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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 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 DECEMBER 31, 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 0-25740
ACT NETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
--------------------
DELAWARE 77-0152144
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
188 CAMINO RUIZ, CAMARILLO, CALIFORNIA 93012
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (805) 388-2474
- --------------------------------------------------------------------------------
FORMER NAME, FORMER ADDRESS AND FORMER THREE MONTHS, IF CHANGED SINCE LAST
REPORT: Not Applicable
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
----- -----
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
INDICATE BY CHECK MARK WHETHER THE REGISTRANT HAS FILED ALL DOCUMENTS AND
REPORTS REQUIRED TO BE FILED BY SECTIONS 12, 13, OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 SUBSEQUENT TO THE DISTRIBUTION OF SECURITIES UNDER A PLAN
CONFIRMED BY A COURT. YES NO
APPLICABLE ONLY TO CORPORATE ISSUERS:
THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK, AS OF
FEBRUARY 9, 1999, WAS 9,781,605.
DOCUMENTS INCORPORATED BY REFERENCE
NONE
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<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
NUMBER
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
December 31, 1998 and June 30, 1998...........................................3
Condensed Consolidated Statements of Operations
for the Three and Six Month Periods Ended
December 31, 1998 and 1997....................................................4
Condensed Consolidated Statements
of Cash Flows for the Six Month Periods Ended
December 31, 1998 and 1997....................................................5
Notes to Condensed Consolidated
Financial Statements..........................................................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.................................9
PART II. OTHER INFORMATION
Item 1 Legal Proceedings ........................................................14
Item 2 Changes in Securities and Use of Proceeds....................................14
Item 3 Defaults upon Senior Securities..............................................14
Item 4 Submission of Matters to a Vote of Security Holders..........................14
Item 5 Other Information; Risk Factors..............................................15
Item 6. Exhibits and Reports on Form 8-K.............................................21
SIGNATURE...................................................................................22
EXHIBIT INDEX...............................................................................23
</TABLE>
2
<PAGE> 3
PART I.
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ACT NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1998
------------ ---------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 41,696 $ 35,018
Marketable securities - available for sale 6,899 11,607
Accounts receivable, less allowances of $2,084
in December and $2,030 in June 16,062 17,226
Inventory 6,304 8,829
Prepaids and other current assets 1,937 1,786
--------- ---------
Total current assets 72,898 74,466
Plant, equipment and other improvements:
Machinery and equipment 6,868 6,288
Furniture and fixtures 990 992
Computer software 2,083 1,822
Leasehold improvements 699 672
--------- ---------
10,640 9,774
Accumulated depreciation and amortization 7,174 6,031
--------- ---------
3,466 3,743
Goodwill and other intangibles 2,161 2,574
Other assets 55 55
--------- ---------
Total assets $ 78,580 $ 80,838
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,206 $ 4,538
Accrued payroll and related benefits 805 1,743
Restructuring cost 916 750
Other accrued liabilities 1,507 1,225
Deferred income taxes 56 65
--------- ---------
Total current liabilities 5,490 8,321
Stockholders' equity:
Common stock and additional paid-in capital 102,634 101,067
Treasury stock, at cost, 214 shares (2,402) (2,402)
Accumulated deficit (27,142) (26,148)
--------- ---------
Total stockholders' equity 73,090 72,517
========= =========
Total liabilities and stockholders' equity $ 78,580 $ 80,838
========= =========
</TABLE>
See accompanying notes.
3
<PAGE> 4
ACT NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------- -------------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net sales $ 12,074 $ 15,310 $ 26,010 $ 28,331
Expenses:
Cost of goods sold 4,870 6,738 10,875 12,437
Research and development 3,243 3,851 6,566 7,673
Sales and marketing 2,831 4,209 6,290 7,799
General and administrative 1,530 1,688 3,411 3,783
In-process research and development -- -- -- 6,750
Impairment and restructuring -- -- 607 --
-------- -------- -------- --------
12,474 16,486 27,749 38,442
-------- -------- -------- --------
Loss from operations (400) (1,176) (1,739) (10,111)
Other:
Interest income, net 625 627 1,176 1,095
-------- -------- -------- --------
Income (loss) before income taxes 225 (549) (563) (9,016)
(Provision) benefit for income taxes -- 66 (178) (413)
-------- -------- -------- --------
Net income (loss) $ 225 $ (483) $ (741) $ (9,429)
======== ======== ======== ========
Net earnings (loss) per share $ 0.02 $ (0.05) $ (0.08) $ (1.03)
======== ======== ======== ========
Net earnings (loss) per share - diluted $ 0.02 $ (0.05) $ (0.08) $ (1.03)
======== ======== ======== ========
Shares used in computing net earnings
(loss) per share 9,434 9,146 9,367 9,188
======== ======== ======== ========
Shares used in computing net earnings
(loss) per share - diluted 9,976 9,146 9,367 9,188
======== ======== ======== ========
</TABLE>
See accompanying notes
<PAGE> 5
ACT NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31,
-------------------------
1998 1997
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (741) $ (9,429)
Adjustments to reconcile net income (loss) to
net cash used in operating activities:
Depreciation and amortization 1,493 1,618
Provision for accounts receivable 54 150
Non-cash charges for warrants and stock 43 --
options
Impairment and restructuring charges 607 --
Write-off of in-process research and
development -- 6,750
Changes in operating assets and
liabilities:
Accounts receivable 1,110 (5,276)
Inventory 2,525 (1,422)
Prepaids and other current assets (151) (675)
Accounts payable, accrued
expenses and income taxes payable (3,691) 79
-------- --------
Net cash provided by (used in) operations 1,249 (8,205)
INVESTING ACTIVITIES
Purchase of marketable securities (6,038) (12,145)
Sale and maturities of marketable securities 10,746 14,079
Purchase of plant, equipment and other fixed (866) (1,605)
assets
Acquisition of SourceCom Assets -- (8,600)
Other assets 63 5
-------- --------
Net cash provided by (used in) investing 3,905 (8,266)
activities
FINANCING ACTIVITIES
Proceeds from exercise of stock options and 1,524 43
warrants
Purchase of treasury stock -- (2,402)
-------- --------
Net cash provided by (used in) financing 1,524 (2,359)
activities
-------- --------
Net increase (decrease) in cash 6,678 (18,830)
Cash and equivalents at beginning of the period 35,018 50,948
======== ========
Cash and equivalents at end of the period $ 41,696 $ 32,118
======== ========
</TABLE>
See accompanying notes
5
<PAGE> 6
ACT NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and six-month periods ended
December 31, 1998 are not necessarily indicative of the results that may be
expected for the full fiscal year or for any future period. For further
information, refer to the financial statements and footnotes thereto included in
the Company's most recent annual report on Form 10-K.
The balance sheet at June 30, 1998 has been derived from the audited financial
statements at that date but does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
2. INVENTORIES
The components of inventory consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31, 1998 June 30, 1998
----------------- -------------
<S> <C> <C>
Purchased parts .................... $2,601 $3,643
Sub-assemblies; finished goods ..... 3,703 5,186
------ ------
$6,304 $8,829
------ ------
</TABLE>
3. NET EARNINGS (LOSS) PER SHARE
During the year ended June 30, 1998, the Company adopted SFAS No. 128, "Earnings
Per Share", which required a change in the method used to compute earnings per
share. Under this new standard, primary and fully diluted earnings per share
were replaced with basic and diluted earnings per share. Basic earnings per
share amounts exclude the dilutive effect of potential common shares. For ACT
Networks, Inc., diluted earnings per share amounts under the new standard are
the same as primary earnings per share amounts previously presented. As required
by SFAS No. 128, all prior period amounts have been restated to conform to the
new presentation.
"Basic earnings per share" is based upon the weighted average number of common
shares outstanding. "Diluted earnings per share" is based upon the weighted
average number of common shares and dilutive potential common shares
outstanding. Potential common shares are outstanding stock options under the
Company's stock option plans, which are included under the treasury stock
method, when dilutive.
6
<PAGE> 7
ACT NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
3. NET EARNINGS (LOSS) PER SHARE (CONTINUED)
The following table sets forth the computation for basic and diluted earnings
(loss) per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three months ended Six months ended
December 31, December 31,
--------------------- ----------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Numerator for basic and diluted earnings (loss)
per share - net earnings (loss) ............ $ 225 $ (483) $ (741) $(9,429)
======= ======= ======= =======
Denominator:
Denominator for basic earnings (loss) per
share - weighted-average shares ......... 9,434 9,146 9,367 9,188
Effect of dilutive securities - employee
stock options .......................... 542 -- -- --
------- ------- ------- -------
Denominator for diluted earnings (loss) per
share - adjusted weighted-average shares ... 9,976 9,146 9,367 9,188
======= ======= ======= =======
Basic earnings (loss) per share ............... $ 0.02 $ (0.05) $ (0.08) $ (1.03)
Diluted earnings (loss) per share ............. $ 0.02 $ (0.05) $ (0.08) $ (1.03)
======= ======= ======= =======
</TABLE>
4. COMPREHENSIVE INCOME
In July, 1998, the Company adopted Statement 130, "Reporting Comprehensive
Income," which establishes new rules for the reporting and display of
comprehensive income and its components. Specifically, it requires requires
unrealized gains or losses on the Company's available-for-sale securities and
foreign currency translation adjustments which, prior to adoption, were reported
separately in stockholders' equity, to be included in other comprehensive
income. Prior year financial statements have been reclassified to conform to the
requirements of Statement 130. The adoption of this Statement had no impact on
the Company's net income or stockholders' equity.
The components of comprehensive income (loss) for the three months and six
months ended December 31, 1998 and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
Three months ended Six months ended
December 31, December 31,
---------------------- ----------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income (loss) $ 225 $ (483) $ (741) $(9,429)
Unrealized gains on securities -- 353 -- 353
Foreign currency translation adjustment (160) (155) (160) (155)
------- ------- ------- -------
Comprehensive income (loss) $ 65 $ (285) $ (901) $(9,231)
</TABLE>
7
<PAGE> 8
ACT NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
5. INCOME TAXES
The provision for income taxes differs from the federal statutory rate due
primarily to foreign income taxes related to the Company's Canadian subsidiary
and to net operating losses not benefited.
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Report may contain forward-looking statements that involve a number
of risks and uncertainties including, without limitation, those set forth in the
"Risk Factors" section under "Other Information." The Company's actual results
may differ materially from any future performance discussed in the
forward-looking statements and this Management's Discussion and Analysis of
Financial Condition and Results of Operations. The Company undertakes no
obligation to update the information, including the forward-looking statements,
if any, in this Report.
GENERAL
ACT develops, manufactures and markets wide area network (WAN) access
products which support a broad range of integrated voice and data network
applications. Service providers and enterprise customers use the Company's
products to build multimedia networks that are bandwidth efficient,
cost-effective and easy to manage. The Company's products incorporate advanced
voice and data compression algorithms, enhanced switching and traffic management
capabilities, and state-of-the-art hardware and software integration
technologies.
The Company is migrating toward two principal product families,
NetPerformer and ServiceXchange, which share a common technology foundation but
are targeted at different market segments. NetPerformer is a family of Frame
Relay access devices targeted at enterprise customers who need to integrate and
transport voice, fax, LAN and SNA data over private or public Frame Relay
networks. The ServiceXchange family, currently in development, is intended to
address the needs of service providers who are especially focused on
transporting large volumes of voice traffic cost-effectively over Frame Relay,
ATM or IP backbones. Within each family, both chassis-based and stand-alone
configurations will be offered to serve specific customer requirements for
price, performance, density and feature set.
The Company's future results will be dependent upon a variety of factors
including, without limitation, the Company's ability to develop and release new
products in a timely manner and within anticipated budgets. While the Company
anticipates the release of new products in fiscal 1999, there can be no
assurance that such products will be released when anticipated or that such
products will achieve market acceptance.
The Company anticipates that, in general, the average sales price for
its products will decrease over time due to competition and other factors. The
Company is currently focusing on developing OEM or similar relationships with
third parties, which may result in significant pricing discounts and lower gross
margins. In particular, the Company has entered into agreements with Lucent
Technologies, Inc. ("Lucent") and FORE Systems, Inc. ("FORE"). Price erosion of
existing products, significant discounting and the Company's introduction of
less expensive networking alternatives could adversely affect the Company's
margins and results of operations.
Sales to customers outside of North America accounted for approximately
64% of the Company's net sales for the fiscal year ended June 30, 1998 and
approximately 48% for the three months ended December 31, 1998. The Company
expects that international sales will continue to account for a significant
portion of the Company's net sales in future periods. In addition, the Company
believes that a significant portion of its sales to customers inside North
America represent sales of products which are used or resold in markets outside
of North America. International sales are subject to certain inherent risks,
including unexpected changes in regulatory requirements and tariffs, problems
and delays in collecting accounts receivable and economic downturns in foreign
markets. A significant number of the Company's products are sold or installed in
countries, including several in South America and Asia, where political or
economic issues have adversely affected, and may in the future adversely affect,
the purchasing decision of the customer. In addition, fluctuations in currency
exchange rates have caused, and may in the future cause, the Company's products
to become relatively more expensive to customers in a particular country,
leading to a reduction in sales or profitability in that country. The Company
believes that recent events in Asia and South America will continue to adversely
impact the Company's net sales in these regions in the near term.
A small number of customers have historically accounted for a
substantial portion of the Company's net sales. In particular, one customer
accounted for approximately 15% of the Company's net sales during the three
months ended December 31, 1998. The Company's five largest customers
collectively accounted for 35% of net sales during the fiscal year ended June
30, 1998, and 38% of net sales during the three months ended December 31, 1998.
Any reduction, delay or change in orders from significant customers could have a
material adverse effect on the Company's business.
9
<PAGE> 10
ACQUISITIONS
In November 1995, the Company acquired all the outstanding shares of Presticom,
a developer of multiprotocol Frame Relay access devises. In December 1996, the
Company acquired all the outstanding shares of DeltaComm Corporation, a
developer of bandwidth-efficient modems with expertise in the satellite
communications industry. In March 1997, the Company acquired the DynaStar family
of products from Dynatech Communications, Inc. The DynaStar product line is a
family of compact, flexible, integrated multi-service access switch connectivity
products that support extensive multiprotocol WAN connections including TCP/IP,
PPP, Frame Relay, X.25 and ATM. In August 1997, the Company acquired out of
bankruptcy certain assets of Sourcecom, Inc., a developer of high performance
broadband access devises. In connection with these acquisitions, the Company
expensed a portion of the purchase prices as in-process research and
development. The products and technologies acquired in the Dynatech
Communications, Inc. and DeltaComm Corporation acquisitions are being either
de-emphasized or discontinued.
RESTRUCTURING PROGRAM
In July 1998, the Company announced a major restructuring program designed to
streamline operations and focus on key markets. As part of the restructuring
program, the Company is concentrating its resources on the Netperformer and
ServiceXchange product lines. In connection with the restructuring, the Company
has significantly reduced its workforce, eliminated its business unit matrix
structure in favor of a functional organization and de-emphasized engineering,
sales and marketing efforts for non-strategic products.
There were no restructuring charges during the quarter ended December 31, 1998.
The Company's net loss for the six month period ended December 31, 1998 includes
certain restructuring charges of $607,000 taken in the first quarter of fiscal
1999 related primarily to severance cost.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated, the
percentages of net sales represented by each item in the Company's statement of
operations.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
------------------- -------------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net sales .............................. 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ..................... 40.3% 44.0% 41.8% 43.9%
----- ----- ----- -----
Gross profit ........................... 59.7% 56.0% 58.2% 56.1%
Operating expenses:
Research and development ............ 26.9% 25.2% 25.3% 27.1%
Sales and marketing ................. 23.4% 27.5% 24.2% 27.5%
General and administrative .......... 12.7% 11.0% 13.1% 13.4%
Impairment and restructuring charges -- -- 2.3% --
In-process research and development . -- -- -- 23.8%
----- ----- ----- -----
Total operating expenses ............... 63.0% 63.7% 64.9% 91.8%
(Loss) income from operations .......... (3.3)% (7.7)% (6.7)% (35.7)%
Net interest and other income .......... 5.2% 4.1% 4.5% 3.9%
----- ----- ----- -----
Income (loss) before taxes ............. 1.9% (3.6)% (2.2)% (31.8)%
Benefit (Provision) for income taxes ... -- 0.4% (0.6)% (1.5)%
----- ----- ----- -----
Net income (loss) ...................... 1.9% (3.2)% (2.8)% (33.3)%
===== ===== ===== =====
</TABLE>
Net Sales
The Company classifies its sales as either international or domestic.
International sales are, in general, shipments to locations outside North
America, regardless of the end-user's or the customer's location. Domestic sales
are, in general, shipments to locations within North America, even if the
end-user or customer is located outside North America. As the Company sells
primarily through resellers, the Company does not know with certainty the
location of the end-user
The Company also classifies its sales by customer type. In general, the
end-users of the Company's products are either enterprise customers who acquire
the Company's products for use in their own network or service providers who use
the Company's products to provide telecommunications services to third parties.
Service providers include alternate service providers (such as wholesale
long-distance carriers and call-back operators), value added network services
providers, competitive local exchange carriers, incumbent local exchange
carriers, competitive access providers, Internet Service Providers and
Interexchange Carriers. The Company's NetPerformer products may be used by both
enterprise customers and service providers. The
10
<PAGE> 11
Company's ServiceXchange products are designed primarily for the service
provider market. As the Company migrates to new products and discontinues the
promotion of certain of its older products which have, historically, accounted
for a majority of the Company's sales, the Company's net sales may be adversely
impacted in the near term. The Company has in the past encountered, and may in
the future encounter, decreased sales as a result of product transitions.
Net sales decreased 21.1% for the quarter ended December 31, 1998 and
decreased 8.2% for the six months ended December 31, 1998 from the comparable
periods in fiscal 1997. All such decreases were due primarily to lower unit
volumes. Substantial decreases in sales to the Asia Pacific and Latin America
regions more than offset the increase in domestic sales. The following table
sets forth, for the quarters indicated the percentage of total net sales in
these categories.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
------------------ ------------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Domestic Sales 52.1% 31.2% 46.6% 25.9%
International Sales 47.9 68.8 53.4 74.1
----- ----- ----- -----
100.0% 100.0% 100.0% 100.0%
Sales to Enterprise 48.0% 65.2% 50.0% 71.9%
Customers
Sales to Service Providers 52.0 34.8 50.0 28.1
----- ----- ----- -----
100.0% 100.0% 100.0% 100.0%
</TABLE>
Gross Profit
Gross profit represents net sales less the cost of goods sold, which
includes cost of materials, direct labor and manufacturing overhead. The
Company's gross profit was $7.2 million for the quarter ended December 31, 1998
as compared with $8.6 million for the quarter ended December 31, 1997 and $15.1
million for the six months ended December 31, 1998 as compared to $15.9 million
for the six months ended December 31, 1997. While declining in dollar amount
with lower sales, gross profit percentage increased, due primarily to product
mix and cost reductions associated with outsourcing. Management anticipates
downward pressure on gross profit as a percentage of sales, particularly as the
Company pursues OEM opportunities with strategic partners that typically produce
lower gross margins.
Operating Expenses
Research and development. As discussed above in "Restructuring Program,"
management has reduced its workforce as the Company de-emphasized engineering
efforts for non-strategic products. In particular, the Company continues to
narrow its product focus to emphasize the NetPerformer and ServiceXchange
product lines. However, the development of new products and features involves a
number of risks and uncertainties, and there can be no assurance that the
Company's research and development expenses will not increase either in actual
dollars or as a percentage of sales in future periods.
Sales and marketing. As discussed above in "Restructuring Program," management
reduced its workforce during the first quarter of the current fiscal year as the
Company de-emphasized sales and marketing efforts for non-strategic products and
adopted a functional organizational structure. However, during the three months
ended December 31, 1998, the Company started to increase its sales force
focusing on OEM relationships and on its primary product lines.
General and administrative. The decrease in general and administrative expense
is due in large part to a decline in amortization expense following the
fair-value write-downs of acquisition-related intangible assets in June 1998. In
addition, certain administrative positions were vacant during a portion of the
three-months period ended December 31, 1998.
The Company plans to combine its two California facilities by the end of the
current fiscal year. Management has not yet determined the effect of this move
on recurring expense but does expect additional general and administrative
expense related to the cost of moving into a new facility.
Net interest and other income (expense)
The increase in net interest for the six months ended December 31, 1998
over the comparable period of 1997 was attributable primarily to higher combined
cash reserve and marketable security balances and the timing of commercial paper
discount recognition, partially offset by lower interest rates.
11
<PAGE> 12
Income Taxes
There was no provision for income taxes for the three months ended December 31,
1998. In general, the provision for income taxes may differ from the federal
statutory rate due to foreign income taxes related to the Company's Canadian
subsidiary, the effect of federal and state alternative minimum taxes, and net
operating losses incurred for the period that are not benefited. For the second
quarter of fiscal 1999, the difference between the federal statutory rate and
the effective tax rate relates primarily to foreign income taxes and operating
losses not benefited.
Inflation/Accounting Pronouncements
Although management cannot accurately anticipate the effect of inflation
on its operations, to date inflation has not had a material effect on product
sales or results of operations. Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS
131), was issued in June 1997. The adoption of this statement is not expected to
have a material impact on the Company's consolidated results of operations,
financial position or cash flows.
Year 2000
The Year 2000 issue is the result of computer programs that were written
using two digits rather than four to define the applicable year; accordingly,
computer programs that have time-sensitive software or firmware may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result in
a system failure or miscalculation causing disruptions of operations including,
among other things, an inability to process transactions, send invoices or
engage in similar normal activities. The Company has begun accessing the impact
the Year 2000 issue may have on its operations and has identified these
potential areas of its business that may be affected:
Internal Systems and Equipment. The Company believes it has
substantially completed its identification of major internal systems and
equipment used in connection with its internal operations that require upgrading
or modification to minimize a material disruption of its business. As a result,
the Company has determined that one of its primary internal information systems
requires a version upgrade of both the operating system and the application
software in order to become Year 2000 compliant. The operating system upgrade is
scheduled for February 1999. The application software upgrade is scheduled for
installation prior to March 1999 and will be in a test mode for a period of
time. Management expects to complete testing and migration to the Year-2000
compliant version of this software prior to June 30, 1999. The Company does not
currently expect any significant cost or issues associated with bringing its
internal systems and equipment into compliance. However, the failure of any
internal systems to achieve Year 2000 compliance could result in a material
disruption to the Company's operations.
Products. The Company has evaluated each of its products and will
continue to verify Year 2000 compliance on developing products. Based on its
testing to date, the Company believes that its current products are
substantially Year 2000 compliant. The Company has not had, and has no present
intention to have, its products tested by an independent lab. The costs of the
testing program related to the Year 2000 have not had, and are not expected to
have, a material impact on operations or financial results. However, the
inability of any of the Company's products to process year 2000 data accurately
could result in increased costs and liabilities which could have a material
adverse effect upon the Company's operations and financial condition.
Third Party Suppliers and Customers. The Company is currently in the
process of accessing the Year 2000 readiness of its suppliers and customers. The
Company has identified two potential sources of third-party risk to the Company
with respect to the Year 2000 issue. The first is the Company's increasing
reliance on turnkey manufacturers of its products; disruption of operations at
such suppliers could adversely impact the Company's shipment schedule and
operations. The Company has begun to survey its major suppliers to assess the
potential impact, if any, of Year 2000 non-compliance on the Company. To date,
no instances of non-compliance have been identified to the Company by a major
supplier. Assessment of the Company's suppliers is expected to be completed
during fiscal 1999. The Company expects to resolve any significant Year 2000
problems with its suppliers; however, there can be no assurance that these
suppliers will resolve any or all Year 2000 problems in a timely manner. The
second potential risk is from the Company's larger customers who are either
end-users or resellers. Year 2000 non-compliance of such customers could impact
the customers' ability to purchase the Company's products. The Company has not
conducted a comprehensive survey of major customers to assess the potential
impact, if any, of Year 2000 noncompliance. Any failure of the Company's
suppliers and customers to resolve their Year 2000 problems in a timely manner
could result in a material disruption of the Company's business. Any such
disruption could have a material adverse effect upon the business and financial
results of the Company. The Company does not have a contingency plan in place to
address such an event and does not presently intend to create one.
12
<PAGE> 13
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations primarily from the sale of stock
and sales of the Company's products. For the six months ended December 31, 1998,
the Company's operating activities provided cash of approximately $1.2 million.
The Company had significant non-cash expenditures included in its net loss. In
addition, the Company's use of funds to reduce payables and accrued expense were
more than offset by its reduction in receivables and inventory. At December 31,
1998, the Company had approximately $67.4 million in working capital, including
$48.6 million in cash, cash equivalents and short-term investments.
The Company currently has no material commitments for capital
expenditures. However, the Company anticipates spending between $1.5 million and
$2.0 million during the next twelve months to acquire test equipment, computer
equipment, office furniture, leasehold improvements and tooling.
The Company believes that available cash, cash equivalents and
investments, together with internally generated cash flow, will be adequate to
satisfy its capital requirements for at least the next twelve months.
13
<PAGE> 14
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS. NONE.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. NONE.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. NONE.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.
At the Company's Annual Meeting of Stockholders held on November 30,
1998 (the "Meeting"), the following matters were submitted and voted
on by security holders and were adopted:
A. The approval of a 150,000 share increase for the Company's
Employee Stock Purchase Plan.
The results of the vote are as follows:
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN BROKER NON-VOTES
--------- ------- ------- ----------------
<S> <C> <C> <C>
7,353,088 161,126 24,875 156,978
</TABLE>
B. The approval of a 200,000 share increase for the Company's
1997 Stock Incentive Plan.
The results of the vote are as follows:
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN BROKER NON-VOTES
--------- ------- ------- ----------------
<S> <C> <C> <C>
5,118,973 2,393,991 26,125 156,978
</TABLE>
C. The election of Andre de Fusco and Frederick W. Gluck as
directors of the Company to serve until the 2001 Meeting
and until their respective successors have been elected
and qualified was carried.
<TABLE>
<CAPTION>
NAME FOR WITHHELD
------------------ --------- --------
<S> <C> <C>
Andre de Fusco 7,637,119 58,948
Frederick W. Gluck 7,637,716 58,351
</TABLE>
D. The ratification of Ernst & Young, LLP as independent
auditors of the Company for the fiscal year ending June
30, 1999.
The results of the vote are as follows:
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN
--- ------- -------
<S> <C> <C>
7,647,244 27,073 21,750
</TABLE>
14
<PAGE> 15
ITEM 5. OTHER INFORMATION.
RISK FACTORS
This report may contain forward-looking statements that involve a number of
risks and uncertainties. Certain results that could cause actual results to
differ are discussed below. The Company's actual results may differ materially
from any future performance discussed in forward-looking statements. The
following risks should be considered carefully, in addition to the other
information contained in this Report, before trading in the shares of the
Company's Common Stock.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS. The Company has experienced and may
in the future experience significant fluctuations in net sales and operating
results as a result of a number of factors including, without limitation, the
volume and timing of orders from, and shipments to, major customers; market
acceptance of the Company's products; the Company's ability to support its
current and new products; the ability of the Company's customers, particularly
international customers, to obtain financing for the purchase of the Company's
products; economic issues in international markets; changes in the Company's
strategies; changes in pricing policies or price reductions by the Company or
its competitors; variations in the Company's sales channels or the mix of
product sales; the Company's ability to expand and implement its sales and
marketing programs; the timing of new product announcements and product
introductions by the Company or its competitors; product obsolescence resulting
from new product introductions or changes in customer demand; the availability
and cost of supplies; the financial stability of major customers; expenses
associated with the acquisition of technologies or businesses; changes in
regulatory requirements; intellectual property disputes; the development of
public telecommunications infrastructures, particularly in international
markets; currency fluctuations; and general economic conditions. While the
Company regularly engages in price discounting, significant discounts in a
particular quarter could adversely affect the results of operations for such
quarter. In addition, significant and continuing discounts due to competition or
other factors could adversely affect the Company's business, operating results
and financial condition. The Company has generally not experienced seasonality
in its net sales, although the Company has from time to time experienced
decreased net sales to customers in Europe in the third calendar quarter of each
year and has experienced some decreases in net sales in other international
markets during certain periods during the year. Due to all of the foregoing
factors, in certain quarters the Company's operating results have been, and it
is likely that in some future periods the Company's operating results will be,
below the expectations of public market analysts and investors. In such event,
the price of the Company's Common Stock has been and in the future could be
materially adversely affected. For example, on several occasions over the last
few years, the Company's net sales decreased when compared to the preceding
quarter and, as a result, the Company's results of operations and, in certain
instances, the price of the Company's Common Stock were adversely affected. In
addition, in July 1998 the Company commenced a restructuring program which
adversely impacted the Company's operating results in the near term. Quarterly
results are not necessarily indicative of future performance for any particular
period, and there can be no assurance that the Company will attain growth in net
sales or profitability on a quarterly or annual basis. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The Company's sales have primarily been through resellers and are
typically characterized by several large orders and a large number of small
orders. The Company's revenue in any period is highly dependant on the sales
efforts and success of the Company's partners and other resellers, which are not
under the Company's control. The Company's partners and resellers typically do
not stock a supply of the Company's products and place orders with the Company
only after they have received orders from their customers. In addition, the
Company's backlog at the beginning of a quarter is generally insufficient to
achieve expected net sales for the quarter. While it is difficult for the
Company to accurately forecast the timing and quantity of orders on a quarter to
quarter basis, the Company may increase expenses with the expectation of future
sales. The failure of the Company to accurately forecast the timing and volume
of orders for a quarter would adversely affect the results of operations for
such quarter and, potentially, for future periods. Fluctuations in quarterly
results may result in significant volatility in the market price of the
Company's Common Stock. In addition, sales of networking products fluctuate from
time to time based on numerous factors, including capital spending levels and
general economic and market conditions. Future declines in networking product
sales, as a result of general economic conditions or for any other reason, could
have a material adverse effect on the Company's business, operating results and
financial condition.
LIMITED HISTORY OF PROFITABILITY; UNCERTAIN FUTURE PROFITABILITY. The Company
was organized in May 1987 and commenced shipments of its first product in
October 1988. While the Company first achieved profitability in the fourth
calendar quarter of 1990, it incurred losses in periods subsequent to that time.
There can be no assurance that the Company will be profitable in future periods.
In the past, the Company has expanded its level of operations, resulting in
increased fixed costs and operating expenses, with the expectation of increased
sales and gross profits. The Company's operating results and net income were
adversely impacted as net sales and gross profits did not increase sufficiently
to offset such increased expenses. While the Company commenced a restructuring
program in July 1998 to decrease expenses, there can be no assurance that
expenses have been, or will be, decreased
15
<PAGE> 16
sufficiently to result in profitability, that the Company will not increase
expenses with the anticipation of increased sales in the future, or that the
Company will maintain or increase net sales or gross profits. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
DEPENDENCE ON KEY PERSONNEL; NEW MANAGEMENT. The Company's success is dependent
in large part on its executive officers, senior management and sales and
technical personnel. Since July 1998, the Company has undergone numerous changes
in all levels of the organization as a result of a restructuring and other
factors. In particular, the Company has a new Chief Executive Officer, Vice
President of Marketing, Vice President of Sales, Vice President of Engineering,
and Chief Financial Officer. The failure of new management and other personnel
to fully integrate into the Company's operations and to execute the Company's
strategy, and the failure of the Company to retain such management and other
personnel, could have a material adverse effect on the Company's business. The
Company's success will be dependent on its continued ability to attract, retain
and motivate highly skilled employees, who are in great demand. There can be no
assurance that the Company will be able to do so.
RESTRUCTURING. In July 1998, the Company commenced a restructuring program to
streamline its operations and focus its efforts on the Netperformer and
ServiceXchange products. The Company discontinued or de-emphasized certain
nonstrategic operations or product lines and effected numerous personnel
changes. As a result of these and other factors, the Company incurred
significant losses in the quarters ended June 30, 1998 and September 30, 1998.
The Company may incur additional expenses related to the restructuring in fiscal
1999. As such, the restructuring program may adversely impact the Company's
results of operations in the near term. There can be no assurance that the
restructuring will positively impact the Company in the long term.
TECHNOLOGICAL CHANGE, CHANGING MARKETS AND NEW PRODUCTS. The market for the
Company's products is characterized by rapid technological advances, evolving
industry standards, frequent new product introductions and enhancements, and
significant price competition. The introduction of products involving superior
or alternative technologies, the emergence of new industry standards,
governmental regulations, changes in a market's pricing structure and other
factors could render the Company's existing products, as well as products under
development, obsolete and unmarketable in one or more markets which could
adversely affect the Company's business, operating results and financial
condition. The Company has experienced instances where one or more of those
factors resulted in a significant decrease in sales of the Company's products in
particular markets or resulted in new products becoming obsolete or
unmarketable. The Company's success will depend, in part, on the viability of
the Company's products in its markets and the ability of the Company to develop
effective distribution channels to address these markets. There can be no
assurance that the Company's products will be widely accepted. Failure of the
Company's products to achieve market acceptance could have a material adverse
effect on the Company's business, operating results and financial condition.
The Company believes its future success will depend, in part, upon its
ability to expand and enhance the features of its existing products and to
develop or acquire and introduce new products designed to meet changing customer
needs on a cost-effective and timely basis. In particular, the completion of the
development and successful commercial release of the ServiceXchange family of
products is critical to the Company's strategies. Failure by the Company to
respond on a timely basis to technological developments, changes in industry
standards or customer requirements, or any significant delay in product
development or introduction (particularly the ServiceXchange products), could
have a material adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that the Company will respond
effectively to technological changes or new product announcements by others or
that the Company will be able to successfully develop and market new products or
product enhancements and that any new product or product enhancement will gain
market acceptance.
Inherent in the product development process are a number of risks. The
development of new, technologically advanced products and product enhancements
is a complex and uncertain process requiring high levels of innovation, as well
as the accurate anticipation of technological and market trends. The Company
budgets research and development expenditures based on planned product
introductions and enhancements; however, actual expenditures may significantly
differ from budgeted expenditures. There can be no assurance that the Company
will successfully identify, develop or introduce new products or product
enhancements. Products such as those offered by the Company may contain
undetected or unresolved software errors when they are first introduced or as
new versions are released. There can be no assurance that, despite extensive
testing by the Company, software errors will not be found in new products or
upgrades after commencement of commercial shipments, resulting in delay in or
loss of market acceptance. Future delays in the introduction or shipment of new
or enhanced products, the inability of such products to gain market acceptance
or problems associated with new product transitions could adversely affect the
Company's operating results, particularly on a quarterly basis. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
SUBSTANTIAL COMPETITION. The market for the Company's products is highly
competitive. The Company competes directly domestically and internationally with
a variety of companies offering fast packet access and/or gateway products
including Cisco Systems, Inc., Lucent, Ascend Communications, Northern Telecom,
Inc., Memotec Communications, Inc., Motorola Information Systems Group, Sync
Research, Inc. and other companies. The Company expects substantial additional
competition from existing competitors and from a number of other companies which
may enter the Company's existing or future markets. Many of the Company's
current and potential competitors have substantially greater name recognition
and financial, marketing, technical and other resources than the Company. Many
of these companies sell directly to end-users, which the Company believes may
provide a
16
<PAGE> 17
competitive edge over the Company when marketing either similar products or
alternative networking solutions. In addition, many of these companies offer a
more comprehensive networking solutions to their customers than the Company.
Consolidations in the industry could enhance the capabilities of the Company's
competitors. There can be no assurance that the Company will be able
successfully to compete against either current or potential competitors or that
competition will not have a material adverse effect on the Company's business,
operation results and financial condition.
INTEGRATION OF ACQUISITIONS. The Company has, and may in the future, acquire
complementary technologies and businesses. Acquisitions by the Company may
result in potentially dilutive issuances of equity securities, the incurrence of
additional debt, the creation and amortization of goodwill and the incurrence of
acquisition related expenses, all of which could adversely affect the Company's
results of operations. In addition, acquisitions involve numerous risks,
including difficulties in the assimilation of the operations, technologies and
products of the acquired businesses; the diversion of management's attention
from other business concerns; risks associated with the Company's entering
markets in which it has no or limited direct prior experience; and the potential
loss of key employees of the acquired company. The Company has engaged in
several acquisitions in the last two years which have resulted in increased
expenses without a commensurate increase in net sales. These acquisitions have
also adversely impacted the Company's results of operations due to in-process
research and development expenses, the write down of tangible and intangible
assets and other factors. In the event the Company engages in additional
acquisitions, no assurances can be given as to the effect thereof on the
Company's business, operating results and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
CUSTOMER CONCENTRATION. A small number of customers have historically accounted
for a substantial portion of the Company's net sales. During the fiscal year
ended June 30, 1998, and the six months ended December 31, 1998, the Company's
five largest customers collectively accounted for 35% and 38%, respectively, of
net sales. In many instances, the Company's major customers in any given period
have ordered significantly less products in future periods. The Company believes
that this has been due, in part, to customers who make large, one-time purchases
to set up their communications infrastructure, after which such customers do not
require further significant purchases. In addition, the Company believes this
may be due to a variety of other factors, including, without limitation, the
economic conditions in various countries, particularly those in Asia and South
America. Therefore, the Company expects that its major customers will fluctuate
from period to period. There can be no assurance that a major customer will not
reduce or delay the amount of products ordered from the Company or significantly
change the terms upon which the Company and such customer do business. Any such
reduction, delay or change could have a material adverse effect on the Company's
business. In addition, the Company's sales and marketing strategy is to focus on
developing distribution channels with major communications companies. The
Company has entered into reseller agreements with Lucent and FORE and is
allocating significant resources to these relationships. There is no assurance
that Lucent or FORE will become significant customers of the Company.
Furthermore, there can be no assurance that the Company ;will retain its current
partners or that it will be able to establish new relationships with new
partners or replace its current partners.
MANAGEMENT OF GROWTH. The Company has from time to time experienced growth in
its operations, both internally and as a result of acquisitions. The Company's
growth has placed, and will continue to place, strain on the Company's
managerial, operational and financial resources, systems and controls. This is
particularly true with respect to sales in international markets since each
specific international market has its own unique regulatory, financial,
technical, customer and other characteristics which often require the Company to
devote significant resources to sell products in that country. In addition, the
Company engages from time to time in customer development activities for
customers which require the allocation of significant resources. The Company's
future operating results will depend on its ability to attract, hire and retain
skilled employees, and to expand and improve the Company's operational, product
development, management information and financial systems and controls. The
Company continues to upgrade its management information and product development
systems. The Company's failure to manage growth effectively, successfully
upgrade its systems or to hire, retain and integrate necessary qualified
personnel could adversely affect the Company's business, operating results and
financial condition.
INTERNATIONAL SALES, TARIFF AND REGULATORY MATTERS. Sales of the Company's
products to customers outside of North America accounted for approximately 64%
and 53% of the Company's net sales for the fiscal year ended June 30, 1998, and
the six months ended December 31, 1998, respectively. In addition, the Company
believes that a majority of its sales to customers inside North America
represent sales of products which are used or resold in markets outside of North
America. The Company expects that international sales will continue to account
for a significant portion of the Company's net sales in future periods.
International sales are subject to certain inherent risks, including unexpected
changes in regulatory requirements and tariffs, difficulties in staffing and
managing foreign operations, potentially adverse tax consequences and problems
in collecting accounts receivable. A significant number of the Company's
products are sold or installed in countries, including several in South America
and Asia, where political or economic issues have adversely affected, and may in
the future adversely affect, the purchasing decision of customers. The Company
believes that recent events in Asia and Latin America have adversely impacted,
and will continue to adversely impact, the Company's net sales in these regions
in the near term. Although the Company's sales are currently denominated in U.S.
dollars, fluctuations in currency exchange rates have in the past caused, and
could in the future cause, the Company's products to become relatively more
expensive to customers in a particular country, leading to a reduction in sales
or profitability in that country and potentially leading to an extension of
payment terms. Furthermore, future international activity may result in foreign
currency denominated sales and, in such event, gains and losses on the
conversion to U.S. dollars of accounts receivable and accounts
17
<PAGE> 18
payable arising from international operations may contribute to fluctuations in
the Company's results of operations. The financial stability of foreign markets
could also affect the Company's international sales. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Rates for telecommunications services are governed by tariffs of
licensed carriers that are subject to regulatory approval. Future changes in
these tariffs could have a material adverse effect on the Company's business.
For example, should tariffs for public switched digital services increase in the
future relative to tariffs for private leased services, the cost-effectiveness
of certain of the Company's products would be reduced, and its business and
results of operations could be adversely affected. In addition, the Company's
products must meet standards and receive certification for connection with the
public telecommunications networks of a country prior to their sale in such
country. In the United States, for example, the Company's products must comply
with certain regulations promulgated by the Federal Communications Commission.
The Company's products must also be certified by domestic telecommunications
carriers. In foreign countries, the Company's products are subject to a wide
variety of governmental review and certification requirements. From time to
time, foreign governments have altered certification or regulatory requirements
which has adversely impacted the Company's ability to sell products in such
markets. Any future inability to obtain on a timely basis or retain domestic
certificate or foreign regulatory approvals could have a material adverse effect
on the Company's business, operating results and financial condition.
DEPENDENCE ON CONTRACT MANUFACTURING. The Company's operational strategy is to
further rely on outsourcing of its manufacturing. The Company also intends to
streamline its manufacturing operations by focusing on one manufacturing
contractor, Solectron. Accordingly, the risks associated with reliance on sole
sources is expected to increase. Any interruption or delay by the Company's
contract manufacturers could have a material adverse effect upon the Company's
business, operations and financial condition. The Company may experience
problems with its contract manufacturers, such as inferior quality, insufficient
quantities and late delivery of product. While such problems have not resulted
in any material liabilities from the Company to its customers and end-users to
date, there can be no assurance that such problems will not generate material
liabilities for the Company or adversely impact the Company's relations with
customers and end-users in the future.
RELIANCE ON THIRD PARTY SUPPLIERS. The Company relies on third party suppliers
who supply the components used in the Company's products. The unavailability of
certain components from current suppliers, especially components custom designed
for the Company, could result in delays in the shipment of the Company's
products as well as additional expenses associated with obtaining and qualifying
a new supplier. In addition, certain key components used in the Company's
products are available only from single sources and the Company does not have
long term contracts ensuring the supply of such components. As the Company
typically maintains less than 90 days supply of such components, there can be no
assurance that components will be available to meet the Company's future
requirements at favorable prices, if at all. The Company's inability to obtain
components in a timely manner would materially and adversely affect the
Company's business and financial condition. In addition, any significant
increase in component prices could also adversely affect the Company's results
of operations. The Company resells Frame Relay switches purchased from Ascend.
Although the Company believes similar products can be purchased from other
sources, the process of qualifying replacement suppliers, generating the
supporting documentation, performing system level integration, obtaining
standards-compliant approval for its products, and retraining sales and
marketing channels would require a significant amount of time and expense. The
Company's ability to offer an integrated, cost-effective networking solution is
based, in part, on its ability to sell such products as part of its present
line. The Company's inability to source these products at satisfactory quality
and quantity levels and with the appropriate lead time would adversely affect
the Company's business and operations.
RELIANCE ON INDIRECT DISTRIBUTION. The Company markets and sells products
domestically and internationally primarily through resellers, such as
distributors, value-added resellers and system integrators. The number of
qualified resellers in certain countries is limited. Resellers typically are not
effective at selling the Company's products until they have been trained and
have successfully completed several sales. The Company's performance depends in
part on attracting, retaining and motivating such resellers. Certain of the
Company's resellers also act as resellers for competitors of the Company and
could devote greater effort and resources to marketing competitive products. The
Company's resellers are generally provided discounts and, occasionally, are
entitled to special pricing or distribution arrangements, the effect of which is
to decrease the Company's gross margins. While the Company has contractual
relationships with many of its resellers, these agreements do not require the
resellers to purchase the Company's products and can generally be terminated on
short notice by the reseller. Resellers in many countries have title to the
governmental authorizations and certifications necessary to market the Company's
products in such country, and there is no assurance that, in the event a
reseller ceased marketing the Company's products, the reseller would transfer
such authorization or certification to the Company or that the expense and delay
associated with obtaining a new authorization or certification would not
adversely affect the Company's business and operations in such country. There
can be no assurance that resellers will continue to market the Company's
products or devote the resources necessary to provide effective sales and
marketing support to the Company. In addition, the Company is dependent on the
continued viability and financial stability of its resellers, many of which are
small organizations with limited capital. The loss of any key reseller could
adversely affect the Company's business.
DEPENDENCE ON PROPRIETARY TECHNOLOGY. The Company's future success will depend
in part on its proprietary technology. In addition, certain technology licensed
from third parties is incorporated in the Company's products. In particular, the
Company licenses certain of its voice compression algorithms, the right to
commercialize its SkyFrame products, components of its network
18
<PAGE> 19
management system software and other software and technology embedded in the
hardware incorporated into the Company's products pursuant to nonexclusive
license agreements. The failure of the Company to retain such licenses or obtain
new licenses as improvements in such technology are developed and new technology
is introduced could adversely affect the Company's business. The Company does
not currently hold any patents. The Company relies principally on copyright,
trade secret and contract law to protect its proprietary technology. There can
be no assurance that such measures are adequate to protect the Company's
proprietary technology. The Company has substantial international operations and
the laws of foreign countries treat the protection of proprietary rights
differently from, and may not protect the Company's proprietary rights to the
same extent as do, laws in the United States. Since patent applications in the
United States are not publicly disclosed until the patent is issued,
applications may have been filed which, if issued as patents, would relate to
the Company's products. In addition, the Company has never conducted a
comprehensive patent search relating to the technology used in its products.
Accordingly, there can be no assurance that third parties will not assert
infringement claims against the Company in the future or that such claims will
not be successful. The Company could incur substantial costs in defending itself
and its customers against any such claims, regardless of the merits of such
claims. Parties making such claims may be able to obtain injunctive or other
equitable relief which could effectively block the Company's ability to sell its
products in the United States and abroad, and could result in an award of
substantial damages. In the event of a successful claim of infringement, the
Company, its customers and end-users may be required to obtain one or more
licenses from third parties. The Company has in the past, and may in the future,
pay significant sums to obtain licenses from third parties to avoid the costs
and uncertainties associated with defending a potential claim. There can be no
assurance that the Company or its customers could obtain necessary licenses from
third parties at a reasonable cost or at all. The defense of any lawsuit could
result in time consuming and expensive litigation, damages, license fees,
royalty payments and restrictions on the Company's ability to sell its products,
any of which could have a material adverse effect on the Company's business,
results of operations and financial condition.
YEAR 2000. The Year 2000 issue is the result of computer programs that were
written using two digits rather than four to define the applicable year;
accordingly, computer programs that have time-sensitive software or firmware may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculation causing disruptions of
operations including, among other things, an inability to process transactions,
send invoices or engage in similar normal activities.
One of the Company's internal information systems requires a version
upgrade of both the operating system and the application software to become Year
2000 compliant. The upgrades are expected to be completed by June 1999. The
Company has performed internal testing of each of its products and expects to
continue such testing for developing products. Based on its testing to date, the
Company believes that its current products are substantially Year 2000
compliant. The Company has not had, and has no present intention to have, its
products tested by an independent lab. The Company does not expect that the
costs to complete the testing program related to the Year 2000 will have a
material impact on operations or financial results. However, the inability of
any of the Company's products to process year 2000 data accurately could result
in increased costs and liabilities which could have a material adverse effect
upon the Company's operations and financial condition. The Company believes that
there are two predominant sources of third party risk for the Company with
respect to the Year 2000 issue. The Company depends on turnkey manufacturers of
components for its manufacturing process and disruption of operations at such a
supplier, whether due to Year 2000 non-compliance or not, could negatively
impact the Company's shipment schedule and operations. The Company also has a
number of large customers who are either end-users or resellers. The Company's
top five customers generated 38% of net sales in the second quarter of fiscal
1999. Year 2000 non-compliance at such customers' sites could negatively impact
sales to such customers by disrupting the networks of such customers or their
customers, in the case of resellers. The Company has begun surveying its major
suppliers to assess the potential impact, if any, of Year 2000 non-compliance on
the part of such suppliers. The Company has not conducted a comprehensive survey
of major customers to assess the potential impact, if any, of Year 2000
non-compliance. Any failure of the Company's suppliers and customers to resolve
their Year 2000 problems in a timely manner could result in a material
disruption of the Company's business. Any such disruption could have a material
adverse effect upon the business and financial results of the Company. In the
event that the Company's internal system or systems of significant outside
vendors are not converted or modified in a timely manner to make them Year 2000
compliant, there could be a material adverse effect upon the business and
financial results of the Company. The Company does not have a contingency plan
in place to address such an event and does not presently intend to create one.
VOLATILITY OF STOCK PRICE. The trading price of the Company's Common Stock has
undergone significant fluctuations and is expected to continue to be subject to
significant fluctuations in response to variations in quarterly operating
results, the gain or loss of significant contracts, changes in management,
announcements of technological innovations or new products by the Company or its
competitors, legislative or regulatory changes, general trends in the industry
and other events or factors. In addition, the stock market has experienced
extreme price and volume fluctuations which have particularly affected the
market price for many high technology companies and which have often been
unrelated to the operating performance of these companies. These broad market
fluctuations may adversely affect the market price of the Company's Common
Stock. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company anticipates
that available cash, together with amounts available under its credit facilities
and cash flow from operations, will be adequate to satisfy its capital
requirements through at least the next 12 months. The Company's future capital
requirements will depend on many factors including, but not limited to, the
19
<PAGE> 20
cost of acquisitions of businesses, products and technologies, the levels at
which the Company maintains inventory, the market acceptance of the Company's
products, the levels of promotion and advertising required to launch such
products and attain a competitive position in the marketplace, and the extent to
which the Company invests in new technology and improvements to its existing
technology. To the extent that existing resources and future earnings are
insufficient to fund the Company's activities, the Company may need to raise
additional funds through public or private financings including equity
financings. If additional funds are raised through the issuance of equity
securities, the percentage ownership of then current stockholders of the Company
will be reduced and such equity securities may have rights, preferences or
privileges senior to those of the holders of the Company's Common Stock. No
assurance can be given that additional financing will be available or that, if
available, it can be obtained on terms favorable to the Company and its
stockholders. The Company's lack of authorized Preferred Stock could hinder the
Company's ability to obtain financing. If adequate funds are not available, the
Company may be required to delay, scale back or eliminate some or all of its
research and development, to curtail its operations significantly or to obtain
funds through arrangements with strategic partners or others that may require
the Company to relinquish rights to certain of its technologies or potential
markets. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
POTENTIAL EFFECT OF ANTI-TAKEOVER PROVISIONS. The Company's Certificate of
Incorporation provides for a Board of Directors with staggered terms, which may
discourage or prevent certain types of transactions involving an actual or
potential change in control of the Company, including transactions in which the
stockholders might otherwise receive a premium for their shares over then
current market prices. Certain provisions of Delaware law applicable to the
Company, including Section 203 of the Delaware General Corporation Law, could
have the effect of delaying, deferring or preventing a change of control of the
Company. It is possible that the staggered board and Section 203 of the Delaware
General Corporation Law may have the effect of delaying, deferring or preventing
a change of control of the Company, may discourage bids for the Company's Common
Stock at a premium over the market price of the Common Stock and may adversely
affect the market price of the Common Stock.
LACK OF DIVIDENDS. The Company has never paid cash dividends on shares of its
capital stock. The Company currently intends to retain any future earnings in
its business and does not anticipate paying any cash dividends in the future.
20
<PAGE> 21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT NO.
- -----------
<S> <C>
3.1 Certificate of Incorporation of the Company. Incorporated by
reference to Exhibit 3.1 to the Company's Registration Statement
on Form S-1, Registration No. 33-90394
3.2 Bylaws of the Company. Incorporated by reference to Exhibit 3.2
to the Company's Registration Statement on Form S-1,
Registration No. 33-90394
27.1 Financial Data Schedule.
</TABLE>
(b) REPORTS ON FORM 8-K:
No reports on Form 8-K were filed during the quarter ended December
31, 1998.
21
<PAGE> 22
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report on Form 10-Q to be signed on its behalf
by the undersigned, thereunto duly authorized.
Date: February 12, 1999 ACT NETWORKS, INC.
/s/ Martin Woll
--------------------------------------
Martin Woll
Vice President, Finance
and Chief Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
22
<PAGE> 23
EXHIBIT INDEX
EXHIBIT NO.
27.1 Financial Data Schedule.
23
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 19,874,000
<SECURITIES> 28,721,000
<RECEIVABLES> 18,146,000
<ALLOWANCES> 2,084,000
<INVENTORY> 6,304,000
<CURRENT-ASSETS> 72,898,000
<PP&E> 10,640,000
<DEPRECIATION> 7,174,000
<TOTAL-ASSETS> 78,580,000
<CURRENT-LIABILITIES> 5,490,000
<BONDS> 0
0
0
<COMMON> 9,000
<OTHER-SE> 64,090,000
<TOTAL-LIABILITY-AND-EQUITY> 78,580,000
<SALES> 26,010,000
<TOTAL-REVENUES> 26,010,000
<CGS> 10,875,000
<TOTAL-COSTS> 27,142,000
<OTHER-EXPENSES> 607,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (1,176,000)
<INCOME-PRETAX> (563,000)
<INCOME-TAX> 178,000
<INCOME-CONTINUING> (741,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (741,000)
<EPS-PRIMARY> (0.08)
<EPS-DILUTED> (0.08)
</TABLE>
