<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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 June 30, 1998
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 0-50464
NETRIX CORPORATION
(Exact name of registrant as specified in charter)
DELAWARE 54-1345159
(State of Incorporation) (IRS Employer Identification No.)
13595 DULLES TECHNOLOGY DRIVE, HERNDON, VIRGINIA 20171
(Address of principal executive offices) (Zip Code)
(703) 742-6000
(Registrant's telephone number, including area code)
Indicate by check number 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
------- -------
At July 31, 1998 there were 11,450,654 shares of the registrant's
Common Stock, $.05 par value per share, outstanding.
<PAGE>
NETRIX CORPORATION
------------------
FORM 10-Q
---------
JUNE 30, 1998
-------------
INDEX
-----
Page No.
--------
PART I -- FINANCIAL INFORMATION
ITEM 1 -- FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Statements of Operations for
the six and three months ended June 30, 1998 and 1997 2
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Cash Flows 4
Notes to Unaudited Condensed Consolidated Financial
Statements 5
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 9
PART II -- OTHER INFORMATION
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K 15
SIGNATURE 16
1
<PAGE>
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
NETRIX CORPORATION
------------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
June 30, June 30,
------------------------ ---------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Product ........................... $ 10,422 $ 11,691 $ 5,427 $ 5,755
Service ........................... 4,649 5,217 2,403 2,732
-------- -------- -------- --------
Total revenues .............. 15,071 16,908 7,830 8,487
Cost of revenues:
Product ........................... 4,696 5,711 2,586 3,011
Service ........................... 2,759 3,756 1,345 1,761
-------- -------- -------- --------
Total cost of revenues ...... 7,455 9,467 3,931 4,772
-------- -------- -------- --------
Gross profit ......... 7,616 7,441 3,899 3,715
Operating expenses:
Sales and marketing ............... 5,986 5,900 3,938 2,684
Research and development .......... 3,243 4,839 1,674 2,067
General and administrative ........ 2,168 2,059 1,074 962
Restructuring reserve ............. -- 875 -- (475)
-------- -------- -------- --------
Loss from operations ... (3,781) (6,232) (2,787) (1,523)
Interest and other income, net ......... (36) 110 (24) 1
Foreign exchange gain (loss) ........... 47 (70) (6) (115)
-------- -------- -------- --------
Loss before income taxes (3,770) (6,192) (2,817) (1,637)
Provision for income taxes ............. -- 40 20
-------- -------- -------- --------
Net Loss ............................... (3,770) (6,232) (2,817) (1,657)
Other comprehensive losses,
net of income tax .................. (56) (30) (19) (14)
-------- -------- -------- --------
Comprehensive loss ..................... $ (3,826) $ (6,262) $ (2,836) $ (1,671)
======== ======== ======== ========
Basic and diluted loss per share ....... $ (0.37) $ (0.66) $ (0.26) $ (0.18)
======== ======== ======== ========
Shares used in per share calculation ... 10,322 9,521 10,993 9,526
======== ======== ======== ========
</TABLE>
See notes to unaudited condensed consolidated financial statements.
2
<PAGE>
NETRIX CORPORATION
------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
ASSETS 1998 1997
------ -------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents......................... $ 516 $ 2,758
Accounts receivable, net of allowance for doubtful
accounts of $2,301 and $1,505, respectively...... 7,441 6,212
Inventories, net.................................. 7,667 8,035
Other current assets.............................. 324 713
-------- --------
Total current assets............................. 15,948 17,718
Property and equipment, net of accumulated
depreciation of $19,131 and $18,016,
respectively........................................ 4,520 4,969
Deposits and other assets............................ 348 543
Goodwill, net of accumulated amortization of $1,386
and $1,447, respectively............................ 661 794
-------- --------
$ 21,477 $ 24,024
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Line of credit.................................... $ 1,095 $ 1,147
Accounts payable.................................. 2,633 3,002
Accrued liabilities............................... 2,915 3,298
-------- --------
Total current liabilities........................ 6,643 7,447
Other liabilities.................................... -- 97
-------- --------
6,643 7,544
-------- --------
Stockholders' equity:
Preferred stock, $0.05 par value; 1,000,000 shares
authorized; zero issued and zero outstanding...... -- --
Common stock, $0.05 par value; 15,000,000
shares authorized; 11,105,615 and 9,593,253
shares issued and outstanding, respectively....... 572 480
Additional paid-in capital.......................... 57,862 55,774
Accumulated other comprehensive loss................ (75) (17)
Accumulated deficit................................. (43,525) (39,757)
-------- --------
Total stockholders' equity......................... 14,834 16,480
-------- --------
$ 21,477 $ 24,024
======== ========
</TABLE>
See notes to unaudited condensed consolidated financial statements.
3
<PAGE>
NETRIX CORPORATION
------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended June 30,
--------------------------------
1998 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ........................................................ $(3,770) $(6,232)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ............................... 1,248 1,704
Changes in assets and liabilities -
Accounts receivable .................................... (1,229) 2,649
Inventories ............................................ 368 (1,768)
Other current assets ................................... 389 239
Deposits and other assets .............................. 195 (11)
Goodwill ............................................... -- 262
Other liabilities ...................................... (97) 43
Accounts payable ....................................... (369) 1,511
Accrued liabilities .................................... (383) (900)
------- -------
Net cash used in operating activities .................. (3,648) (2,503)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment ......................... (666) (752)
Sales of short-term investments ............................. -- 6,127
Purchases of short-term investments ......................... -- (2,473)
------- -------
Net cash (used in) provided by investing activities..... (666) 2,902
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from private placement ............................. 2,076 --
Payments on line of credit, net ............................ (52) 100
Proceeds from exercise of stock options ..................... 14 68
Proceeds from employee stock purchase plan .................. 90 --
Payments on long-term debt .................................. -- (120)
------- -------
Net cash provided by (used in) financing activities ..... 2,128 48
------- -------
Effect of foreign currency exchange rate changes on
cash and cash equivalents ................................... (56) (38)
------- -------
Net (decrease) increase in cash and cash equivalents ................. (2,242) 409
Cash and cash equivalents, beginning of period ....................... 2,758 687
------- -------
Cash and cash equivalents, end of period ............................. $ 516 $ 1,096
======= =======
Supplemental disclosure of cash flow information:
Cash paid during the period for interest .................... $ 88 $ 79
Cash paid during the period for income taxes ................ -- 11
</TABLE>
See notes to unaudited condensed consolidated financial statements.
4
<PAGE>
NETRIX CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
---------------------
Netrix Corporation ("Netrix" or the "Company") is a worldwide provider
of voice and data networking products. Netrix develops, manufactures, markets,
and supports networking equipment for voice, data, and image networks. Netrix
products are designed to transport voice over data networks to enable its
customers to realize significant cost savings. Netrix was incorporated in 1985.
The Company maintains operations in the United Kingdom through its wholly-owned
subsidiary, Netrix International Corporation (a Delaware corporation), and in
Germany and Italy through its wholly-owned subsidiaries Netrix GmbH and Netrix
S.r.l., respectively. These unaudited condensed consolidated financial
statements include the accounts of the Company and its subsidiaries. All
significant intercompany transactions have been eliminated.
The unaudited condensed financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission and include, in the opinion of
management, all adjustments, consisting of normal, recurring adjustments,
necessary for a fair presentation of interim period results. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations. The Company believes, however,
that its disclosures are adequate to make the information presented not
misleading. The results for such interim periods are not necessarily indicative
of results to be expected for the full year.
Certain reclassifications have been made to the prior year financial
statements to conform with current year presentation.
Risks and Liquidity Factors
For the six and three months ended June 30, 1998, the Company
experienced declining revenues and net losses of approximately $3.8 and $2.8
million, respectively, due to declining sales of the Company's mature products
which were partially offset by increases in sales of new products at slower
growth rates than expected. For the six and three months ended June 30, 1998,
the Company's operating activities used approximately $3.7 million and $2.4
million of cash, respectively. The cash used by operations was primarily due to
continued net losses from operations and an increase in accounts receivable. The
success of the Company is dependent on its ability to generate adequate cash for
operations and capital needs. At June 30, 1998, the Company had approximately
$516,000 in cash and cash equivalents and approximately $48,000 in available
borrowings under its line of credit. At July 31, 1998, the Company had
approximately zero cash. The Company is relying on future sales and the
collection of its accounts receivable to meet its obligations. The Company may
be unable to meet these obligations as they become due and may be required to
curtail its operations. If the Company is required to curtail its operations
there can be no assurances that the Company's assets will be fully realized. The
Company estimates that in the absence of adequate financing, it has sufficient
cash and borrowing ability to operate for approximately three months although
there can be no assurances of the Company's ability to continue to operate.
The Company's ability to generate adequate cash is in large part
dependent on its success at increasing sales of its new products. The Company's
plan to increase revenues through sales of its Network Exchange product line is
continuing to evolve in order to exploit new marketing channels; however, due to
market conditions, competitive pressures, and other factors beyond its control,
the Company has been unable to achieve sufficient incremental growth in new
product sales to replace the decline in mature product sales and achieve
increases in revenues from quarter-to-quarter and there can be no assurances
that the Company will be able to adequately increase new product sales in the
future.
5
<PAGE>
The Company may have to generate additional cash through other means, which
may include the sale of assets, including intellectual property and proprietary
technology, the sale of equity, additional borrowings, the sale of selected
operations, or one or more strategic partnerships. Although the Company believes
it has the ability to generate additional cash through such activities, there
can be no assurances that adequate funds will be available, or available on
terms that are reasonable or acceptable, to the Company. If the Company is
unable to generate or borrow adequate cash, there will be a material and adverse
effect on the business and financial condition of the Company, to the extent
that a sale, liquidation or restructuring of the Company will be required, in
whole or in part. The Company has mandated certain cost control measures, and is
evaluating various business processes, such as credit administration, order
fulfillment, and asset management, in order to mitigate its liquidity risk.
The Company's line of credit agreement requires it to maintain a tangible
net worth of at least $13.5 million. At June 30, 1998, the Company's tangible
net worth was approximately $14.2 million. Management estimates that the Company
will be in violation of this covenant as of August 31, 1998. Management intends
to seek a waiver of, and renegotiate, this covenant, but there can be no
assurances that a waiver will be received, or that a renegotiation will be
successful, or that the outstanding loan balance will not be called by the
Company's lending institution upon violation of this covenant.
In August 1998, as a result of concerns about the deterioration of aged
international accounts receivable, the Company's current lending institution
informed the Company that it intends to gradually eliminate international
receivables as qualified accounts receivable for borrowing collateral. The
lending institution has agreed to release international receivables from its
collateral base, which will allow the Company to pursue financing alternatives
for these receivables. As of June 30 and July 31, 1998 the amount of loans
collateralized by international receivables was approximately $913,000 and
$311,000 respectively. The lending institution intends to increase the interest
rate for outstanding loan amounts to prime plus 3 1/2%, from prime plus 2%. The
Company is currently reviewing alternatives with the present lending institution
and has initiated discussion with another financial institution, including the
possibility of utilizing the Export-Import Bank loan guarantee program to
finance international inventory and receivables. The Company believes it will be
able to obtain new financing for these international receivables; however, there
can be no assurances that such financing can or will be obtained.
Future operating results may be affected by a number of other factors
including the timing of new products in the market place, competitive pricing
pressures and global economic conditions. Because the market for the Company's
products is characterized by rapidly changing technology, the development,
introduction, and evolution of competitive products may require a significant
investment of financial resources. Additionally, the Company relies on reseller
channels that are not under its control for a significant portion of its
revenues, particularly in its international regions. Also, while the Company has
generally been able to obtain adequate supplies of components to date, the
interruption or termination of the Company's current manufacturing relationships
could have an adverse effect on the Company's liquidity and operating results.
2. New Accounting Pronouncements:
-----------------------------
In June 1997, the Financial Accounting Standards Board issued SFAS No.
130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information." SFAS No. 130 requires that
an enterprise (a) classify items of other comprehensive income by their nature
in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional
paid-in-capital in the equity section of a statement of financial position. The
Company implemented SFAS No. 130 in the first quarter of 1998, and it did not
have a material impact on the financial statements. SFAS No. 131 requires the
Company to report financial and descriptive information about its reportable
operating segments. The Company will adopt SFAS No. 131 at its year-end December
31, 1998. The Company is currently evaluating the impact of SFAS No. 131 on its
financial statements.
3. Cash Equivalents:
----------------
Cash equivalents are primarily bank deposits, commercial paper, and
government agency securities with original maturities of three months or less.
These investments are carried at cost which approximates market value.
4. Inventories:
-----------
Inventories consisted of the following (in thousands):
June 30, 1998 December 31, 1997
------------- -----------------
Raw materials ........................ $ 474 $ 462
Work in process ...................... 758 772
Finished goods ....................... 6,435 6,801
------ ------
Total inventories .................... $7,667 $8,035
====== ======
6
<PAGE>
5. Commitments and Contingencies:
-----------------------------
Line of Credit
In November 1997, the Company negotiated a revolving $3.0 million line
of credit agreement with a lending institution to be used for working capital.
This agreement provides for interest at a per annum rate equal to the lender's
prime rate plus 2%. The line of credit agreement includes a covenant that
requires the Company to maintain tangible net worth of at least $13.5 million.
At June 30, 1998, the Company's tangible net worth was approximately $14.2
million. Management estimates that the Company will be in violation of this
covenant as of August 31, 1998. The Company intends to seek a waiver of, and
renegotiate, this covenant, but there can be no assurances that a waiver will be
received, or that a renegotiation will be successful, or that the outstanding
loan balance will not be called by the Company's lending institution upon
violation of this covenant.
The credit facility, which matures on November 30, 1999, is
collateralized by all of the Company's assets, including copyrights and
intellectual property that may not be reflected in the Company's financial
statements. Borrowings under the line are based on qualified accounts
receivable. At June 30, 1998, the Company had approximately $1.1 million of
total eligible borrowing availability (approximately $206,000 of domestic and
$926,000 of international eligible receivables) and approximately $1.1 million
outstanding under the line of credit. At December 31, 1997, the Company had
approximately $2.1 million of eligible borrowing availability (approximately
$1.1 million of domestic and $1.0 million of international eligible receivables)
and approximately $1.1 million outstanding under the line of credit. At July 31,
1998, the Company had approximately $653,000 of total eligible borrowing
availability (approximately $500,000 of domestic and approximately $153,000 of
international eligible receivables) and approximately $653,000 outstanding under
the line of credit.
6. Product Revenues:
----------------
The Company's product revenues were generated in the following
geographic regions:
Six Months Ended Three Months Ended
June 30, June 30,
---------------------- ---------------------
1998 1997 1998 1997
---- ---- ---- ----
Domestic ............ $ 3,757 $ 4,791 $ 2,002 $ 2,372
Europe .............. 4,856 4,234 2,329 2,177
Pacific Rim and other 1,809 2,666 1,096 1,206
------- ------- ------- -------
Total ............... $10,422 $11,691 $ 5,427 $ 5,755
======= ======= ======= =======
Sales are primarily denominated in US dollars.
7. Restructuring Charge:
--------------------
In March 1997, the Company recorded a restructuring charge of
approximately $1.4 million before income taxes, which was reduced in May 1997 to
a net restructuring charge of approximately $875,000. The net charge included
anticipated costs associated with an overall reduction in work force and the
discontinuance of the Company's micro.pop product.
8. Foreign Currency Exchange Gain:
------------------------------
Generally, assets and liabilities denominated in foreign currencies are
translated into US dollars at current exchange rates. Operating results are
translated into US dollars using the average rates of exchange prevailing during
the period. Gains or losses resulting from translation of assets and liabilities
are included in the cumulative translation adjustment account in stockholders'
equity, except for the translation effect of intercompany balances that are
anticipated to be settled in the foreseeable future. For the six and three
months ended June 30, 1998, the Company reported approximately $47,000 in
translation gains and $6,000 in translation losses, respectively. For the six
and three months ended June 30, 1997, translation losses were approximately
$70,000 and $115,000, respectively.
7
<PAGE>
9. Basic and Diluted Earnings (Loss) Per Share:
-------------------------------------------
Basic earnings (loss) per share amounts are computed using the weighted
average number of common shares. Diluted earnings (loss) per share amounts are
computed using the weighted average number of common shares and common
equivalent shares having a dilutive effect during the periods. For the six and
three months ended June 30, 1998 and 1997 the effect of options has not been
considered as they would have been antidilutive.
10. Stockholders Equity:
-------------------
In April 1998, the Company completed a private placement by issuing and
selling 1,750,000 shares of common stock at a price of $1.25 per share and by
issuing warrants to purchase an additional 140,000 shares of common stock at an
exercise price of $1.75 per share. In connection with the private placement, the
Company received net proceeds of approximately $2.1 million that were used for
working capital and other corporate purposes. The shares issued in the private
placement and issuable upon exercise of the warrants were registered for resale
pursuant to a registration statement declared effective by the Securities and
Exchange Commission on June 12, 1998.
8
<PAGE>
NETRIX CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
This Quarterly Report on Form 10-Q contains forward looking statements. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward looking statements. Without limiting the
foregoing, the words "believes," "anticipates," "plans," "expects," and similar
expressions are intended to identify forward looking statements. There are a
number of important factors that could cause the Company's actual results to
differ materially from those indicated by such forward-looking statements. The
factors include without limitation, those set forth below under the captions
"Liquidity and Capital Resources" and "Certain Factors That May Affect Future
Results."
Results of Operations
Recent Developments. In January 1998, the Company announced its Vodex Voice
Gateway software for the Network Exchange 2210, a voice/data/fax-over-IP gateway
switch. The Network Exchange is one of the industry's first voice gateways to
simultaneously deliver high quality Voice over IP and Voice over Frame Relay
with the ability to gateway between the two.
Beginning in March 1998 and going through June, the Company announced the
first installations of its Voice over IP products. In June, NETRIX entered into
a five-year cooperative research and development agreement with the US
Department of Commerce (DoC). The initial research conducted under the agreement
will include both subjective and objective voice quality testing of the Network
Exchange. Also in June, the Company introduced its Network Exchange 2201, a
Voice over IP (VoIP) and Voice over Frame Relay (VoFR) solution for the Remote
Office/Branch Office (ROBO) market. The product extends the capabilities of the
Network Exchange for applications requiring up to four voice ports, such as
small enterprise offices, or Internet Telephony Service Providers (ITSPs) that
need to supply lower density CPE equipment. Finally in June, the Company
announced its Partners on the Net, which connects participating NETRIX sales
partners and NETRIX locations throughout the world. When it was announced,
NETRIX believes it was the most geographically dispersed Voice over IP/Frame
Relay network at that time.
Background. The results for six and three months ended June 30, 1998
reflect an overall decrease in the revenues and R&D expenses of the Company from
the comparable period in 1997. The Company's plan to increase revenues through
sales of its Network Exchange product line is continuing to evolve in order to
exploit new marketing channels; however, due to market conditions, competitive
pressures, and other factors beyond its control, the Company has been unable to
achieve sufficient incremental growth in new product sales to replace the
decline in mature product sales and achieve increases in revenues from
quarter-to-quarter. During this six month period, Netrix continued to experience
a decline in revenues in its mature product lines, and an increase in its new
products, the 2210, which combines the Republic Telecom technology with Netrix
switching capability, and the 2550, Netrix' enhanced switching platform. In
April 1997, the Company implemented a restructuring of operations to reduce and
economize its work force. The restructuring resulted in the overall reduction of
compensation and travel expenses and other operating costs of the Company.
However, during the first half of 1998, the Company experienced an increase in
marketing and product implementation costs in order to introduce and deploy its
new products. In addition, in the second quarter of 1998, the Company incurred
specific expenses associated with an increase in the allowance for doubtful
accounts of approximately $1.1 million. The Company has mandated certain cost
control measures, and is evaluating various business processes, such as credit
administration, order fulfillment, and asset management, in order to improve its
operating performance.
Revenues. For the six months ended June 30, 1998, total revenues decreased
by approximately $1.8 million, or 10.9%, compared to the six months ended June
30, 1997. Total revenues also decreased approximately $650,000, or 7.7%, in the
second quarter of 1998 compared to the second quarter of 1997. Product revenues
decreased approximately $330,000, or 5.7%, for the second quarter of 1998
compared to the same period in 1997. Product revenues decreased approximately
$1.3 million, or 10.9%, for the first six months of 1998 compared to same period
in 1997. The decrease in revenues was due primarily to the decline in mature
product sales, partially offset by incremental growth in new product sales, as
the mix of products sold continued to transition from the mature products to the
2210 and 2550. Service revenues decreased by approximately $568,000, or 10.9%,
for the six months ended June 30, 1998 when compared to the six months ended
June 30, 1997. For the second quarter of 1998, service revenues decreased by
approximately $330,000, or 12.0%, when compared to the second quarter of 1997.
In the six and three months ended June 30, 1998, the lower volume of service
revenues remained fairly consistent with the discontinuation of older products
from the installed base, which was partially offset by an increase in service on
new product installations and new customer arrangements.
9
<PAGE>
Gross Profit. For the first six months of 1998, gross profit increased
by approximately $175,000, or 2.4%, when compared to the first six months of
1997, and increased as a percentage of total revenues from 44.4% to 50.5%. For
the second quarter of 1998, gross profit increased approximately $183,000, or
4.9%, when compared to the second quarter of 1997, and increased as a percent of
total revenues from 43.8% to 49.8%. Product gross margin increased to 54.9% in
the first six months of 1998, from 51.2% in the first six months of 1997.
Product gross margin increased to 52.3% in the second quarter of 1998, from
47.7% in the second quarter of 1997. The year over year and quarter over quarter
increases were primarily the result of a higher proportion of products sold
through less competitive channels that required lower discounts, combined with a
more favorable mix of higher margin product shipments. The gross profit in any
particular quarter is dependent upon the mix of products sold and the channels
of distribution. As a result, the gross profit on a quarter to quarter basis can
vary within a wide range. Due to this variable mix, margins earned in the six
months ended June 30, 1998 are not necessarily indicative of margins that will
be earned in the future. The gross margin for service revenues increased from
28.0% in the first six months of 1997 to 40.6% in the first six months of 1998.
The gross margin for service revenues increased from 35.5% in the second quarter
of 1997 to 44.0% in the second quarter of 1998. The higher service margin is a
result of generally consistent levels of service revenues in the first half of
1998 combined with lower service costs due to the restructuring discussed below.
Sales and Marketing. Sales and marketing expenses for the first six
months of 1998 were equivalent to the first six months of 1997. For the second
quarter of 1998, sales and marketing expenses increased by approximately $1.3
million, or 46.7%, when compared to the second quarter of 1997. This net
increase was primarily attributable to an increase in the allowance for doubtful
accounts of approximately $1.1 million, and an increase in sales and marketing
expenses associated with new product introductions and roll-out of approximately
$200,000.
Research and Development. Research and development expenses decreased
by approximately $1.6 million, or 33.0%, for the first six months of 1998 when
compared to the first six months of 1997. For the second quarter of 1998,
expenses decreased approximately $392,000, or 19.0%, when compared to the second
quarter of 1997. The six month and three month decreases were principally due to
decreased expenses of salaries and related personnel costs from the
restructuring that occurred in March of 1997. All of the Company's research and
development costs are charged to operations as incurred.
General and Administrative. General and administrative expenses
increased approximately $109,000,or 5.3%, for the first six months of 1998 when
compared to the same period in 1997. For the second quarter of 1998, general and
administrative expenses increased approximately $112,000, or 11.6%, when
compared to the second quarter of 1997. The increase in these expenses was due
to increases in a variety of costs.
Restructuring Charge. In March 1997, the Company recorded a
restructuring charge of approximately $1.4 million before income taxes. The
charge included anticipated costs associated with an overall reduction in work
force, the discontinuance of its micro.pop product, and the discontinuance of
its direct operation in Germany. In May 1997, the Company reduced the
restructuring charge of approximately $1.4 million recorded in the first quarter
by approximately $475,000. The net reduction was due mainly to the decision not
to discontinue its operation in Germany.
Interest and Other Income, Net. For the first six months of 1998, the
Company incurred net interest expense of approximately $36,000, compared to
approximately $110,000 in net interest earnings for the same period of 1997, an
increase in net interest expense of approximately $146,000. For the second
quarter of 1998, the Company incurred approximately $24,000 of net interest
expense, compared to net interest earnings of approximately $1,000 for the same
period in 1997. This increase is due primarily to lower investment levels
maintained in short-term investments, combined with increased interest expense
on the Company's borrowings.
10
<PAGE>
Foreign Exchange Gain (Loss). The foreign exchange translation gain
for the six months ended June 30, 1998, was approximately $47,000, and the
foreign exchange translation loss for the three months ended June 30, 1998 was
approximately $6,000. For the six and three months ended June 30, 1997, the
foreign exchange translation loss was approximately $70,000 and $115,000,
respectively.
Net Income (Loss). For the first six months of 1998, the Company
generated a net loss of approximately $3.8 million, compared to a net loss of
$6.2 million for the same period in 1997. The net loss for the second quarter of
1998 was approximately $2.8 million, compared to a net loss of approximately
$1.7 million in the second quarter of 1997, an unfavorable change of
approximately $1.1 million. The year-to-year and quarter-to-quarter changes in
net income were the result of the factors discussed above.
Liquidity and Capital Resources
- -------------------------------
For the six and three months ended June 30, 1998, the Company
experienced declining revenues and net losses of approximately $3.8 and $2.8
million, respectively, due to declining sales of the Company's mature products
which were partially offset by increases in sales of new products at slower
growth rates than expected. The success of the Company is dependent on its
ability to generate adequate cash for operations and capital needs. At June 30,
1998, the Company had approximately $516,000 in cash and cash equivalents and
approximately $48,000 in available borrowings under its line of credit. At July
31, 1998, the Company had approximately zero cash. The Company is relying on
future sales and the collection of its accounts receivable to meet its
obligations. The Company may be unable to meet these obligations as they become
due and may be required to curtail its operations. If the Company is required to
curtail its operations there can be no assurances that the Company's assets will
be fully realized. The Company estimates that in the absence of adequate
financing, it has sufficient cash and borrowing ability to operate for
approximately three months although there can be no assurances of the Company's
ability to continue to operate.
The Company's ability to generate adequate cash is in large part
dependent on its success at increasing sales of its new products. The Company's
plan to increase revenues through sales of its Network Exchange product line is
continuing to evolve in order to exploit new marketing channels; however, due to
market conditions, competitive pressures, and other factors beyond its control,
the Company has been unable to achieve sufficient incremental growth in new
product sales to replace the decline in mature product sales and achieve
increases in revenues from quarter-to-quarter and there can be no assurances
that the Company will be able to adequately increase new product sales in the
future.
Capital acquisitions during the first six months of 1998 were
approximately $666,000 compared to approximately $752,000 in the six months of
1997. Capital acquisitions in both periods were primarily for equipment used in
research and development and computer testing activities. For the six months
ended June 30, 1997, the Company generated approximately $2.9 million from
investing activities, as sales of investments exceeded purchase of investments
and capital equipment.
11
<PAGE>
In November 1997, the Company negotiated a revolving $3.0 million line of
credit agreement with a lending institution to be used for working capital. This
agreement provides for interest at a per annum rate equal to the lender's prime
rate plus 2%. The credit facility, which matures on November 30, 1999, is
collateralized by all of the Company's assets, including copyrights and
intellectual property that may not be reflected in the Company's financial
statements. Borrowings under the line are based on qualified accounts
receivable, as previously discussed in Footnote 1. At June 30, 1998, the Company
had approximately $1.1 million of total eligible borrowing availability
(approximately $206,000 of domestic and $926,000 of international eligible
receivables) and approximately $1.1 million outstanding under the line of
credit. At December 31, 1997, the Company had approximately $2.1 million of
eligible borrowing availability (approximately $1.1 million of domestic and $1.0
million of international eligible receivables) and approximately $1.1 million
outstanding under the line of credit. At July 31, 1998, the Company had
approximately $653,000 of total eligible borrowing availability (approximately
$500,000 of domestic and approximately $153,000 of international eligible
receivables) and approximately $653,000 outstanding under the line of credit.
In August 1998, as a result of concerns about the deterioration of aged
international accounts receivable, the lending institution initiated discussions
regarding the gradual elimination of international receivables as qualified
accounts receivable for borrowing collateral. The lending institution has agreed
to release international receivables from its collateral base, which will allow
the Company to pursue financing alternatives for these receivables. As of June
30 and July 31,1998, the amount of loans collateralized by international
receivables was approximately $913,000 and $311,000, respectively. The lending
institution also intends to increase the interest rate for all outstanding loan
amounts to prime plus 3 1/2%, from prime plus 2%.
The Company's line of credit agreement includes a covenant that requires
the Company to maintain tangible net worth of at least $13.5 million. At June
30, 1998, the Company's tangible net worth was approximately $14.2 million.
Management estimates that the Company will be in violation of this covenant as
of August 31, 1998. The Company intends to seek a waiver of, and renegotiate,
this covenant, but there can be no assurances that a waiver will be received, or
that a renegotiation will be successful, or that the outstanding loan balance
will not be called by the Company's lending institution upon violation of this
covenant.
Certain Factors That May Affect Future Results
The following important factors, among others, could cause actual results
to differ materially from those indicated by forward-looking statements made in
this Quarterly Report on Form 10-Q and presented elsewhere by management from
time to time.
The success of the Company is dependent on its ability to generate adequate
cash for operations and capital needs. The Company's ability to generate
adequate cash for such needs is in large part dependent on its success at
increasing sales of its new products. The Company's plan to increase revenues
through sales of its Network Exchange product line is continuing to evolve in
order to exploit new marketing channels; however, due to market conditions,
competitive pressures, and other factors beyond its control, the Company has
been unable to achieve sufficient incremental growth in new product sales to
replace the decline in mature product sales and achieve increases in revenues
from quarter-to-quarter, and there can be no assurances that the Company will be
able to adequately increase new product sales in the future.
The Company may have to generate additional cash through other means, which
may include the sale of assets, including intellectual property and proprietary
technology, the sale of equity, additional borrowings, the sale of selected
operations, or one or more strategic partnerships. Although the Company believes
it has the ability to generate additional cash through such activities, there
can be no assurances that adequate funds will be available, or available on
terms that are reasonable or acceptable, to the Company.
12
<PAGE>
The Company has mandated certain cost control measures, and is evaluating
various business processes, such as credit administration, order fulfillment,
and asset management, in order to mitigate its liquidity risk. The Company
estimates that, in the absence of an acceptable long-term credit facility for
its international operations, it has sufficient cash and borrowing ability to
operate for approximately three months, although there can be no assurances of
the Company's ability to operate.
The Company is currently reviewing alternatives with the present lending
institution and has initiated discussions with another financial institution,
including the possibility of utilizing the Export-Import Bank loan guarantee
program to finance international inventory and receivables. The Company believes
it will be able to obtain new financing for the international operation;
however, there can be no assurances that such financing can or will be obtained.
If the Company is unable to generate or borrow adequate cash, there will be
a material and adverse effect on the business and financial condition of the
Company, to the extent that a sale, liquidation or restructuring of the Company
will be required, in whole or in part.
Future operating results may be affected by a number of other factors
including the timing of new products in the market place, competitive pricing
pressures and global economic conditions. Because the market for the Company's
products is characterized by rapidly changing technology, the development,
introduction, and evolution of competitive products may require a significant
investment of financial resources. Additionally, the Company relies on reseller
channels which are not under its control for a significant portion of its
revenues, particularly in its international regions. Also, while the Company has
generally been able to obtain adequate supplies of components to date, the
interruption or termination of the Company's current manufacturing relationships
could have an adverse effect on the Company's liquidity and operating results.
A limited number of relatively large customer orders has accounted for and
is likely to continue to account for a substantial portion of revenues in any
particular fiscal period. As a result, the timing of orders could significantly
affect the Company's operating results. In any period, the unexpected loss of or
decline in revenues from a major customer, or the failure to generate
significant revenues from other customers, could have an adverse effect on the
business and operating results of the Company. Although the Company's expense
levels are based in part on its expectations as to future revenue, most expenses
are relatively fixed and cannot be adjusted in the short term. Accordingly if
revenue levels are below expectations, operating results could be adversely
affected. In addition, the Company's products often represent a significant
capital expenditure for its customers and, for that reason, the Company's
operating results may vary significantly depending upon general economic
conditions and customers' budgetary cycles.
A portion of the Company's revenues results from sales to the United States
government, primarily through systems integrators. The revenues generated by
this government business, which is spread across numerous agencies and
departments, could be adversely affected by governmental budgetary or fiscal
restraints or changes in government policy.
The market for the Company's products is characterized by rapidly changing
technology, evolving industry standards and changes in telecommunications
services offered by public carriers. The introduction of products embodying new
technologies and the emergence of new industry standards or telecommunications
services may adversely affect the Company's ability to market its products. This
may require the Company to make substantial expenditures on research and
development in order to develop new products or to maintain the competitiveness
of its existing products. The Company's ability to anticipate changes in
technology and in industry standards, to anticipate changes in market
requirements and to successfully develop and introduce new and enhanced products
on a timely basis, will be a significant factor in the Company's ability to
remain competitive. If the Company is unable, for technological, financial or
other reasons, to develop, introduce and successfully market products in a
timely manner in response to changes in the industry, the Company's business
would be materially and adversely affected. In addition, the Company has
experienced delays in releasing certain of its products
13
<PAGE>
and there can be no assurance that it will not encounter technical or other
difficulties that could delay the introduction or release of new products in the
future.
The development and introduction of new and enhanced products requires a
significant investment of financial resources. To the extent that the Company's
existing financial resources are insufficient to fund the Company's activities,
additional funds will be required. There can be no assurance that additional
financing will be available on terms reasonable to the Company or at all.
The market for networking systems is extremely competitive. Many of the
Company's competitors are more established, benefit from greater market
recognition and have greater financial, technological, production and marketing
resources than the Company. Competition could increase if new companies enter
the market or if existing competitors expand their product lines. An increase in
competition could have an adverse effect on the Company's business and operating
results. Maintaining the competitiveness of the Company's products will require
continued investment by the Company in research and development and sales and
marketing. There can be no assurance that the Company will have sufficient
resources to make such investment or that the Company will be able to make the
technological advances necessary to maintain the competitiveness of its
products.
A significant portion of the Company's total revenues has been derived from
international sales, and the Company expects that international business will
continue to represent an important element of its business. Substantially all of
the Company's international sales have been made through third-party
distributors, and in many cases the Company relies upon only one distributor for
a particular country. A reduction in the sales by some or all of these
distributors or a termination of their relationships with the Company could have
a material adverse effect on the Company's operations and financial performance.
In addition, the Company's international business may be adversely affected by
changes in demand for its products resulting from fluctuations in exchange
rates, as well as by risks such as trade and tariff regulations, political
instability, difficulties in obtaining export licenses, difficulties or delays
in collecting accounts receivable and difficulties in staffing and managing
international operations.
The Company's success depends to a significant extent upon the continued
service of its executive officers and other key personnel. None of the Company's
executive officers or key employees is subject to an employment or
non-competition agreement. The loss of the services of any of its executive
officers or other key employees could have a material adverse effect on the
Company. The Company's future success will depend in part upon its continuing
ability to attract and retain highly qualified personnel. There can be no
assurance that the Company will be successful in attracting and retaining such
personnel.
The Company relies on reseller channels, including distributors and systems
integrators, for a significant portion of its revenues. None of these resellers
are under the control of the Company and there can be no assurance that future
sales by resellers will continue at present levels or will not decline. The loss
of one or more significant resellers could adversely affect the Company's
business. In addition, the Company relies on resellers to provide certain
limited service and support to their customers, and any deficiencies in such
service and support could adversely affect the Company's business and operating
results.
Certain components used in the Company's products are currently available
from only one source and others are available from only a limited number of
sources. Although the Company has generally been able to obtain adequate
supplies of components to date, the Company's inability to develop alternative
sources if and as required in the future, or to obtain sufficient sole-source or
limited-source components as required, could result in delays or reductions in
product shipments, which could adversely affect the Company's operating results.
Certain products that are or may in the future be marketed with or incorporated
into the Company's products are supplied by or under development by third
parties. These third parties may be the sole suppliers of such products. The
Company also currently relies on a single contract manufacturer to assemble and
test most of the Company's products. Although a number of such contract
manufacturers exist, the interruption or termination of the Company's current
manufacturing relationship could have a short-term adverse effect on the
Company's business. The inability of
14
<PAGE>
any such third parties to supply, develop or manufacture components or products
in a timely manner or the termination of the Company's relationship with any
such third party could delay shipment of the Company's products and could have a
material adverse impact on the Company's operating results.
Because of these and other factors, past financial performance should
not be considered an indicator of future performance. Investors should not use
historical trends to anticipate future results and should be aware that the
trading price of the Company's Common Stock may be subject to wide fluctuations
in response to quarter-to-quarter variations in operating results, general
conditions in the networking industry, changes in earnings estimates and
recommendations by analysts or other events.
PART II -- OTHER INFORMATION
----------------------------
Items 1 through 5 are not applicable.
Item 6. Exhibits and Reports of Form 8-K
--------------------------------
(a) Exhibits - None
(b) Reports on Form 8-K
No report on Form 8-K was filed during the quarter ended June 30, 1998.
15
<PAGE>
SIGNATURE
---------
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
NETRIX CORPORATION
Date: August 14, 1998 By: /s/ Lynn C. Chapman
------------------------------
Lynn C. Chapman
President and Chief Executive
Officer
16
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