the six-month period
ended July 4, 1998 primarily consisted of the purchase of
treasury stock, partially offset by proceeds from stock option
<PAGE> 16
exercises. Net cash provided by financing activities in the six-
month period ended June 28, 1997 consisted of proceeds from stock
option exercises, 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 July 4, 1998, available
borrowings were reduced by outstanding letters of credit of
$837,000 which expire at various dates in 1998. The Company had
no borrowings outstanding under this line at July 4, 1998. At
July 4, 1998, the Company was in violation of certain covenants
of this credit facility which have been waived by the bank. There
can be no assurance that the bank will waive any such violations
in the future, which could require the Company to obtain an
alternative credit facility on terms less favorable than the
current facility. The Company also has a foreign credit facility
of approximately $2,613,000, all of which was available at July
4, 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
July 4, 1998.
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 July 4, 1998, the Company had outstanding forward
exchange contracts to purchase $5,198,000 and to sell $1,379,000
in various currencies which matured on July 23, 1998.
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.
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 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 has been party to a strategic relationship with
Nortel since 1995 which has evolved over time. Under the terms of
<PAGE> 17
the 1998 Agreement with Nortel signed on February 27, 1998,
Nortel will purchase minimum quarterly amounts of the Company's
products within 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. There can be no assurance that Nortel will
purchase in excess of the minimum amount or that the Company will
be able to fulfill such orders from Nortel and thus recognize the
revenue associated with such orders, in a linear fashion over the
contract term. Non-linear order patterns from Nortel could cause
material fluctuations in the Company's quarterly financial
results. In addition, the Company has received professional
services revenue from Nortel, through the second quarter of
fiscal 1998, related to the development of carrier class remote
access technology. There is no obligation on the part of Nortel
to contract for additional such development services nor does the
Company expect to provide such services beyond the second quarter
of fiscal 1998. Revenues from Nortel have exceeded 10% of total
revenues in the six-month period ended July 4, 1998 and in fiscal
1997 and 1996.
On March 26, 1998, the Company completed its acquisition of
Isolation, a leading developer of VPN hardware and software
solutions based in Toronto, Ontario. Achieving the anticipated
benefits of this acquisition or any other acquisitions the
Company may undertake will depend in part upon whether the
effective integration of the acquired companies' research and
development organizations, products and technologies, and sales,
marketing and administrative organizations is accomplished in a
timely manner. There can be can be no assurance that the Company
will be successful in integrating the operations of Isolation.
Moreover, the integration process may temporarily divert
management attention from the day-to-day business of the Company.
Failure to successfully accomplish the integration of Isolation
could have a material adverse effect on the Company's business,
financial condition and/or results of operations.
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
expmrience 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 increasingly 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
six 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 the Company's products is characterized by rapidly
changing technology, evolving industry standards and frequent new
product introductions. The Company's future success will depend
on its ability to enhance its existing products and to introduce
new products and services to meet and adapt to changing customer
requirements and emerging technologies, such as VPN and other
technologies. The introduction of new products requires the
Company to manage the transition from its older product offerings
in order to minimize the impact on customer ordering patterns,
avoid excessive levels of obsolete inventories and to ensure that
adequate supplies of new products are available to meet customer
demand.
<PAGE> 18
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 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. Increased
competition could result in price reductions and loss of market
share which would 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 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
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.
<PAGE> 19
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, the outcome of the litigation discussed below
under "Legal Proceedings," the Company's ability to complete all
necessary Year 2000 upgrades in a timely and cost-effective
manner, the realization of the intended benefits of the 1998
restructuring, and material changes in the level of customer-
funded research and development activities.
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.
<PAGE> 20
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 10.1 Sublease Between Shiva Corporation, Landlord, and
Netcentric Corporation, Tenant, dated May 29, 1998 is
incorporated herein by reference to Exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended July 4, 1998 (File No. 000-24918).
Exhibit 27.0 Restated Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K:
The Company filed a Current Report on Form 8-K dated April 9,
1998 pursuant to Item 2 thereof, reporting the completion of its
acquisition of substantially all of the assets of Isolation, an
Ontario corporation, for approximately US$37,000,000 in cash
pursuant to an Asset Purchase Agreement dated as of February 18,
1998 between the Company and Isolation. In addition, the Company
assumed substantially all the liabilities of Isolation as part of
the acquisition, including the payment of transaction fees
associated with the acquisition of approximately in the aggregate
of US$1,900,000.
<PAGE> 21
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)
<PAGE> 22
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
- ----------- ----------------------
<S> <C>
Exhibit 10.1 Sublease Between Shiva Corporation, Landlord, and
Netcentric Corporation, Tenant, dated May 29, 1998 is
incorporated herein by reference to Exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended July 4, 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> 6-MOS
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-START> JAN-03-1998
<PERIOD-END> JUL-04-1998
<CASH> 21,113
<SECURITIES> 45,914
<RECEIVABLES> 27,641
<ALLOWANCES> 8,148
<INVENTORY> 10,939
<CURRENT-ASSETS> 108,244
<PP&E> 49,299
<DEPRECIATION> 29,114
<TOTAL-ASSETS> 178,612
<CURRENT-LIABILITIES> 40,236
<BONDS> 0
0
0
<COMMON> 304
<OTHER-SE> 137,511
<TOTAL-LIABILITY-AND-EQUITY> 178,612
<SALES> 76,325
<TOTAL-REVENUES> 76,325
<CGS> 36,111
<TOTAL-COSTS> 36,111
<OTHER-EXPENSES> 55,096
<LOSS-PROVISION> 251
<INTEREST-EXPENSE> (415)
<INCOME-PRETAX> (12,453)
<INCOME-TAX> (3,985)
<INCOME-CONTINUING> (8,468)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,468)
<EPS-PRIMARY> (0.28)
<EPS-DILUTED> (0.28)
</TABLE>
