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SECURITIES AND EXCHANGE COMMISSION
Washington D. C. 20549
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FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________.
Commission File Number 0-19640
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VERTEL CORPORATION
(Exact name of Registrant as specified in its charter)
California 95-3948704
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
21300 Victory Boulevard, Suite 700, Woodland Hills, California 91367
(Address of principal executive offices) (Zip code)
(818) 227-1400
(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 as the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety days.
Yes X No .
- ---
As of November 8, 2000 there were 28,321,482 shares of common stock outstanding.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERTEL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 2000 1999
------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents..................................... $ 11,230 $ 3,974
Short-term investments........................................ 988 5,677
Trade accounts receivable (net of allowances of $536 as of
September 30, 2000 and $486 as of December 31, 1999).... 5,053 6,289
Prepaid expenses and other current assets..................... 362 519
-------- --------
Total current assets..................................... 17,633 16,459
Property and equipment, net........................................ 1,088 1,638
Investments........................................................ 1,437 1,437
Goodwill, net...................................................... 3,272 3,987
Other assets....................................................... 306 306
-------- --------
$ 23,736 $ 23,827
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................. $ 596 $ 931
Accrued wages and related liabilities......................... 1,639 1,672
Capital lease obligations..................................... -- 26
Accrued restructuring expenses................................ 48 439
Accrued taxes payable......................................... 508 483
Other accrued liabilities..................................... 1,747 1,773
Deferred revenue.............................................. 1,072 1,621
-------- --------
Total liabilities........................................ 5,610 6,945
-------- --------
Shareholders' equity:
Preferred stock, par value $.01, 2,000,000 shares authorized;
none issued and outstanding
Common stock, par value $.01, 100,000,000 shares authorized;
shares issued and outstanding: 2000, 28,309,738;
1999, 26,246,531................................. 283 262
Additional paid-in capital.................................... 86,470 82,049
Accumulated deficit........................................... (68,398) (65,242)
Accumulated comprehensive loss................................ (229) (187)
-------- --------
Total shareholders' equity............................... 18,126 16,882
-------- --------
$ 23,736 $ 23,827
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
VERTEL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Month Period Ended Nine Month Period Ended
---------------------------------- ----------------------------------
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net revenues:
License.................................... $ 1,735 $ 2,618 $ 8,170 $ 9,382
Service and other.......................... 1,629 2,072 5,486 5,432
------- ------- ------- -------
Net revenues......................... 3,364 4,690 13,656 14,814
------- ------- ------- -------
Cost of revenues:
License.................................... 235 353 713 1,344
Service and other.......................... 1,294 1,522 4,069 4,433
------- ------- ------- -------
Total cost of revenues............... 1,529 1,875 4,782 5,777
------- ------- ------- -------
Gross profit................................... 1,835 2,815 8,874 9,037
------- ------- ------- -------
Operating expenses:
Research and development................... 1,216 2,118 4,058 5,729
Sales and marketing........................ 1,887 2,547 5,357 6,306
General and administrative................. 830 1,078 2,883 3,041
General and administrative - non-cash
stock compensation..................... 35 -- 553 192
Goodwill amortization...................... 238 238 714 516
Restructuring benefit...................... -- (82) -- (82)
------- ------- ------- -------
Total operating expenses.............. 4,206 5,899 13,565 15,702
------- ------- ------- -------
Operating loss................................. (2,371) (3,084) (4,691) (6,665)
Other income, net.............................. 227 79 1,650 471
------- ------- ------- -------
Loss before provision for income taxes......... (2,144) (3,005) (3,041) (6,194)
Provision for income taxes..................... 35 30 115 50
------- ------- ------- -------
Net loss....................................... (2,179) (3,035) (3,156) (6,244)
Other comprehensive income (expense)........... 5 (29) (42) (21)
------- ------- ------- -------
Comprehensive loss............................. $(2,174) $(3,064) $(3,198) $(6,265)
======= ======= ======= =======
Basic and diluted net loss per common share ... ($0.08) ($0.12) ($0.11) ($0.25)
======= ======= ======= =======
Weighted average shares outstanding used in
net loss per common share calculations
basic and diluted....................... 28,165 25,452 27,670 25,337
</TABLE>
See accompanying notes to consolidated financial statements.
3
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VERTEL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Nine Month Period Ended
---------------------------------
September 30, September 30,
2000 1999
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss from operations......................................... $(3,156) $ (6,244)
Adjustments to reconcile net loss to net cash provided
by (used for) operating activities:
Depreciation and amortization.................................. 1,766 1,577
Reserve for returns and bad debts.............................. 50 135
Restructuring benefit.......................................... -- (82)
Non-cash stock compensation.................................... 553 208
Changes in operating assets and liabilities.................... 34 (1,545)
------- --------
Net cash used for operating activities......................... (753) (5,951)
------- --------
Cash flows from investing activities:
Net sales (purchases) of short-term investments.................. 4,689 (4,877)
Purchases of property and equipment.............................. (501) (1,208)
Cash paid for business acquisition, net of cash acquired......... -- (2,887)
Changes in other assets.......................................... -- 128
------- --------
Net cash provided by (used for) investing activities........... 4,188 (8,844)
------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options.......................... 3,889 314
Payments on capital lease obligations............................ (26) (576)
------- --------
Net cash provided by (used for) financing activities........... 3,863 (262)
------- --------
Effect of exchange rate changes on cash............................ (42) (21)
------- --------
Net increase (decrease) in cash and cash equivalents............... 7,256 (15,078)
Cash and cash equivalents, beginning of period..................... 3,974 19,495
------- --------
Cash and cash equivalents, end of period........................... $11,230 $ 4,417
======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
4
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VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
The consolidated financial statements include the accounts of Vertel
Corporation and its subsidiaries (the "Company"). Intercompany balances and
transactions have been eliminated in consolidation. The interim consolidated
financial statements are unaudited. In the opinion of management, the interim
financial statements include all adjustments, consisting of only normal,
recurring adjustments, necessary for a fair presentation of the Company's
financial position, results of operations and cash flows.
It is suggested that these consolidated financial statements and the
accompanying notes be read in conjunction with the audited consolidated
financial statements and the accompanying notes for the year ended December 31,
1999 included in the Company's Annual Report on Form 10-K. The results of
operations for the three and nine month periods ended September 30, 2000 are not
necessarily indicative of results that may be expected for the full year.
Certain reclassifications have been made to the 1999 consolidated financial
statements to conform to the 2000 consolidated financial statement presentation.
2. Statement of Cash Flows
Increases (decreases) in operating cash flows arising from changes in assets
and liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
Nine Month Period Ended
------------------------------
September 30, September 30,
2000 1999
------------- -------------
<S> <C> <C>
Trade accounts receivable..................... $ 1,186 $(1,501)
Prepaid expenses and other current assets .... 157 (26)
Accounts payable ............................. (335) 128
Accrued wages and related liabilities......... (33) 81
Cash payments for restructuring expenses...... (391) (1)
Other accrued liabilities..................... (26) 462
Accrued taxes payable......................... 25 (154)
Deferred revenue.............................. (549) (534)
------- -------
$ 34 $(1,545)
======= =======
</TABLE>
Cash payments of $391,000 were made for restructuring expenses in the nine
months ended September 30, 2000. These payments were primarily comprised of
severance and vacated facility costs.
3. Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which the Company is required to
adopt beginning in fiscal year 2001. SFAS No. 133 will require the Company to
record all derivatives on the balance sheet at fair value. Changes in
derivative fair values will either be recognized in earnings as offsets to the
changes in fair value of related hedged assets, liabilities and firm
commitments, or, for forecasted transactions, deferred and recorded as a
component of other comprehensive income until the hedge transactions occur and
are recognized in earnings. The ineffective portion of a hedging derivative's
change in fair value will be immediately recognized in earnings. The Company
does not believe the effect of adopting SFAS No. 133 will be material to its
operating results or financial position.
5
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VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
In December 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-9, which provides certain amendments
to SOP No. 97-2, and is effective for transactions entered into by the Company
beginning January 1, 2000. The Company's adoption of SOP No. 98-9 has not been
material to its financial position or its results of operations.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101, ("SAB 101") "Revenue Recognition in
Financial Statements," which provides guidance on the recognition, presentation
and disclosure of revenue in financial statements filed with the SEC. SAB 101
outlines the basic criteria that must be met to recognize revenue and provides
guidance for disclosures related to revenue recognition policies. The Company
has reviewed these criteria and believes its policies for revenue recognition to
be in accordance with SAB 101.
In March 2000, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions
Involving Stock Compensation - an interpretation of APB Opinion No. 25." FIN
44 clarifies the application of APB Opinion No. 25 and, among other issues
clarifies the following: the definition of an employee for purposes of applying
APB Opinion No. 25; the criteria for determining whether a plan qualifies as a
noncompensatory plan; the accounting consequence of various modifications to the
terms of the previously fixed stock options or awards; and the accounting for an
exchange of stock compensation awards in a business combination. FIN 44 is
effective July 1, 2000, but certain conclusions in FIN 44 cover specific events
that occurred after either December 15, 1998 or January 12, 2000. The Company
does not expect the application of FIN 44 to have a material impact on the
Company's financial position or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
We are a provider of telecommunications software and middleware for network
management applications. We develop, market, and support vertically integrated,
object oriented software solutions for the management of public
telecommunications networks. Our solutions cover the Telecommunications
Management Network (TMN) market and the emerging Common Object Request Broker
Architecture (CORBA) market. Our TMN products are based upon the International
Telecommunications Union's TMN standard and support network operation and
management over diverse transmission media and protocols. We believe that we
offer the only commercially available, fully interoperable suite of products and
tools that span the network element, element management, network management and
service management layers of the TMN model. Our CORBA software products (e*ORB)
are designed to enable Operations Support Systems (OSS) and network
infrastructure to integrate in ways which will accelerate network and service
deployment and provide for the transition from TMN managed networks to CORBA
solutions. The Vertel Mediation Framework (VMF) software product is used to
simplify and accelerate the integration of network infrastructure with telecom
OSS infrastructure. We offer embedded software for network equipment and
software solutions to allow telecommunications service providers to integrate
proprietary, Simple Network Management Protocol (SNMP), TMN, and CORBA based
network management systems with standards-based solutions. In addition, we offer
object oriented software platforms that facilitate the rapid development of
network and service management applications and features such as fault detection
and automatic response, remote improvement of network configuration, automation
of accounting and billing functions and optimization of network traffic and
security.
In September 2000, we announced plans to offer a new set of services based on
the VMF. These web-based hosted services, known as WebResolve, are designed to
automate service assurance functions for telecommunications providers. Costs
relating to the introduction of WebResolve are included in the financial
statements. However, we do not expect any material revenues until 2001.
We also provide professional services to customers such as turnkey management
solutions in addition to product integration and product application services.
Our professional services include system analysis and design, source code
portation and interface, custom application development, conformance and
certification testing and technical support services.
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
We sell products and services primarily through a direct sales force in the
United States and abroad and, in some territories, through third party agents.
Our customers include telecommunications service providers and their customers,
network equipment manufacturers, independent software developers and software
platform vendors.
We derive revenue primarily from software license fees, royalties and
services, including professional services, technical support and maintenance.
Software license fees consist primarily of licenses of our software products.
We recognize software license revenue based on the American Institute of
Certified Public Accountants Statement of Position No. 97-2, as amended.
Software license agreements generally do not provide for a right of return. We
maintain reserves for returns and potential credit losses, neither of which has
had a material effect on our results of operations or financial condition
through September 30, 2000.
Pursuant to source code license agreements, licensees may distribute binary or
embedded versions of our software in our licensees' products. Royalties become
due upon deployment of products containing the binary or embedded code.
Generally, software license royalty revenue is recognized upon notification by
our licensee that products incorporating our software have been shipped by our
licensee or, for customers for which we have sufficient historical information,
upon estimated amounts which we expect the customer to report. Because of the
development times required for licensees to design and ship products containing
binary or embedded software, we generally do not receive royalties from
shipments of such products for at least three quarters from the date we
initially ship source code.
We separately offer professional services, including system design and
engineering, custom application development, source code portation, conformance
testing and certification and application development. Many of our customers
contract for professional services. These services are typically based on a
detailed statement of work. Revenue from professional services is recognized
using the percentage of completion method, or on a time and materials basis. In
certain cases, customers reimburse us for non-recurring engineering efforts.
Such reimbursements are recognized as revenue and associated costs are reflected
as cost of revenues.
Our technical support services consist of product support and maintenance,
training and on-site consulting. Product support and maintenance fees have
constituted the majority of technical support and service revenue. Product
support and maintenance fees typically have ranged from 10-20% of the initial
source license fee and are recognized on a straight-line basis over the term of
the contract, which is generally six to twelve months. Other revenue from
training and on-site consulting is recognized as performed.
While we are largely dependent on products complying with the TMN
standard and must be evaluated in light of the risks and uncertainties
frequently encountered by companies dependent upon such standards and products,
we are expanding our products and technologies to reduce our dependence on TMN.
In addition, our markets are new and rapidly evolving which heightens these
risks and uncertainties. To address these risks, we must, among other things,
successfully implement our marketing strategy, respond to competitive
developments, continue to develop and upgrade our products and technologies more
rapidly than our competitors and commercialize our products and services
incorporating these enhanced technologies. There can be no assurance that we
will succeed in addressing any or all of these risks.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
FORWARD-LOOKING INFORMATION AND SAFE HARBOR STATEMENT UNDER THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.
This report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. In addition, forward-looking statements may be made orally or in press
releases, conferences, reports, on the Company's web site or otherwise, in the
future by or on behalf of the Company. Statements that are not historical are
forward-looking. When used by or on behalf of the Company, the words "expect,"
"anticipate," "estimate," "believe," "intend," and similar expressions generally
identify forward-looking statements.
Forward-looking statements involve risks and uncertainties. These
uncertainties include factors that affect all businesses operating in a global
market, as well as matters specific to the Company and the markets it serves.
Particular risks and uncertainties facing the Company at the present include the
Company's ability, including financial ability, to continue to invest in
research and development necessary for the development of new and existing
products (including WebResolve) that are required to offset the anticipated
decline in Telecommunications Management Network (TMN) revenues; the timely and
successful development of existing and new markets; the maturing nature of the
TMN product marketplace and the financial uncertainties associated with an
anticipated decline in TMN revenues as more fully described under "Results of
Operations--Net Revenues" below; the fact that some of our products are
relatively new and, although we see increasing market interest, it is difficult
to predict sales for new products such as e*ORB, Mediation Framework and
WebResolve and the ultimate adoption of these technologies by the marketplace is
uncertain; the length of the Company's sales cycle for most of its products,
including e*ORB and Mediation Framework, making initial license sales and future
royalties difficult to forecast; additional difficulty in predicting royalty
revenue because that revenue is dependent on successful development and
deployment by our customers of our products; fluctuation from quarter to quarter
in revenue from our professional service unit as a result of a limited number of
large consulting contracts, whether the Company has large contracts and the
timing of such contracts; loss of key customer, partner and alliance
relationships and the possibility that the Company may not be able to replace
the loss of a significant customer; the dependence on a limited number of
customers for a significant portion of the Company's quarterly license revenues;
size and timing of license fees closed during the quarter which may result in
large swings in quarterly operating results and the likely continued significant
percentage of quarterly revenues recorded in the last month of the quarter,
frequently in the last weeks or even days of a quarter, which further adds to
the difficulty of forecasting and leads to a substantial risk of variance from
actual results.
Additionally, more general risk factors include the possible development and
introduction of competitive products and new and alternative technologies by the
Company's competitors; the increasing sales and marketing costs of attracting
new and retaining existing customers; pricing, currency and exchange risks;
governmental and regulatory developments affecting the Company and its
customers; the ability to identify, conclude, and integrate acquisitions on a
timely basis; the ability to attract and/or retain essential technical or other
personnel; political and economic uncertainties associated with conducting
business on a worldwide basis; and the Company's ability to control expenditures
at a level consistent with revenues. Further risks inherent in the Company's
business are listed under "Risk Factors" in Part I, Item I of Vertel's Annual
Report on From 10-K for the fiscal year ended December 31, 1999 which is
incorporated by reference.
Readers are cautioned not to place undue reliance on any forward-looking
statement and to recognize that the statements are not predictions of actual
future results. Actual results could differ materially from those anticipated
in the forward-looking statements and from historical results, due to the risks
and uncertainties referred to above, as well as others not now anticipated. The
foregoing statements and Risk Factors are not exclusive and further information
concerning the Company and its business, including factors that potentially
could materially affect the Company's financial results, may emerge from time to
time. It is not possible for management to predict all risk factors or to
assess the impact of such risk factors on the Company's business. The Company
undertakes no obligation to revise or publicly release the results of any
revision to the forward-looking statements.
The following discussion should be read in conjunction with the unaudited
consolidated financial statements and accompanying notes, included in Part I -
Item 1 of this Quarterly Report, and the audited consolidated financial
statements and accompanying notes for the year ended December 31, 1999 contained
in the Company's Annual Report on Form 10-K.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Results of Operations
Net Revenues. Net revenues decreased 28% to $3,364,000 for the three months
ended September 30, 2000 (the "third quarter of 2000") compared to $4,690,000
for the three months ended September 30,1999 (the "third quarter of 1999"), and
decreased 8% to $13,656,000 for the nine months ended September 30, 2000 (the
"first three quarters of 2000") compared to $14,814,000 for the nine months
ended September 30,1999 (the "first three quarters of 1999").
License revenues consist primarily of license fees and royalties derived from
the Company's software solutions and development platforms. License revenues
decreased 34% to $1,735,000 during the third quarter of 2000 from $2,618,000
during the third quarter of 1999, primarily as a result of lower TMN product
revenues and lower revenues from legacy CORBA products. These decreases were
partially offset by license revenues from newer products, including the Vertel
Mediation Framework and e*ORB. License revenues for the first three quarters of
2000 decreased 13% to $8,170,000 compared to $9,382,000 for the first three
quarters of 1999. The decrease resulted primarily from lower TMN product
revenues and lower revenues from legacy CORBA products. These decreases were
partially offset by license revenues from newer products, including the Vertel
Mediation Framework and e*ORB. We believe that the TMN product marketplace is
maturing and we anticipate that revenues associated with such products will
decline in future quarters as telecommunications service providers and network
manufacturers look towards general computing technologies for the next phase of
integrated management solutions. While we offer such a product (e*ORB), there
can be no assurance that we will be successful in establishing e*ORB as a source
of consistent revenue.
Service revenues, which consist primarily of fees from professional service
unit (PSU) projects, software maintenance, training and non-recurring
engineering services, decreased 21% to $1,629,000 during the third quarter of
2000 from $2,072,000 during the third quarter of 1999. The decrease was the
result of lower software maintenance ($273,000), which was primarily due to non-
renewals of maintenance contracts on certain older or discontinued products,
lower PSU revenue ($111,000) and lower non-recurring engineering services
revenues ($59,000). However, service revenues for the first three quarters of
2000 increased 1% to $5,486,000 from $5,432,000 for the first three quarters of
1999. The revenue increase was primarily due to higher PSU revenue ($972,000),
which was partially offset by lower non-recurring engineering services
($443,000) and lower software maintenance revenue ($449,000) due to non-renewals
of maintenance contracts on some older or discontinued products.
Sales to customers outside of the U.S. comprised approximately 43% of net
revenues in the third quarter of 2000 compared to approximately 50% in the same
period of 1999. For the first three quarters of 2000, sales to customers
outside the U.S. comprised approximately 29% of net revenues compared to
approximately 46% in the same period of 1999. The Company has historically
reported a high percentage of sales to customers outside of the United States
and the Company expects that international sales will continue to be
significant. However, the Company's sales cycle is usually lengthy and results
in quarterly fluctuations between geographic markets. In addition, a continued
decline in the European currencies versus the United States Dollar may
ultimately reduce the Company's competitiveness in the European marketplace and
any political or economic turmoil in our major Asian markets (China, Japan and
Korea) could impact future sales in the affected regions.
Sales to Lucent Technologies comprised approximately 14% of net revenues in
the third quarter of 2000. Sales to Alcatel USA and the U.S. Department of
Defense comprised approximately 19% and 13% of net revenues, respectively, for
the first three quarters of 2000. Sales to customers LG Information &
Communications, Lucent Technologies and Sprint Corp comprised approximately 18%,
13% and 10% of net revenues respectively, in the third quarter of 1999. Sales
to Sprint Corp comprised approximately 10% of net revenues for the first three
quarters of 1999. No other single customer accounted for more than 10% of the
Company's revenues in either the third quarter or first three quarters of 2000
and 1999.
Management anticipates that revenues in both licensing and service segments
will continue to be difficult to predict for a number of reasons. The Company's
sales cycle for its products, including the new e*ORB product, is long, often
requiring six to nine months from initial contact to completion of a sale and
recording of revenue. Once a prospect becomes a customer, additional future
revenues remain difficult to predict and are dependent on the customer's timing
and success in developing and deploying products containing our software.
Several of our important products are new and we do not yet have a sales history
on which to base predictions for future revenues. If we have a customer that
contributes a large percentage of revenues during one period, it may be
difficult to replace those revenues in a future period.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Cost of Revenues - License. Cost of license revenues consists primarily of
royalty fees associated with third party software, the cost of user
documentation and the cost of reproduction and delivery of software. Cost of
license revenues was $235,000 and $353,000 for the third quarters of 2000 and
1999, respectively, representing 14% and 13% of license revenues, respectively.
Cost of license revenues was $713,000 and $1,344,000 for the first three
quarters of 2000 and 1999, respectively, representing 9% and 14% of license
revenues, respectively. The higher cost of license revenues in dollar terms in
1999 was primarily the result of two non-recurring items: (1) a one-time payment
of $150,000 required under a third party license agreement related to the
Company's Trader Service CORBA product which was introduced during the second
quarter of 1999 and, (2) the costs of an Expersoft license transaction in March
1999 (after Vertel's acquisition of Expersoft's assets) valued at $402,000, of
which $385,000 in costs and estimated earnings had accrued to Expersoft prior to
the acquisition as a result of Expersoft completing substantially all of the
related software development.
Cost of Revenues - Service. Cost of service revenues consists primarily of
costs associated with performing professional consulting services, software
maintenance and technical support to customers such as telephone support and
costs associated with training services, non-recurring engineering services and
the introduction of WebResolve. Cost of service revenues was $1,294,000 and
$1,522,000 for the third quarters of 2000 and 1999, respectively, representing
79% and 73% of service revenues, respectively. The increase in percentage of
cost of service revenues in 2000 was the result of expenses relating to the
introduction of WebResolve. Cost of service revenues was $4,069,000 and
$4,433,000 for the first three quarters of 2000 and 1999, respectively,
representing 74% and 82% of service revenue, respectively. The lower percentage
of cost of service revenues during the first three quarters of 2000 was
primarily due to increased PSU revenues and improved personnel utilization,
which was partially offset by costs relating to the introduction of WebResolve.
We expect to hire additional consulting personnel to expand our capabilities in
anticipation of additional consulting service contracts from customers and to
staff WebResolve. To the extent that new consulting service contracts and
revenues from WebResolve do not materialize, our future profit margins from
services would be adversely impacted.
Research and Development. The Company has historically invested heavily in
research and development to expand its expertise in TMN-based software solutions
and TMN-based applications and technologies, and to continue sustaining support
of its product offerings. Through its Expersoft acquisition, the Company added
CORBA technology to its network management solutions and is developing embedded
telecom specific implementations of this technology. The major components of
R&D expenses are engineering salaries, employee benefits and associated
overhead, fees to outside contractors, the cost of facilities and depreciation
of capital equipment, which consists primarily of computer and test equipment.
Costs related to R&D in certain cases are offset by customer reimbursement of
non-recurring engineering efforts.
Total R&D expenses decreased 43% to $1,216,000 in the third quarter of 2000
from $2,118,000 in the third quarter of 1999. The decrease in R&D expenses was
primarily the result of lower payroll, consulting, recruiting and related
facilities costs ($856,000) due to the Company's October 1999 workforce
reduction and a non-recurring expense for development software in the third
quarter of 1999 ($75,000). The lower costs were partially offset by a lower
chargeback to cost of revenues for non-recurring engineering services ($34,000).
R&D expenses for the first three quarters of 2000 decreased 29% to $4,058,000
compared to $5,729,000 for the first three quarters of 1999, for the same
reasons affecting the quarter, and the decrease was also partially offset by a
lower chargeback to cost of revenues for non-recurring engineering services
($289,000).
In October 1999, the Company announced a restructuring plan designed to reduce
operating costs, and reduced its overall workforce by approximately 20%. The
TMN product development staff in Woodland Hills, California accounted for
approximately half of the reduction in personnel. The Company has transitioned
TMN product development to its Poland operations, where its costs are lower.
The Company expects to continue to make investments at the current level in the
development of new products and feature enhancements to existing product lines
but changes in net revenues of future quarters could influence expenditures in
future periods. Since the restructuring, the Company's R&D expenditures are
concentrated in the areas of CORBA product development including the Company's
e*ORB product and related application services and the Vertel Mediation
Framework which is designed for the integration of telecom Operation Support
Systems and the underlying network equipment management systems.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Sales and Marketing. Sales and marketing expenses consist primarily of
personnel and associated costs and selling and marketing programs such as trade
shows and other promotional costs. The Company believes that substantial sales
and marketing expenditures are essential to develop opportunities for revenue
growth and to sustain the Company's competitive position. Sales and marketing
expenses are expected to continue to comprise a significant percentage of the
Company's total expenses because of costs associated with supporting the
worldwide sales and marketing functions necessary to meet the needs of the
Company's customer base and respond to opportunities in the CORBA, mediation and
TMN marketplaces.
Sales and marketing expenses decreased 26% to $1,887,000 in the third quarter
of 2000 from $2,547,000 in the third quarter of 1999. The decrease in the third
quarter of 2000 was primarily due to decreased personnel and associated payroll,
commissions, recruiting, relocation and travel costs ($620,000) and lower trade
show and promotional expenses ($93,000), which was partially offset by expenses
for the introduction of WebResolve ($90,000). Sales and marketing expenses for
the first three quarters of 2000 decreased 15% to $5,357,000 from $6,306,000 for
the first three quarters of 1999 primarily as a result of decreased personnel
and associated payroll, commissions, recruiting, relocation and travel costs
($1,000,000) and lower consulting expenses ($87,000), which was partially offset
by expenses for the introduction of WebResolve ($123,000).
General and Administrative. General and administrative expenses consist
primarily of salaries, facilities costs and other related expenses for
administrative, executive and financial personnel as well as professional fees
and investor relations costs. General and administrative expenses decreased 23%
to $830,000 in the third quarter of 2000 compared to $1,078,000 in the third
quarter of 1999. The decrease in the third quarter of 2000 was primarily the
result of lower professional fees ($69,000), investor relations costs ($22,000),
and facilities costs ($137,000). General and administrative expenses for the
first three quarters of 2000 decreased 5% to $2,883,000 from $3,041,000 for the
first three quarters of 1999. The decrease for the first three quarters of 2000
was primarily due to lower payroll and facility costs ($418,000), which were
partially offset by increased professional fees ($151,000) related to the
Company's merger and acquisition activities and higher investor relations costs
($83,000), primarily due to the increased number of shareholders in 2000
compared to 1999.
General and Administrative - Non-Cash Stock Compensation. Non-cash stock
compensation was $35,000 in the third quarter of 2000. There was no such
expense in the third quarter of 1999. For the first three quarters of 2000,
non-cash stock compensation was $553,000 compared to $192,000 for the first
three quarters of 1999. The charges in both periods in 2000 relate to the value
of stock options held by non-employee directors which vested during the periods,
while the charge in the first three quarters of 1999 was a non-recurring charge
related to the value of stock options granted to three former officers in
January of 1999.
Goodwill Amortization. Goodwill amortization for the third quarter of 2000
was $238,000, the same as the third quarter of 1999. Goodwill amortization for
the first three quarters of 2000 was $714,000 compared to $516,000 for the first
three quarters of 1999. The goodwill results from the purchase of Expersoft in
March of 1999 and is being amortized over five years at approximately $238,000
per quarter. The increase in the first three quarters of 2000 represents the
charge for the full period in 2000 compared to a charge for a partial period in
1999 (from March 12, 1999 through September 30,1999).
Restructuring Benefit. There were no restructuring benefits in the third
quarter and first three quarters of 2000. The restructuring benefit for the
third quarter and first three quarters of 1999 ($82,000) resulted from the
reversal of excess restructuring reserves recorded in the 1997 financial
statements. This resulted because the Company negotiated more favorable lease
exit terms in 1999 than were originally estimated.
Operating Loss. The Company reduced its operating loss to $2,371,000 in the
third quarter of 2000 from $3,084,000 in the third quarter of 1999. The
improvement was due primarily to lower research and development, sales and
marketing, general and administrative and PSU expenses which were partially
offset by lower license, PSU and software maintenance revenues, as discussed
above. The operating loss for the first three quarters of 2000 was $4,691,000
compared to an operating loss of $6,665,000 for the corresponding period in
1999. The improvement was due to higher professional service revenue, higher
gross profit margins, lower research and development, sales and marketing and
general and administrative expenses, which were partially offset by lower
license, software maintenance and non-recurring engineering services revenues,
higher general and administrative non-cash stock compensation, and goodwill
amortization expenses, as discussed above.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Other Income, Net. Other income, net increased $148,000 to $227,000 in the
third quarter of 2000 compared to $79,000 for the third quarter of 1999. Other
income, net for the third quarter of 2000 consists primarily of interest income,
which increased $70,000 due to higher cash balances and higher interest rates,
and net sub-lease income ($33,000). For the first three quarters of 2000, other
income, net increased $1,179,000 to $1,650,000 compared to $471,000 for the
first three quarters of 1999. Other income, net for the first three quarters of
2000 consisted primarily of a non-recurring gain on the sale of the Company's
remaining equity interest in Systems Wizards ($961,000), interest income
($521,000), net sub-lease income ($101,000) and a gain on the early termination
of a capital lease ($55,000). Other income, net for the third quarter of 1999
and the first three quarters of 1999 was primarily interest income.
Provision for Income Taxes. The Company recorded a provision for income
taxes of $35,000 in the third quarter of 2000 compared to $30,000 in the third
quarter of 1999. For the first three quarters of 2000, the Company has recorded
a provision for income taxes of $115,000 compared to $50,000 for the first three
quarters of 1999. The income tax provisions are primarily for non-U.S. taxes as
the Company anticipates utilizing net operating losses to offset any pre-tax
income.
Liquidity and Capital Resources
Net cash used for operating activities during the first three quarters of 2000
was $753,000 compared to $5,951,000 used by operating activities in the first
three quarters of 1999. The negative cash flow from operations in the first
three quarters of 2000 was primarily the result of the net loss ($3,156,000), a
decrease in deferred revenue ($549,000), a decrease in accounts payable
($335,000) and payments for restructuring expense ($391,000). These amounts were
partially offset by a decrease in accounts receivable ($1,186,000), a decrease
in prepaid expenses and other current assets ($157,000), non-cash stock-based
compensation ($553,000) and non-cash depreciation and amortization ($1,766,000).
Net cash provided by investing activities during the first three quarters of
2000 was $4,188,000 compared to net cash used for investing activities of
$8,844,000 in the first three quarters of 1999. The net cash provided by
investing activities in the first three quarters of 2000 resulted from net sales
of short-term investments ($4,689,000), which was partially offset by purchases
of property and equipment ($501,000).
Net cash provided by financing activities during the first three quarters of
2000 was $3,863,000 compared to net cash used for financing activities in the
first three quarters of 1999 of $262,000. The net cash provided during the
first three quarters of 2000 was due to the exercise of stock options under the
Company's stock option plans ($3,889,000), which was partially offset by
payments of capital lease obligations ($26,000).
The Company believes that its cash and short-term investments balance of
$12,218,000 at September 30, 2000 will be sufficient to meet its liquidity
requirements for the next twelve months. From time to time, the Company may
also consider the acquisitions of, or evaluate investments in, certain products
and businesses complementary to its business. Any such acquisitions or
investments may require additional capital resources. There can be no assurance
that such additional financing will be available, if needed, or, if available,
will be on terms satisfactory to the Company.
At September 30, 2000, the Company's long-term liquidity needs consisted
principally of operating lease commitments related to facilities and office
equipment.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
European Monetary Union
In January 1999, eleven European countries, including France, Germany and the
Netherlands, where the Company maintains operations, implemented a single
currency (the ''Euro'') to replace their separate currencies. While
transactions may be consummated in the individual currencies of the member
countries, the Company will be required to, and is currently in the process of,
implementing modifications to its payroll and benefits systems as well as its
contracts and other obligations in order to accommodate the Euro. The Company
does not currently believe that it will incur a material financial expense in
connection with such modifications. The introduction of the Euro presents
certain risks for the Company including risks associated with its reduced
ability to adjust pricing of its products based on local currencies, and
fluctuations in the Euro based on economic turmoil in countries in the Union
other than those where the Company does business, increasing the risks normally
associated with doing business in international currencies, any of which could
have an adverse effect on the Company's business, financial condition and
results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
(a) Quantitative Information About Market Risk.
The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's investment portfolio. The Company maintains an
investment policy that ensures the safety and preservation of its invested
funds by limiting default risk, market risk and investment risk. As of
September 30, 2000, the Company had $11,230,000 of cash and cash equivalents
and $988,000 of short-term investments with a weighted average variable rate
of 5.97% and 6.70%, respectively. As of September 30, 1999, the Company had
$4,417,000 and $5,855,000 in cash and cash equivalents and short-term
investments, respectively, with a weighted average variable rate of 4.26% and
5.01%, respectively.
The Company mitigates default risk by investing in high credit quality
securities and by constantly positioning its portfolio to respond
appropriately to a significant reduction in a credit rating of any investment
issuer or guarantor and by placing its portfolio under the management of
professional money managers who invest within specified parameters established
by the Board of Directors. The portfolio includes only marketable securities
with active secondary or resale markets to ensure portfolio liquidity and
maintains a prudent amount of diversification.
The Company currently has no short or long-term debt.
(b) Qualitative Information About Market Risk
While the Company's consolidated financial statements are prepared in
United States dollars, a portion of the Company's worldwide operations have a
functional currency other than the United States dollar. In particular, the
Company maintains operations in France, Germany, Japan, Korea, the
Netherlands, Poland and the United Kingdom, where the functional currencies
are: French Franc, Deutschemark, Yen, Won, Dutch Guilder, Zloty and British
Pound, respectively. Most of the Company's revenues are denominated in the
United States Dollar. Fluctuations in exchange rates may have a material
adverse effect on the Company's results of operations and could also result in
exchange losses. The impact of future exchange rate fluctuations cannot be
predicted adequately. To date, exchange fluctuations have not had a material
impact on the Company's earnings and the Company has not sought to hedge the
risks associated with fluctuations in exchange rates, but may undertake such
transactions in the future. The Company does not have a policy relating to
hedging. There can be no assurance that any hedging techniques implemented by
the Company would be successful or that the Company's results of operations
will not be materially adversely affected by exchange rate fluctuations. The
Company's foreign assets are not material.
13
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Neither the Company nor any of its subsidiaries is a party to, nor is their
property the subject of, any material pending legal proceeding. The Company
may, from time to time, become a party to various legal proceedings arising in
the normal course of its business.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
The exhibits required to be furnished are listed in the Exhibit List
following this Report
(b) REPORTS ON FORM 8-K
None.
14
<PAGE>
SIGNATURES
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.
VERTEL CORPORATION
(Registrant)
Date: November 13, 2000 /s/ Gordon L. Almquist
-----------------------------
Gordon L. Almquist
Vice President, Finance and Administration,
and Chief Financial Officer
(Principal Financial Officer)
15
<PAGE>
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.3 (and 4.1) Amended and Restated Articles of Incorporation of the Registrant.
(13)
3.4 (and 4.2) Bylaws of the Registrant, as amended to date. (8)
3.5 Certificate of amendment to Company's articles of incorporation,
as filed with the California Secretary of State on April 7, 1998,
changing the Company's name to Vertel Corporation. (9)
10.5 1991 Employee Stock Purchase Plan and form of subscription
agreement thereunder. (2)
10.6 Form of Indemnification Agreement. (1)
10.22 Lease Agreement between the Registrant and Moorpark Associates, a
California Limited Partnership, dated February 5, 1993. (3)
10.27 Lease Agreement between the Registrant and OMA El Segundo
Properties, a California general partnership, dated May 23, 1995.
(5)
10.32 1996 Directors' Stock Option Plan and forms of option agreement
thereunder. (8)
10.45 Sublease Agreement dated May, 1996 between Value Behavioral
Health and Retix. (6)
10.46 Master Agreement between Retix and Internetworking Solutions
dated May 31, 1996. (6)
10.48 Lease Agreement between the Registrant and Nomura-Warner Center
Associates, L.P., dated November 26, 1996. (7)
10.55 Amended and Restated Articles of Incorporation of Sonoma Systems,
Inc., and related documents dated January 7, 1998. (8)
10.56 Sub-sublease between Retix and Sonoma Systems, Inc., dated
December 28, 1997. (8)
10.62 Consulting Agreement between the Company and Joe Stephan dated
January 5, 1999. (10)
10.63 Notice of Stock Option Grant and Stock Option Agreement between
the Company and Joe Stephan dated January 5, 1999. (10)
10.64 Consulting Agreement between the Company and Philip Mantle dated
January 5, 1999. (10)
10.65 Notice of Stock Option Grant and Stock Option Agreement between
the Company and Philip Mantle dated January 5, 1999. (10)
10.68 Form of Retention Agreement between the Company and each of its
officers. (10)
10.69 Employment Agreement between the Company and Bruce W. Brown dated
January 12, 1999. (11)
10.70 Employment Agreement between the Company and Gordon L. Almquist
dated January 12, 1999 (11)
10.72 Employment Agreement between the Company and Cyrus D. Irani dated
January 12, 1999. (11)
10.73 Employment Agreement between the Company and Richard L. Hamilton
dated January 18, 1999.(11)
10.75 Amended 1996 Directors' Stock Option Plan and form of option
agreement thereunder. (11)
10.76 Amended 1998 Stock Option Plan and form of option agreement
thereunder. (11)
10.77 Employment Agreement between the Company and Stephen J. McDaniel
dated November 1, 1999.(11)
10.78 Amendment No. 1, dated December 3, 1999 to the Employment
Agreement between the Company and Gordon L. Almquist. (11)
10.79 Amendment No. 1, dated December 3, 1999 to the Employment
Agreement between the Company and Richard L. Hamilton. (11)
10.80 Amendment No. 1, dated December 3, 1999 to the Employment
Agreement between the Company and Cyrus D. Irani. (11)
10.81 Vertel Corporation 2000 Stock Option Plan (12)
11.0 Statement re: Computation of per share earnings (13)
27.1 Financial Data Schedule. (13)
16
<PAGE>
EXHIBIT INDEX (continued)
(1) Incorporated by reference to identically numbered exhibits filed in
response to Item 16(a), "Exhibits," of the Registrants Registration
Statement on Form S-1 and Amendment No. 1 thereto (File No. 33-43544) which
became effective on December 9, 1991.
(2) Incorporated by reference to identically numbered exhibits filed in
response to Item 6(a), "Exhibits," of the Registrant's Quarterly Report on
Form 10-Q for the fiscal quarter ended September 26, 1992.
(3) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report on
Form 10-K for the fiscal year ended January 2, 1993.
(4) Incorporated by reference to identically numbered exhibit filed in response
to Item 6(a), "Exhibits," of the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended October 1, 1994.
(5) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 30, 1995.
(6) Incorporated by reference to identically numbered exhibit filed in response
to Item 6(a), "Exhibits," of the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended June 30, 1996.
(7) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 28, 1996.
(8) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 27, 1997.
(9) Incorporated by reference from registrant's report on Form 8-K as filed
with the Securities and Exchange Commission on April 7, 1998.
(10) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1998.
(11) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1999.
(12) Incorporated by reference to identically numbered exhibit filed in response
to Item 6(a), "Exhibits," of the Registrant's Quarterly Report on Form 10-Q
for the fiscal quarter ended June 30, 2000.
(13) Filed herewith.
17
