Back to GetFilings.com
1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-K
------------------------
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 000-21783
NETERGY NETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0142404
(STATE OR OTHER JURISDICTION (IRS EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2445 MISSION COLLEGE BLVD.
SANTA CLARA, CA 95054
(408) 727-1885
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR
VALUE $.001 PER SHARE
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Based on the closing sale price of the Registrant's common stock on the
NASDAQ National Market System on May 14, 2001, the aggregate market value of the
voting stock held by non-affiliates of the Registrant was $20,839,752. Shares of
the Registrant's common stock held by each officer and director and by each
person who owns 5% or more of the Registrant's outstanding common stock have
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
The number of shares of the Registrant's common stock outstanding as of May
14, 2001 was 26,540,585.
DOCUMENTS INCORPORATED BY REFERENCE
Items 11, 12, and 13 of Part III incorporate information by reference from
the Proxy Statement for the Annual Meeting of Stockholders to be held on July
17, 2001.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
2
NETERGY NETWORKS, INC.
INDEX
PAGE
----
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 12
Item 3. Legal Proceedings........................................... 12
Item 4. Submission of Matters to a Vote of Security Holders......... 12
PART II
Item 5. Market for Registrant's Common Stock and Related Security
Holder Matters.............................................. 13
Item 6. Selected Financial Data..................................... 13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 14
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 31
Item 8. Financial Statements and Supplementary Data................. 31
Consolidated Balance Sheets................................. 33
Consolidated Statements of Operations....................... 34
Consolidated Statements of Stockholders' Equity............. 35
Consolidated Statements of Cash Flows....................... 36
Notes to Consolidated Financial Statements.................. 37
Consolidated Quarterly Financial Data....................... 59
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosures................................... 60
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 60
Item 11. Executive Compensation...................................... 60
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 60
Item 13. Certain Relationships and Related Transactions.............. 60
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 60
i
3
PART I
ITEM 1. BUSINESS
GENERAL
Statements contained in this Report on Form 10-K that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act and Section 21E of the Exchange Act, including, without
limitation, statements regarding our expectations, beliefs, estimates,
intentions or strategies. All forward-looking statements included in this Report
on Form 10-K are based on information available to us on the date hereof, and we
assume no obligation to update any such forward-looking statements. You should
not place undue reliance on these forward-looking statements. Actual results
could differ materially from those anticipated in these forward-looking
statements as a result of a number of factors, including, but not limited to,
those set forth below under the headings "Manufacturing," "Customers and
Marketing," and "Factors That May Affect Future Results" and elsewhere in this
Report on Form 10-K.
Netergy Networks, Inc. and its subsidiaries (collectively, Netergy or the
Company) develop and market telecommunication technology for Internet Protocol
(IP) telephony and video applications. The Company has three product lines:
voice and video semiconductors and related software, hosted Internet Private
Branch Exchange (iPBX) solutions, and Voice-over-IP (VoIP) service creation
software.
During the fiscal year ended March 31, 2001, the Company formed two
subsidiaries, Netergy Microelectronics, Inc. (NME) and Centile, Inc. (Centile)
and reorganized its operations more clearly along its three product lines. NME
provides voice and video semiconductors and related communication software to
original equipment manufacturers (OEMs) of telephones, terminal adapters, and
other edge devices and to other semiconductor companies. NME's technologies are
used to make IP telephones and to voice-enable cable and digital subscriber line
(DSL) modems, wireless devices, and other broadband technologies. Centile
develops and markets hosted iPBX solutions that allow service providers to offer
private branch exchange (PBX) functionality to small and medium-sized businesses
over broadband networks. The Company is developing its third product line, a
VoIP service creation environment (SCE), at the parent company level. This
product is designed for use by telecommunication equipment manufacturers and
service providers.
HISTORY
The Company effected its initial public offering on July 2, 1997 under the
name 8x8, Inc. In August 2000, the Company changed its name to Netergy Networks,
Inc.
The Company began developing its multimedia communication technology in the
form of programmable semiconductors and accompanying software in 1990 and became
a leading manufacturer of semiconductors for the embedded videoconferencing and
videophone markets. The primary customer applications for these semiconductors
were communication terminals (such as videophones, telephones or room
conferencing systems) for the integrated services digital network (ISDN), the
public switched telephone network (PSTN), and IP networks, such as local area
networks (LANs), wide area networks (WANs), and the Internet.
The Company began developing low cost consumer videophones and marketing
these products to consumers under the ViaTV brand name in 1997. The Company
exited the consumer videophone business in the second quarter of the fiscal year
ended March 31, 2000.
In June 1998, using technology designed for its consumer videophone
business, the Company entered the video monitoring market, focusing on security
applications for small businesses. However, the Company determined that its
video monitoring business was not well aligned with its strategic focus on the
IP telephony market and, in May 2000, sold its remaining video monitoring
business to Interlogix, Inc. (Interlogix), a leading manufacturer of security
equipment. Interlogix continues to purchase semiconductors from NME for certain
of its security systems.
The Company entered the market for embedded VoIP telephony products in
December 1998 with the announcement of its Audacity Internet Telephony Processor
(Audacity-ITP). The Audacity-ITP processor
1
4
combines IP telephony protocol support with audio compression/decompression
capability and runs multiple simultaneous IP phone calls on a single integrated
circuit. In April 1999, the Company announced its Netergy Media Hub, an
integrated system product that is based on the Audacity-ITP semiconductor and
that connects up to four analog telephone lines to an IP network. In September
1999, the Company announced its Audacity-T2 IP Phone Processor, which provides
the digital processing required to implement an IP telephone. In November 2000,
the Company announced that it was moving its IP telephony and videoconferencing
semiconductor and embedded software business into a new subsidiary, Netergy
Microelectronics, Inc. (NME). In March 2001, NME announced its Media Hub 2 (MH2)
reference design based on the Audacity-T2, which allows OEMs to manufacture a
gateway system that connects two analog telephone lines to an IP network. NME's
IP telephony products target OEM manufacturers of IP telephony equipment, such
as voice-enabled cable and DSL modems, wireless devices, as well as IP phones
and gateways.
In May 1999, the Company acquired Odisei S.A. (Odisei), a developer of IP
telephony software based in Sophia Antipolis, France. The Company leveraged the
acquisition of Odisei to develop and market a hosted iPBX solution, which uses
VoIP technology to deliver voice services over broadband networks. The hosted
iPBX solution makes use of certain of NME's IP telephony technology and
products, as well as IP phones and other devices developed by third-party
manufacturers. The Company introduced the hosted iPBX in March 2000. In March
2001, the Company announced the commercial release and general availability of
the hosted iPBX solution. In March 2001, the Company also announced that it was
moving its hosted iPBX business into a new subsidiary, Centile, Inc. (Centile).
Odisei will become a subsidiary of Centile.
In June 2000, the Company acquired U/Force, Inc. (U/Force), a developer of
IP-based software applications, including the SCE and a unified messaging
product, based in Montreal, Canada with a consulting office in Hull, Canada. In
the fourth quarter of the fiscal year ended March 31, 2001, the Company
discontinued its Canadian operations and closed the offices in Montreal and
Hull.
INDUSTRY BACKGROUND
Traditional telecommunication networks use a fixed electrical path that
travels through a series of switches across the network. These networks were
designed solely to carry low-fidelity audio signals with a high level of
reliability. Although these networks are indeed reliable for their initially
intended use, these networks are not well-suited to service the explosive growth
of digital communications applications.
Traditional networks transmit data at very low rates and resolutions,
making them poorly suited for delivering high-fidelity audio,
entertainment-quality video or other rich multimedia content. Traditional
networks are also expensive to build because each subscriber's telephone must be
individually connected to the central office switch, which is usually several
miles away from a typical subscriber's location. The digital component of the
traditional telecommunications infrastructure is also less efficient than modern
networks because it allots fixed bandwidth throughout the duration of each call,
whether or not voice is actually being transmitted. Further, it is difficult for
telecommunication service providers to provide new or differentiated services
that the network was not designed to accommodate.
In contrast to the traditional telecommunications infrastructure, data
networks -- such as the Internet or a corporate LAN -- utilize a
"packet-switched" system in which information between two communicating
terminals (for example, a PC downloading a page from a web server) is
transmitted in the form of small data packets that travel through a series of
switches, routers, and hubs across the network. Packet-switched networks have
been built mainly for carrying non real-time data. The advantages of such
networks are their efficiency, flexibility, and scalability. Bandwidth is only
consumed when needed. Networks can be built in a variety of configurations to
suit the number of users, client/server application requirements and desired
availability of bandwidth. Furthermore, many terminals can share the same
connection to the network. The exponential growth of the Internet in recent
years has proven the scalability of these underlying packet networks. The most
common protocol used for communicating on these packet networks is "Internet
Protocol" (IP).
As broadband connectivity has become more available and less expensive, it
is now possible for service providers to offer VoIP services to businesses and
consumers. Providing such services has the potential to both
2
5
substantially lower the cost of telephone and equipment costs to these customers
and to increase the breadth of features available to the end-user. Next
generation services like full-motion, two-way video are now within the bandwidth
available to broadband customers, whether business or residential. To enable
such new products to take hold, service and equipment suppliers need
semiconductor products and software to connect input and output devices to the
networks and to build system functionality.
TECHNOLOGY AND PRODUCTS
The Company has developed a broad range of communication technologies,
including semiconductors, embedded software, system design, telephony call
management software, and VoIP service creation software and related development
tools.
The Company has leveraged its technologies to develop the following product
lines: semiconductors and embedded software designed for IP telephony and
videoconferencing applications, developed and marketed by NME; hosted iPBX
solutions, developed and marketed by Centile; and VoIP service creation
software.
SEMICONDUCTORS AND EMBEDDED SOFTWARE
The Company's subsidiary, NME, develops and markets a range of technology
products, including semiconductors, embedded software, system software, and
reference designs, that allow telecommunication equipment OEMs to build IP
phones and IP to PSTN gateway products and to add IP telephony functions to DSL,
cable, and wireless modems. Additionally, NME provides semiconductors and
embedded software for use in videoconferencing applications. The following
sections describe NME's technology and related products more fully.
Technology
SEMICONDUCTOR ARCHITECTURE -- NME's semiconductors are based on
programmable processor architectures that enable implementation of IP telephony
and videoconferencing applications in a highly efficient manner. NME's
semiconductor architectures employ 32-bit reduced instruction set computer
(RISC) microprocessor cores, which execute the embedded applications software.
Some of NME's semiconductors also employ a 64-bit Single Instruction Multiple
Data (SIMD) digital signal processor (DSP) to accelerate the processing of
signal processing intensive operations.
NME's RISC processor cores use a proprietary instruction set specifically
designed for multimedia communication applications. The RISC cores control the
overall chip operation and manage the input/output interface through a variety
of specialized ports which connect the chip directly to external host, audio,
and network subsystems. The cores are programmable in the C programming language
and allow customers to add their own features and functionality to the device
software provided by NME. The RISC cores access 32-bit instructions and data
through a bus that interfaces to internal and external static random access
memory (SRAM). The RISC core in the Audacity-T2 semiconductor also contains an
extended instruction set to execute specialized DSP instructions.
NME's DSP core architecture is a SIMD processor that implements
computationally intensive video, audio, and graphics processing routines as well
as certain digital communication protocols. The VCP and LVP DSP cores operate at
frequencies up to 72 MHz, the VCPex and Audacity-ITP DSP cores operate up to 80
MHz, the Audacity-T2 DSP core operates up to 150 MHz, and the VP7 DSP core
operates up to 100 MHz. The DSP cores are programmable with a proprietary
instruction set consisting of variable-length 32-bit and 64-bit microcode
instructions that provide the flexibility to improve algorithm performance,
enhance audio and video quality, and maintain compliance with changing digital
audio, video, graphics, and communication protocol standards. The DSP cores
access their instructions through an internal bus that interfaces to on-chip
SRAM and read-only memory (ROM) that is preprogrammed with video and audio
processing subroutines. The combination of RISC and DSP cores can be
reconfigured through a change of application software. This flexibility allows
for the implementation of fundamental processing steps that form the basis of
Media Gateway Control Protocol (MGCP), Session Initiation Protocol (SIP), and
H.323
3
6
standards-based audio telephony systems, as well as H.320, H.323, and H.324
(collectively, H.32x) standards-based video communication systems, all in
embedded software that runs on the integrated circuit device.
EMBEDDED SOFTWARE -- NME has developed a broad range of embedded
application software that runs on its semiconductor products. NME's application
software allows the use of its semiconductors in systems that conform with
various emerging and established international telephony standards for vocoders
and call signaling protocols. By refining its software, NME can enhance quality,
address new standards, and add significant features and functionality to systems
that contain the semiconductor product. In addition, certain customers have
licensed source code to which they add proprietary features and custom
interfaces, and in some cases, port to other semiconductor architectures.
Call signaling protocol stacks are complex software programs required to
make voice calls over IP networks, including the Internet. Vocoders format and
compress digital audio signals and serve as the interface between the old phone
networks and new VoIP networks. Developing and establishing interoperability for
VoIP software requires major engineering resources and significant development
time, which is why many OEMs choose to license it instead. NME's protocol stacks
support the three most commonly deployed VoIP protocols, along with seven
vocoders.
Written in ANSI C, NME's VoIP software is modular and portable, making it
straightforward to use with industry-standard operating systems. It can be
compiled and run unchanged under NME's own POSIX micro-kernel, Linux, and
Solaris. Using a thin translation layer it can be adapted to run on other
embedded operating systems, such as VxWorks and pSOS.
NME's protocol stacks were designed specifically for embedded applications
such as consumer electronics products and terminals, rather than for personal
computers. NME has also designed a compact real-time POSIX micro-kernel, along
with TCP/IP, RTP, and other network services, that provides process scheduling
and communication support services for its protocol stacks and vocoders. This
micro-kernel is appropriate for VoIP devices where a large, costly, real-time
operating system is not practical.
SYSTEM DESIGN -- NME has developed expertise in integrating its
semiconductors and software with peripheral components to produce complete IP
telephony and multimedia communication systems. NME's system technology consists
of modular subsystems that can be combined and rearranged to interface to
various networks (such as POTS, ISDN, Ethernet LAN, wireless, and home networks)
and to various telephony devices, such as the analog phones in a home. NME's
systems are designed and tested to satisfy national and certain international
regulatory requirements such as consumer safety, public telephone network
requirements and electromagnetic emissions.
Products
AUDACITY INTERNET TELEPHONY PROCESSOR -- The Audacity-ITP semiconductor is
designed to support four-port IP based phone terminals and gateways operating
over broadband networks. The Audacity-ITP translates audio signals from analog
telephones into the compressed data format needed for real-time audio
transmission over networks that use packet protocols, including corporate LANs,
WANs, and the Internet.
AUDACITY-T2 IP PHONE PROCESSOR -- The Audacity-T2 semiconductor performs
the digital processing functions required to build an IP phone, including
formatting digital audio data for transmission over packet networks, including
Ethernet, the Internet, DSL links, digital cable systems, etc. The chip can also
be used in two-port media hub or gateway applications.
VERACITY VOIP SOFTWARE -- The Veracity software product provides complex
DSP and protocol functions required in VoIP terminal devices in a documented,
portable software package. The Veracity software can be run on the Audacity
processors or third-party processors.
VP7 AUDIO COMPRESSION ENGINE -- The VP7 audio compression engine (VP7) is a
synthesizable Verilog HDL core that can be integrated into custom semiconductor
designs. For example, the VP7 has been integrated into STMicrolectronics'
STV0397 semiconductor. The VP7 is based on NME's proprietary DSP architecture,
which allows flexibility via software microcode that is downloaded to the core
engine.
4
7
REFERENCE DESIGN KITS -- NME currently supplies the following reference
design kits for its semiconductor products:
- The Media Hub MH2 reference design is a two-line, VoIP gateway based on
the Audacity-T2 processor. It supports two analog telephone interfaces, a
10/100 Mbps Ethernet port, and a simple LCD display.
- The IP phone reference design includes plastics, keypad, display, and
handset and is based on the Audacity-T2 processor.
NME's reference design kits are intended to serve as prototype system
products. The designs are intended to allow a customer to leverage NME's system
design expertise and accelerate its time to market with new products. Each
reference design is provided with schematics, bills of materials (BOMs),
documentation, embedded software, and a software development environment that
enables a customer to customize the software and add new features.
VIDEOCONFERENCING SEMICONDUCTORS -- NME's family of videoconferencing
semiconductors includes the VCP, LVP, VPIC, and VCPex. These semiconductors are
used in H.323, H.320, and H.324 videoconferencing applications including group
videoconferencing systems, personal computer (PC) videophone add-in boards,
consumer videophones, and video monitoring systems. These semiconductors are
based on NME's proprietary architecture, which combines on a single chip a
custom RISC microprocessor, a high performance DSP core, SRAM, and proprietary
software, which together perform the core processing functions required by LAN,
ISDN, and POTS-based video communication and other digital video applications.
HOSTED IPBX SOLUTIONS
The Company's subsidiary, Centile, is developing and marketing a hosted
iPBX, a software-driven telephony solution that allows network service providers
and PBX resellers to offer PBX functionality as a business communication service
over broadband IP networks. The following sections describe Centile's technology
and products more fully.
Technology
A business today requires an individual phone for each office worker,
typically dozens for small and medium sized enterprises (SMEs). Until recently,
there were two ways that businesses could obtain this type of phone service:
subscribe to Centrex services from their local telephone company or buy a PBX
system. In a Centrex service, the telephone company provides a telephone line
from its central office switch for each "extension" and associates all of the
lines with a central number assigned to the business. Centrex, however, scales
poorly for both regulatory and architectural reasons. It is expensive on a
per-line basis when compared to enterprise-owned PBXs, which typically deliver
additional functionality as well. In addition, Centrex services do not offer the
ability for easy integration with computer programs, require long lead times for
moves, adds, and changes, and are difficult to manage.
Rather than subscribe to individual telephone lines for each employee (as
with Centrex), most companies purchase a PBX system, a telephone switch that
allows dozens or hundreds of employees to share a few incoming and outgoing
telephone lines, allowing efficient usage of those lines. Traditional PBXs use
circuit-switched technology and must be installed on the enterprise premise
because every phone is connected to it by an individual cable. These systems are
expensive (from $20,000 to $200,000 or more, depending on the number of
extensions), difficult to manage, maintain, and use, and cannot be easily
integrated with data processing systems.
With the availability of broadband IP connectivity to businesses, however,
a third alternative has emerged: hosted iPBX services. In this model, the
service provider delivers PBX functionality over an IP connection, which reduces
the scaling problems by allowing many extensions to share a single connection.
This solution also offers many of the advantages of an enterprise-owned PBX and
further enables integration with enterprise data processing systems and support
of call centers, while eliminating the capital and maintenance investments
required for a PBX.
5
8
TELEPHONY CALL MANAGEMENT SOFTWARE -- Centile's telephony call management
software (the iPBX server software, hosted iPBX, or iPBX), uses an IP network
for both its switching fabric and media connections, providing the call routing,
setup, and teardown necessary to establish a connection between two terminals on
an IP network. It also provides a variety of more complex PBX features such as
call transfers, web-based control and voice message retrieval, and conferencing.
The iPBX software runs on a cluster of carrier-grade server platforms that
are located in a data center. A cluster typically consists of both active and
backup servers. Each active server runs several copies or "instances" of the
iPBX software simultaneously. Each instance is dedicated to a particular phone
line for an individual user. The server cluster in the data center is linked to
customer sites with a dedicated broadband IP link such as a T1 line. On the
customer premise, media hubs or IP telephones are connected to the IP link via
an IP router and Ethernet hubs or switches. Media hubs connect standard analog
telephones and fax machines to the IP network.
To address scalability and reliability issues, Centile uses a modular and
distributed architecture for the iPBX system. In this architecture, a single
instance of the iPBX server software provides complete PBX functionality, but it
is designed to support approximately 100 extensions. Limiting the number of
extensions supported limits both the processing capacity and memory requirements
of the server platform, allowing less powerful, less expensive servers to be
used. Multiple iPBX instances can be run on each server and the system can be
scaled by adding more servers.
This modular approach has another advantage. By limiting the capacity and
therefore the size and processing requirements of the iPBX software, an instance
of the iPBX can be dedicated to a specific customer. Doing so allows each
instance to be customized for each customer by linking it to customer-specific
computer programs for call center automation or by selecting unique functions
for feature phone buttons.
Much of the flexibility of the iPBX is due to the use of abstraction layers
between the core iPBX engine and the devices with which it interfaces and which
it controls. To allow it to interface to a variety of different telephone sets,
PSTN gateways, and softswitches, the iPBX uses hardware drivers that support
various industry standard and proprietary call setup and teardown protocols.
Currently, the iPBX supports session initiation protocol (SIP), media gateway
control protocol (MGCP), H.323v2, and a variety of proprietary protocols.
To allow easy integration with computer programs (computer telephony
integration, or CTI), the iPBX was based on the ECTF C.001 specification for PBX
functionality and supports Sun Microsystems' Java Telephony Application Program
Interface (JTAPI) version 1.3 for telephony call control. The ECTF C.001
specification defines a consistent call control behavior for PBXs, making it
easier to develop computer programs that can control a PBX, and JTAPI provides
an industry standard series of function calls to allow computer programs to
control PBXs from more than one manufacturer. Computer programs interfaced to
the PBX might provide a graphical user interface to make it easier to transfer
calls or initiate conference calls, or they might connect a company's customer
relationship management software directly to the phone system, displaying
customer information on a computer screen when that customer calls for support.
Running each instance of the iPBX in its own Java Virtual Machine (Java VM)
offers a number of advantages. First, every instance of the iPBX is designed to
be completely insulated from every other instance so a failure in one should
never cause a failure in any other. In other operating environments, system
resources such as communication routines and database managers are frequently
shared between all of the programs that run on that machine. If one program
misuses a display driver, for example, all of the other programs running on that
machine may be affected. Because each Java VM provides all of these resources to
the program it hosts, this kind of inter-process interference should not occur.
A second advantage is security because each iPBX instance is separate from all
others. Its configuration data and call control logic are also separate. It is
much less likely that another user will inadvertently (or purposely)
mis-configure another customer's iPBX.
6
9
The iPBX solution was designed to address the shortcomings of traditional
Centrex service offerings in a number of ways as described below.
- The use of an IP network allows the iPBX to scale relatively easily and
economically because subscribers can add additional extensions without
adding a new cable for each extension. Additional IP phones are plugged
into the existing LAN.
- The iPBX uses an IP network instead of a circuit-switched one so it can
be located in the service provider's data center which may be miles away
from the customer enterprise premise and connected to it by only a single
broadband IP link.
- The redundancies built into the system increase its reliability,
particularly when compared to enterprise owned PBXs. The Company also
offers a monitoring service, in partnership with its customers, via a
Network Operations Center (NOC) to minimize service outages and downtime
of the iPBX network.
Products
IPBX SERVER SOFTWARE -- Introduced in March 2000 and commercially released
for general availability in March 2001, the Centile iPBX server software runs on
a cluster of five Sun Microsystems Netra T1s to provide software PBX
functionality over IP networks. The iPBX software was designed specifically to
allow service providers to deliver hosted iPBX services to small and
medium-sized business customers. The Centile iPBX will allow service providers
to support up to eighty discrete iPBXs per cluster, each dedicated to an
individual customer, and up to five thousand total extensions.
The Netra cluster running the iPBX server software is located in the
service provider's data center. It is connected to the customer's premise using
any broadband IP connection, though deployments to date have generally utilized
a T1 connection. For telephone sets, customers can use media hubs to adapt
standard analog telephones to IP service or they can use IP phones. The iPBX
server software connects to the PSTN and the long-distance IP backbone through a
gateway.
Service providers control and configure the iPBX server software via a Web
interface, allowing the system administrator to manage the iPBX from any
location using any workstation with a browser. Centile also offers a Network
Operations Center (NOC) service (discussed below) to provide service
provisioning and network monitoring services. The administrator interface is
designed to provide control of phone number block assignments, dial plans,
service provisioning, DID assignments, iPBX status, bandwidth management, and
network topology. The iPBX supports external billing, voicemail, interactive
voice response, automatic call distribution, auto attendants, directory service,
unified messaging modules, and OSS (operation, service, and support)
integration.
MH4 MEDIA HUB -- Media hubs are customer premise equipment that adapt
conventional telephony equipment, such as analog telephones and fax machines,
for IP service. Centile's MH4 media hub product supports four analog lines.
Centile currently uses the Company's MH4 product, along with certain IP phones
and media hubs developed by third parties, in its hosted iPBX business
communication service deployments.
Each media hub supports as many simultaneous connections as it has analog
lines and multiple media hubs can be used in an IP telephony system to provide
as many lines as required. Because it uses a standard touch-tone telephone as
both its audio and user interface, media hub-based systems are both reliable and
cost-effective, especially when compared to proprietary digital PBX telephones.
MH4 media hubs support the MGCP IP telephony standard with Centile
extensions for auto-discovery and configuration. All media hubs deployed by
Centile incorporate FLASH memory for remote upgrade capability so that the
Centile iPBX server software can upgrade media hubs automatically via the
network as required.
IPBX USER INTERFACE SOFTWARE -- Centile has announced three user interface
applications for its hosted iPBX solution: Communication Center, Switchboard,
and Administrator. All of these applications are designed to harness the
graphical capabilities of personal computers and workstations to make the hosted
iPBX easy to use.
7
10
The Centile Communications Center software with Call Announcer is designed
for the end users of the iPBX. It provides Caller ID, call transfers, conference
call setup, on-screen directories, contact management, and call logging. It also
lets users set up and control their voicemail, set forwarding numbers and
filters, and set up personal speed dial numbers.
The Centile Switchboard software (Switchboard) is the attendant interface
for the iPBX. Switchboard runs on a personal computer or workstation to allow
attendants to route incoming calls to an enterprise with a point-and-click
interface. Switchboard provides caller ID for multiple incoming calls, extension
status, two-click call transfers, corporate voice mailbox management, and
multi-attendant support. Its graphical interface minimizes training and improves
attendant productivity.
With the iPBX, customers control their own moves, adds, and changes using
the Centile Administrator (Administrator). To add additional lines, the customer
simply connects an additional media hub to the IP network. The Centile Auto
Discovery mechanism automatically configures the media hub. The customer then
uses Administrator to assign extension numbers, associate user names, and create
a voicemail account for each line. Administrator also allows the customer to
define hunt groups, set user permissions, define phone button functions, and set
voicemail parameters, all with a point-and-click interface.
NETWORK OPERATIONS CENTER (NOC) -- Centile maintains a 24x7 Network
Operations Center (NOC) staffed by personnel trained in the use of monitoring,
debugging, and deploying software associated with the hosted iPBX business
communication service. The NOC monitors customer deployments, responds to
service and add/move/change requests, and assists customers with any reported
service problems. The NOC personnel training and operating procedures are
documented and packaged in a form which allows Centile to provide service
providers with the capability to create and deploy their own NOC facilities.
SERVICE CREATION SOFTWARE
Technology and Products
SERVICE CREATION ENVIRONMENT -- The Company is developing a set of software
applications that enable telecommunication equipment providers to specify,
create, and deploy next-generation VoIP services. Historically,
telecommunication equipment providers offered their customers fixed menus of
services and applications that could be run in conjunction with the
telecommunication network. The providers offered rigid sets of available
applications that were slow to change and were not customizable to meet the
needs of different customers.
With the convergence of voice and data networks, telecommunication
providers now have the building blocks to build rich sets of custom-tailored
voice and data services. Based upon technology acquired from UCForce in June
2000, the Company has been developing a software tool that is designed to enable
these new services and applications to be quickly created, customized, modified,
deployed, and delivered while maintaining the robust service delivery paradigm
of the legacy switched network. This tool provides users with an easy to use
graphical user environment for creating a specification of the logical flow for
a range of telecommunication service applications, such as voicemail, unified
messaging, automated call centers, and other call processing applications. The
critical requirements of this tool are: to de-couple service creation and
delivery from the physical network or set of devices that the service is running
on; to allow open, flexible, and fast service creation (even by the end-user of
the service, in some instances); and to provide robust service delivery.
The Company's product offering, which bundles this tool and other related
software development applications, is called the Service Creation Environment
(SCE). The core software components of the SCE are written in Java. Java
provides a number of important advantages over older computer languages, such as
C and C++. For example, all Java programs run in a Java VM, which translates
Java code to a specific operating environment, such as Windows or Sun Solaris.
This allows the SCE to be easily run on a number of different hardware
platforms, including Windows-based machines, Solaris platforms, and Linux
machines. The Java VM also provides memory management that eliminates frequent
sources of problems in other
8
11
development environments including pointer arithmetic and automatic garbage
collection. Moreover, Java removes coding ambiguities that are a common problem
with C and C++.
As with the hosted iPBX, the SCE uses JTAPI for its system telephony
interface design. While JTAPI is a standard interface, different system
implementations of the JTAPI protocol can make it extremely difficult to port a
JTAPI application to a new platform. The Company's software takes advantage of
its robust implementation of JTAPI calls and usage to maximize the SCE's
compatibility with different computing platforms.
The Company is currently developing an enhanced version of the SCE for
executing service logic applications in high volume call processing
environments.
UNIFIED MESSAGING -- The Company's unified messaging (UM) software is a
pre-packaged application, or service, that was created with the SCE. The UM
software was designed to allow a user to receive and retrieve messages of
different data types from a single telephony access point. For example, a user
is assigned a telephone number that can be used to leave or retrieve voice
messages, FAX messages or e-mail (FAX and e-mail messages are sent through a
text-to-speech engine and read back to the user on the phone). Similarly, a user
could access voice messages from any network-enabled personal computer or
receive FAX messages in electronic form as e-mail. The Company's UM software is
not currently deployed in a commercial setting, and future UM development
efforts are dependent on deployments of the Company's SCE product.
CUSTOMERS AND MARKETING
SEMICONDUCTORS AND EMBEDDED SOFTWARE
CUSTOMERS -- NME sells its IP telephony semiconductors, embedded software,
and reference designs to OEMs of VoIP products, such as BATM, CIDCO, D-Link,
Ericsson, and WellTech. NME has also licensed portions of its semiconductor
technology and embedded VoIP software to Alcatel Microelectronics and
STMicroelectronics.
NME sells its LVP semiconductors, related software, and reference board
designs to OEMs of POTS video communication systems for the consumer and video
monitoring market, such as Interlogix, Inc., Kyushu Matsushita Electric Co.,
Ltd., (KME), Leadtek Research, Inc., and Samsung. NME is selling its VCP and
VCPex semiconductors, related software, and reference designs primarily to OEMs
of ISDN and LAN office videoconferencing systems, including Mitsubishi
Electronics, PictureTel Corporation, Sony Electronics, Inc., VCON
Telecommunications Ltd., and VTEL Corporation.
SALES AND MARKETING -- NME markets its semiconductor, embedded software,
and reference design products through its own direct sales force, third-party
sales representatives, and distributors. NME supports its domestic and
international direct sales efforts from its headquarters in Santa Clara,
California and a European office in Marlow, United Kingdom. NME's sales and
marketing personnel typically provide support to its OEM and distributor
customers through its application engineering team and periodic training
sessions.
COMPETITION -- NME competes with both manufacturers of digital signal
processing semiconductors and software products developed for the OEM VoIP
marketplace. NME also competes with manufacturers of videoconferencing
semiconductors and related firmware. The markets for NME's products are
characterized by intense competition, declining average selling prices, and
rapid technological change. The principal competitive factors in the market for
IP telephony and videoconferencing semiconductors and embedded software include
product definition, product design, system integration, chip size, code size,
functionality, time-to-market, adherence to industry standards, price, and
reliability. NME has a number of competitors in this market including: Agere
Systems, Analog Devices, Inc., AudioCodes Ltd., Broadcom Corporation, Conexant
Systems, Inc., DSP Group, Mitel Semiconductor, Motorola, Inc., Radvision Ltd.,
Texas Instruments/Telogy Networks, Inc., TriMedia Technologies, Inc. (a Philips
Electronics and Sony Corporation joint venture), and Winbond Electronics.
9
12
HOSTED IPBX SOLUTIONS
CUSTOMERS -- During fiscal 2000, the Company announced its iPBX server
software product and a limited external deployment of its hosted iPBX services
through Dialink, a competitive local exchange carrier (CLEC) based in the San
Francisco Bay Area. In addition to the Dialink customer trial, the Company is in
laboratory trial testing with several other service providers.
In fiscal 2001, the Company decided that the long trials and time-to-market
constraints of the CLEC and service provider market, as well as the decreasing
availability of cash to certain CLECs in the North American market, required
that the Company provide a hosted business communication service offering to PBX
resellers in addition to the existing service provider offering. In March 2001,
the Company formed Centile to conduct the operations of the hosted iPBX business
and announced a reseller agreement with Millennia Telecom. Centile is still
actively marketing the product to service providers in Europe. In April 2001
Centile announced a licensing agreement with Telecom Partners and in May 2001
announced a licensing agreement with Tele1 Europe Holding AB.
SALES AND MARKETING -- Centile markets the hosted iPBX software product
through a direct sales force. In addition, Centile has established a
relationship with Exodus Communications, a hosted service provider partner, and
intends to establish relationships with PBX and other system integrators that
can serve as resellers. The sales force operates primarily from the Company's
headquarters in Santa Clara, California.
COMPETITION -- Centile currently competes with suppliers of traditional
PBXs, Centrex equipment, and newer generation IP-based PBX or Centrex solutions
that seek to sell such products to telecommunication service providers or to the
small and medium-size enterprise (SME) marketplace. The main competition
includes Avaya, Cisco, Commworks Corporation, Lucent, Mitel, Nortel Networks,
Sylantro Systems, VocalData, Inc., VocalTec Communications, and several other
providers of traditional and newer generation IP-based solutions, such as
Broadsoft, Inc. (which is being acquired by Unisphere Networks), IP Centrex,
Shoreline Communications, Sphere Communications, Tundo Corporation and Vertical
Networks.
As an IP-based solution, the hosted iPBX product competes by leveraging the
innate efficiencies of IP architectures and combining those efficiencies with
certain required features from competitive legacy products. The principal
competitive factors in the market for hosted iPBX solutions include product
feature parity, interface design, product reliability, time-to-market, adherence
to standards, price, functionality, and IP network delivery/design. The Company
believes that the market for iPBX solutions is currently in the initial adoption
phase and that growth of the market will be driven primarily by three factors:
the ability of iPBX products to meet the advanced feature requirements of end
customers; the lower costs of IP-based solutions; and a general trend toward the
replacement of circuit-switched networks with packet-switched ones.
SERVICE CREATION SOFTWARE
CUSTOMERS -- In May 2001, the Company announced the first customer license
of its SCE to Lucent. The SCE will be used in Lucent's enhanced Service
Authoring Environment (eSAE), an authoring environment for creating intelligent
networking applications for both voice and data networks within Lucent's
PacketIN intelligent network service control point. The Company has established
a royalty-bearing licensing agreement with Lucent whereby Lucent will sell the
SCE under Lucent's eSAE branding. Under a maintenance clause in the agreement,
the Company may also provide support, training, and professional services
directly to Lucent's customers, at Lucent's option.
SALES AND MARKETING -- As a result of the cessation of the Company's
Canadian operations in the fourth quarter of fiscal 2001, sales and marketing
efforts related to the SCE and related products, including UM, have been
drastically reduced. The Company does not currently have any in-house or third
party sales efforts dedicated to marketing its SCE and related products to
customers other than Lucent nor does the Company presently have plans to
increase such efforts. Sales and marketing activities in the foreseeable future
may include demonstrating the SCE product to other potential OEM customers if
opportunities arise and providing sales literature, demonstration platforms, and
pre-sales support in pursuing such opportunities.
10
13
COMPETITION -- The Company competes with other providers of enhanced
service platforms, applications, and service creation solutions for
next-generation communication networks. The applications generated by the SCE
also compete with suppliers of traditional telecommunication applications
software that seek to sell such products to telecommunication equipment
manufacturers and service providers. The main competitors for the Company's SCE
product line are Alcatel, Dynamicsoft, Inc., LongBoard, Inc., Nortel Networks,
Pactolus Communications, Pagoo, Sylantro Systems, Tekelec, Telcordia, Telsis,
and Ubiquity Software. This market is characterized by rapid technological
change, intense competition, and first-mover advantage. Principal competitive
factors in the market for the Company's SCE product include product feature
parity, interface design, product reliability, performance, time-to-market,
adherence to standards, price, functionality, and IP network delivery/design.
MANUFACTURING
NME outsources the manufacturing of its semiconductors to independent
foundries. NME's primary semiconductor manufacturer is Taiwan Semiconductor
Manufacturing Corporation (TSMC). NME also relies on various independent third
party companies for packaging and testing of its semiconductors. NME does not
have long-term purchase agreements with its subcontract manufacturers or its
component suppliers.
RESEARCH AND DEVELOPMENT
Research and development expenses in the fiscal years ended March 31, 2001,
2000, and 1999 were $18.8 million, $11.9 million, and $9.9 million,
respectively. The development of new products and the enhancement of existing
products by the Company and its subsidiaries are essential to their success.
The Company's current and future research and development efforts relate
primarily to VoIP semiconductors and embedded software, hosted iPBX systems, and
service creation and execution technologies. Areas of emphasis will include:
enhanced versions of its Audacity-T2 semiconductor architecture to provide
higher performance, enhanced functionality, and further integration of certain
essential system functions and interfaces; enhanced versions of its hosted iPBX
business communication service to include additional call control features,
system management capabilities, additional protocol and telephony device
support, and new graphical user interface and web-based applications; and
enhanced versions of the SCE to offer additional editor features and a
performance-enhanced version of the service logic execution environment,
specifically tailored for high volume call switching environments. Future
developments may also focus on emerging audio and video telephony standards and
protocols, quality and performance enhancements to multimedia compression
algorithms, and additional features supporting all of the Company's products.
LICENSING AND DEVELOPMENT ARRANGEMENTS
The Company has entered into licensing and development arrangements with
its customers to promote the design, development, manufacture, and sale of the
Company's products. In order to encourage the use of its semiconductors, NME has
licensed portions of its systems technology and software object code for its
semiconductors to virtually all of its semiconductor customers. Moreover, many
of NME's OEM customers have licensed portions of the source code to its software
for its semiconductors. NME intends to continue to license its semiconductor,
software, and systems technology to other companies, many of which are current
or potential competitors. Such arrangements may enable these companies to use
NME's technology to produce products that compete with the Company's IP
telephony and video products.
NME has also licensed the right to manufacture certain of its
videoconferencing and IP telephony semiconductor products, subject to payment of
royalties, to several original equipment manufacturers (OEMs). Of these OEM
licensees, only Alcatel Microelectronics, ESS Technology, Inc. (ESS), and
STMicroelectronics may sell semiconductors based on the licensed technology to
third parties, while other licensees are limited to sales of such semiconductors
as part of multimedia communication systems or sub-systems. The obligation of
ESS to pay royalties to the Company with regard to the sale of semiconductors
based on the licensed technology expired in October 2000.
11
14
In addition, Netergy has licensed source code for its SCE product to
Lucent. Under the agreement, Lucent has licensed the technology for use in its
Enhanced Service Authoring Environment (eSAE), which enables carriers and
application developers to design innovative new services for converged voice and
data networks. Netergy may continue to license its SCE source code to other
companies. Such arrangements may enable these companies to use the technology to
produce products that compete with Netergy's SCE and related products.
The Company expects to continue licensing its technology to others, many of
whom may be located outside of the United States. In addition to licensing its
technology to others, the Company from time to time will take a license to
technology owned by third parties and currently relies upon certain technology,
including hardware and software, licensed from third parties.
EMPLOYEES
As of March 31, 2001, the Company employed 156 persons, including 8 in
manufacturing operations, 86 in research and development, 35 in sales and
marketing, and 27 in general and administrative capacities. None of the
Company's employees are represented by a labor union or are subject to a
collective bargaining arrangement. The Company believes that relations with
employees are good.
ITEM 2. PROPERTIES
The Company's principal operations are located in an approximately 45,000
square foot facility in Santa Clara, California that is leased through May 2003.
Design, limited manufacturing, research and development, marketing, and
administrative activities are performed in this facility.
The Company also leases facilities for its sales office in Marlow, United
Kingdom, and for its research and development operation in Sophia Antipolis,
France. In addition, the Company has a lease for approximately 6,000 square feet
of vacant office space in Hull, Canada that it is actively seeking to sublet.
The Company believes that its existing facilities are adequate to meet its
current and foreseeable future needs. For additional information regarding the
Company's obligations under leases see Note 10 to the Consolidated Financial
Statements contained in Part II, Item 8.
ITEM 3. LEGAL PROCEEDINGS
On April 6, 2001, the Company, along with Sun Microsystems, Inc., Netscape
Communications Canada Inc., Burntsand Inc., and Intraware Canada Inc., was sued
by Milinx Business Services, Inc. and Milinx Business Group Inc. (collectively,
"Milinx") in the Supreme Court of British Columbia, Canada (the "Court"). Milinx
has alleged that the Company failed to perform certain contractual obligations
and knowingly misrepresented the capabilities of its products. The lawsuit seeks
general, special, and aggravated damages totaling in excess of Canadian $65
million plus interest, costs, and any other relief which the Court may choose to
provide. Management believes that the Company has valid defenses against the
claims alleged by Milinx and intends to defend this lawsuit vigorously. However,
due to the nature of litigation and because the lawsuit is in the very early,
pre-discovery stages, the Company cannot determine the possible loss, if any,
that may ultimately be incurred either in the context of a trial or a negotiated
settlement. If the Company does not prevail in any such litigation, its
operating results and financial condition could be adversely impacted.
The Company is involved in various other legal claims and litigation that
have arisen in the normal course of the Company's operations. While the results
of such claims and litigation cannot be predicted with certainty, the Company
believes that the final outcome of such matters will not have a significant
adverse effect on the Company's financial position or results of operations.
However, should the Company not prevail in any such litigation, its operating
results and financial condition could be adversely impacted.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this Report.
12
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
The Company effected its initial public offering on July 2, 1997 under the
name 8x8, Inc. From that date through April 3, 2000, the Company's common stock
was traded on the NASDAQ National Market (the NASDAQ) under the symbol "EGHT."
Starting April 4, 2000 the Company's common stock has been traded on the NASDAQ
under the symbol "NTRG." The Company has never paid cash dividends on its common
stock and has no present plans to do so. As of May 4, 2001, there were 272
holders of record of the Company's common stock. The following table sets forth
the range of high and low closing prices for each period indicated:
PERIOD HIGH LOW
------ ------ -----
Fiscal 2001
First Quarter............................................. $29.63 $7.67
Second Quarter............................................ $12.94 $6.63
Third Quarter............................................. $ 9.06 $1.50
Fourth Quarter............................................ $ 4.72 $0.78
Fiscal 2000
First Quarter............................................. $ 6.25 $3.94
Second Quarter............................................ $ 5.50 $2.75
Third Quarter............................................. $ 5.83 $3.94
Fourth Quarter............................................ $34.63 $5.63
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED MARCH 31(1)
-------------------------------------------------------
2001(2)(5) 2000(3)(5) 1999(4) 1998 1997
---------- ---------- -------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Total revenues.............................. $ 18,228 $ 25,384 $ 31,682 $49,776 $ 19,146
Net income (loss)........................... $(74,399) $(24,848) $(19,224) $ 3,727 $(13,613)
Net income (loss) per share:
Basic..................................... $ (2.99) $ (1.38) $ (1.28) $ 0.31 $ (2.56)
Diluted................................... $ (2.99) $ (1.38) $ (1.28) $ 0.25 $ (2.56)
Total assets................................ $ 39,145 $ 59,983 $ 28,709 $46,429 $ 12,727
Convertible subordinated debentures......... $ 6,238 $ 5,498 $ -- $ -- $ --
- ---------------
(1) Fiscal 2001 was a 52 week and 2 day fiscal year. Fiscal year 2000 was a
53-week fiscal year, while fiscal 1999, 1998, and 1997 were 52-week fiscal
years.
(2) Net loss and net loss per share include a restructuring charge of $33.3
million, an in-process research and development charge of $4.6 million, and
a $1.1 million charge for the cumulative effect of a change in accounting
principle.
(3) Net loss and net loss per share include a $6.4 million charge for a discount
on the issuance of common stock and an in-process research and development
charge of $10.1 million.
(4) Net loss and net loss per share include a $5.7 million charge associated
with the write off of ViaTV consumer videophone inventories.
(5) Convertible subordinated debentures are presented net of the related debt
discount, which is being amortized over the three-year term of the
debentures. The face value of the debentures is $7.5 million.
13
16
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements within the meaning of Section 27A
of the Securities Act and Section 21E of the Exchange Act, including, but not
limited to, those specifically identified as such, that involve risks and
uncertainties. The statements contained in this Report on Form 10-K (the Report)
that are not purely historical are forward looking statements, including,
without limitation, statements regarding our expectations, beliefs, estimates,
intentions or strategies regarding the future, including statements regarding
working capital and capital expenditure requirements, efforts to raise
additional financing, the acquisition or investment in other businesses and
products, commitment of resources, and reduction in operating costs including
the possible sale or cessation of certain business lines and the possible
reduction of personnel and suspension of salary increases and capital
expenditures. All forward-looking statements included in this Report are based
on information available to us on the date hereof, and we assume no obligation
to update any such forward-looking statements. You should not place undue
reliance on these forward-looking statements. Actual results could differ
materially from those anticipated in these forward-looking statements as a
result of a number of factors, including, but not limited to, risks faced by us
as described in this Report, including those set forth under the section
entitled "Factors that May Affect Future Results" in Item 1, and the other
documents we file with the Securities and Exchange Commission (SEC) including
our most recent reports on Form 8-K.
OVERVIEW
Netergy Networks, Inc. and its subsidiaries (collectively, We or Netergy)
develop and market telecommunication technology for Internet Protocol (IP)
telephony and video applications. We have three product lines: voice and video
semiconductors and related software, hosted Internet Private Branch Exchange
(iPBX) solutions, and Voice-over-IP (VoIP) service creation software.
During the fiscal year ended March 31, 2001, we formed two subsidiaries,
Netergy Microelectronics, Inc. (NME) and Centile, Inc. (Centile) and reorganized
our operations more clearly along our three product lines. NME provides voice
and video semiconductors and related communication software to original
equipment manufacturers (OEMs) of telephones, terminal adapters, and other edge
devices and to other semiconductor companies. NME's technologies are used to
make IP telephones and to voice-enable cable and digital subscriber line (DSL)
modems, wireless devices, and other broadband technologies. Centile develops and
markets hosted iPBX solutions that allow service providers to offer private
branch exchange (PBX) functionality to small and medium-sized businesses over
broadband networks. We are also developing a third product line, a VoIP service
creation environment (SCE), at the parent company level. This product is
designed for use by telecommunication equipment manufacturers and service
providers.
14
17
RESULTS OF OPERATIONS
The following table sets forth consolidated statement of operations data
for each of the years ended March 31, 2001, 2000, and 1999, as well as the
percentage of our total revenues represented by each item. Cost of product
revenues is presented as a percentage of product revenues and cost of license
and other revenues is presented as a percentage of license and other revenues.
You should read this information in conjunction with our Consolidated Financial
Statements and related notes included elsewhere in this Report:
YEAR ENDED MARCH 31,
--------------------------------------------------
2001 2000 1999
-------------- -------------- --------------
($ IN MILLIONS)
Product revenues......................... $ 12.8 70% $ 20.8 82% $ 26.2 83%
License and other revenues............... 5.4 30% 4.6 18% 5.5 17%
------ ---- ------ ---- ------ ----
Total revenues................. 18.2 100% 25.4 100% 31.7 100%
------ ---- ------ ---- ------ ----
Cost of product revenues................. 5.2 41% 8.5 41% 24.2 92%
Cost of license and other revenues....... 1.8 33% 0.1 3% 0.1 2%
------ ---- ------ ---- ------ ----
Total cost of revenues......... 7.0 38% 8.6 34% 24.3 77%
------ ---- ------ ---- ------ ----
Gross profit................... 11.2 62% 16.8 66% 7.4 23%
------ ---- ------ ---- ------ ----
Operating expenses:
Research and development............... 18.7 104% 11.9 47% 9.9 31%
Selling, general and administrative.... 18.1 99% 21.3 84% 17.7 56%
In-process research and development.... 4.6 25% 10.1 40% -- --%
Restructuring charge................... 33.3 183% -- --% -- --%
Amortization of intangibles............ 11.0 60% 0.6 2% -- --%
------ ---- ------ ---- ------ ----
Total operating expenses....... 85.7 471% 43.9 173% 27.6 87%
------ ---- ------ ---- ------ ----
Loss from operations..................... (74.5) (409)% (27.1) (107)% (20.2) (64)%
Other income, net........................ 2.6 14% 2.8 11% 1.0 3%
Interest expense......................... (1.4) (8)% (0.4) 2% -- --%
------ ---- ------ ---- ------ ----
Loss before provision for income taxes... (73.3) (403)% (24.7) (97)% (19.2) (61)%
Provision for income taxes............... -- --% 0.1 1% -- --%
------ ---- ------ ---- ------ ----
Net loss before cumulative effect of
change in accounting principle......... (73.3) (403)% (24.8) (98)% (19.2) (61)%
Cumulative effect of change in accounting
principle.............................. (1.1) (6)% -- --% -- --%
------ ---- ------ ---- ------ ----
Net loss................................. $(74.4) (409)% $(24.8) (98)% $(19.2) (61)%
====== ==== ====== ==== ====== ====
Revenues
The following table illustrates net revenues by groupings of similar
products (in thousands):
YEAR ENDED MARCH 31,
-----------------------------
2001 2000 1999
------- ------- -------
Videoconferencing semiconductors............................ $ 9,478 $11,323 $10,302
IP telephony semiconductors................................. 1,878 37 --
Consumer videophone systems................................. 105 3,000 12,935
Video monitoring systems.................................... 915 6,006 2,952
Media hub systems........................................... 432 451 --
------- ------- -------
Product revenues.................................. 12,808 20,817 26,189
------- ------- -------
Videoconferencing licenses and royalties.................... 3,237 4,318 4,248
IP telephony licenses and royalties......................... 825 179 --
Nonrecurring engineering fees............................... -- -- 1,245
Hosted iPBX licenses........................................ 198 70 --
Professional services....................................... 1,160 -- --
------- ------- -------
License and other revenues........................ 5,420 4,567 5,493
------- ------- -------
Total revenues.................................... $18,228 $25,384 $31,682
======= ======= =======
15
18
Product revenues were $12.8 million in fiscal 2001, a decrease of $8.0
million from the $20.8 million reported in fiscal 2000. The decrease in product
revenues in fiscal 2001 was primarily due to decreases in sales of video
monitoring and consumer videophone systems, resulting from our exit from these
businesses, and a decrease in average selling prices for our videoconferencing
semiconductors. These decreases were partially offset by an increase in IP
telephony semiconductor revenues resulting from the commercial release of our
Audacity-T2 product in fiscal 2001. Product revenues were $20.8 million in
fiscal 2000, a decrease of $5.4 million from the $26.2 million reported in
fiscal 1999. The decrease in product revenues in fiscal 2000 compared to fiscal
1999 was primarily due to a significant decrease in unit shipments of our
consumer videophone systems and average selling prices (ASPs) realized on those
shipments. This decrease was partially offset by increases in unit shipments of
our videoconferencing semiconductor and video monitoring system products.
License and other revenues consist primarily of technology licenses,
including royalties earned pursuant to such licenses, and nonrecurring
engineering fees for services performed by us for our customers. License and
other revenues for fiscal 2001 also included service revenues resulting from the
integration of U/Force's professional services organization after the
acquisition of U/Force in June 2000. License and other revenues increased
$853,000, from $4.6 million in fiscal 2000 to $5.4 million in fiscal 2001, due
primarily to U/Force professional service revenues of $1.2 million, offset by a
decrease in royalties earned under a license agreement with ESS Technology, Inc.
for certain of our video compression technology, which expired in October 2000.
License and other revenues were $4.6 million in fiscal 2000, a decrease of
$926,000 from the $5.5 million reported in fiscal 1999, due primarily to a
decrease in nonrecurring engineering fees.
Revenues from our ten largest customers in the fiscal years ended March 31,
2001, 2000, and 1999 accounted for approximately 48%, 35%, and 40%,
respectively, of our total revenues. During the fiscal years ended March 31,
2001, 2000, and 1999, no customer accounted for 10% or more of total revenues.
Sales to customers outside the United States represented 63%, 47%, and 43%
of total revenues in the fiscal years ended March 31, 2001, 2000, and 1999,
respectively. Specifically, sales to the Asia Pacific region represented 31%,
24%, and 26% of our total revenues for the fiscal years ended March 31, 2001,
2000, and 1999, respectively. Our sales to Europe represented 32%, 23%, and 17%
of total revenues for the fiscal years ended March 31, 2001, 2000, and 1999,
respectively.
Cost of Revenues and Gross Profit
The cost of product revenues consists of costs associated with components,
semiconductor wafer fabrication, system and semiconductor assembly and testing
performed by third-party vendors, and direct and indirect costs associated with
purchasing, scheduling, and quality assurance. Gross profit from product
revenues was $7.6 million, $12.3 million, and $2.0 million for the fiscal years
ended March 31, 2001, 2000, and 1999, respectively. Product gross margin was 59%
for fiscal 2001 and fiscal 2000, compared to 8% in fiscal 1999. The $4.7 million
decrease in gross profit from fiscal 2000 to fiscal 2001 is due primarily to a
significant decrease in sales of our video monitoring and consumer videophone
products due to our exit from those businesses. Gross profit in fiscal 2001 was
also impacted by lower average selling prices (ASPs) realized on sales of our
videoconferencing semiconductors, offset by a significant increase in IP
telephony semiconductor sales. The significant increase in product gross profit
in fiscal 2000 compared to fiscal 1999 was due to an increase in higher margin
videoconferencing semiconductor and video monitoring system revenues and due to
higher gross margins realized on sales of our ViaTV products. In addition,
fiscal 1999 gross profit and margins were significantly impacted by a $5.7
million charge associated with the write-off of ViaTV product inventory due to
our decision to cease production of the ViaTV product line and withdraw from our
distribution channels.
Gross profit from license and other revenues, substantially all of which
were nonrecurring, was $3.7 million, $4.5 million, and $5.4 million in fiscal
2001, 2000, and 1999, respectively. Associated gross margins were 67%, 97%, and
98% in fiscal 2001, 2000, and 1999. The significant decrease in gross margin
from fiscal 2000 to fiscal 2001 was due to reduced margins associated with our
professional service revenues in fiscal 2001. This was a result of lower than
expected utilization of our professional services resources and the
16
19
elimination of the professional services organization as part of the
restructuring of our Canadian operations in the fourth quarter of fiscal 2001.
Research and Development Expenses
Research and development expenses consist primarily of personnel, system
prototype design and fabrication, mask, prototype wafer, and equipment costs
necessary for us to conduct our development efforts. Research and development
costs, including software development costs, are expensed as incurred. Research
and development expenses were $18.7 million, $11.9 million, and $9.9 million for
fiscal 2001, 2000, and 1999, respectively. Higher research and development
expenses during fiscal 2001 as compared to fiscal 2000 were due primarily to
increases in personnel, resulting from the acquisition of U/Force and increases
in hosted iPBX development efforts, higher consulting expenses associated with
the development of a graphical user interface for the hosted iPBX product,
higher depreciation and maintenance expenses as a result of additional lab
equipment and computer aided design tools, and increased stock compensation
charges of approximately $325,000 related to stock option bonus programs. Higher
research and development expenses during fiscal 2000 as compared to fiscal 1999
were due primarily to increased spending related to hosted iPBX system software
development. Significant expenses were also incurred in fiscal 2000 related to
development efforts associated with the Audacity-T2 processor and media hub
products.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses consist primarily of
personnel and related overhead costs for sales, marketing, finance, human
resources, and general management. Such costs also include advertising, sales
commissions, trade show, and other marketing and promotional expenses. Selling,
general, and administrative expenses were $18.1 million, $21.3 million, and
$17.7 million in fiscal 2001, 2000, and 1999, respectively. The decrease in
selling, general, and administrative expenses during the year ended March 31,
2001 as compared to the comparable period in the prior year is due primarily to
a one-time $6.4 million charge related to the sale of 3.7 million shares of our
common stock to STMicroelectronics that we recorded in the fourth quarter of
fiscal 2000. The charge reflected the discount from the fair market value of our
common stock on the date of the related agreement. The decrease also reflects
lower headcount and other costs required to support ViaTV and video monitoring
sales, promotion, and support activities due to our exit from the consumer
videophone and video monitoring businesses. These decreases were substantially
offset by increased expenses associated with the addition of the U/Force sales,
marketing, finance, and corporate organizations, costs incurred related to our
name change, and increased stock compensation charges. The increase in expenses
in fiscal 2000 compared to fiscal 1999 was primarily the result of the $6.4
million charge discussed above. This increase was offset by lower costs
associated with the marketing, advertising, and promotion of the ViaTV product
line and lower headcount required to support these activities as we exited the
consumer videophone business.
In-Process Research and Development and Amortization of Intangibles
We incurred in-process research and development charges of $10.1 million in
the first quarter of fiscal 2000 related to the acquisition of Odisei S.A.
(Odisei), and $4.6 million in the second quarter of fiscal 2001 related to the
acquisition of U/Force, Inc. (U/Force). A discussion of these acquisitions
follows below.
U/Force, Inc.
The Company's consolidated financial statements reflect the acquisition of
all of the outstanding stock of U/Force, Inc. on June 30, 2000 for a total
purchase price of $46.8 million. U/Force, based in Montreal, Canada, was a
developer of IP-based software applications and a provider of professional
services. U/Force was also developing a Java-based service creation environment
(SCE) that is designed to allow telecommunication service providers to develop,
deploy, and manage telephony applications and services to their customers. The
purchase price was comprised of Netergy common stock with a fair value of
approximately $38.0 million comprised of: (i) 1,447,523 shares issued at closing
of the acquisition, and (ii) 2,107,780 shares to be issued upon the exchange or
redemption of the exchangeable shares (the Exchangeable Shares) of Canadian
entities
17
20
held by former employee shareholders or indirect owners of U/Force stock. The
Exchangeable Shares held by U/Force employees are subject to certain
restrictions, including our right to repurchase the Exchangeable Shares if an
employee departs prior to vesting. In addition, we also agreed to issue one
share of preferred stock (the Special Voting Share) that provides holders of
Exchangeable Shares with voting rights that are equivalent to the shares of
common stock into which their shares are convertible. We also assumed
outstanding stock options to purchase 1,023,898 shares of U/Force common stock
for which the Black-Scholes pricing model value of approximately $6.6 million
was included in the purchase price. Direct transaction costs related to the
merger were approximately $747,000.
The purchase price was allocated to tangible assets acquired and
liabilities assumed based on the book value of U/Force's assets and liabilities,
which we believe approximated their fair value. In addition, we engaged an
independent appraiser to value the intangible assets, including amounts
allocated to U/Force's in-process research and development. The in-process
research and development related to U/Force's initial products, the SCE and a
unified messaging application, for which technological feasibility had not been
established and the technology had no alternative future use. The estimated
percentage complete for the unified messaging and SCE products was approximately
44% and 34%, respectively, at June 30, 2000. The fair value of the in-process
technology was based on a discounted cash flow model, similar to the traditional
"Income Approach," which discounts expected future cash flows to present value,
net of tax. In developing cash flow projections, revenues were forecasted based
on relevant factors, including estimated aggregate revenue growth rates for the
business as a whole, characteristics of the potential market for the technology,
and the anticipated life of the technology. Projected annual revenues for the
in-process research and development projects were assumed to ramp up initially
and decline significantly at the end of the in-process technology's economic
life. Operating expenses and resulting profit margins were forecasted based on
the characteristics and cash flow generating potential of the acquired
in-process technologies. Risks that were considered as part of the analysis
included the scope of the efforts necessary to achieve technological
feasibility, rapidly changing customer markets, and significant competitive
threats from numerous companies. We also considered the risk that if we failed
to bring the products to market in a timely manner, it could adversely affect
sales and profitability of the combined company in the future. The resulting
estimated net cash flows were discounted at a rate of 25%. This discount rate
was based on the estimated cost of capital plus an additional discount for the
increased risk associated with in-process technology. Based on the independent
appraisal, the value of the acquired U/Force in-process research and
development, which was expensed in the second quarter of fiscal 2001,
approximated $4.6 million. The excess of the purchase price over the net
tangible and intangible assets acquired and liabilities assumed was allocated to
goodwill. Amounts allocated to goodwill, the value of an assumed distribution
agreement, and workforce were being amortized on a straight-line basis over
three, three, and two years, respectively. The allocation of the purchase price
was as follows (in thousands):
In-process research and development........................ $ 4,563
Distribution agreement..................................... 1,053
Workforce.................................................. 1,182
U/Force net tangible assets................................ 1,801
Goodwill................................................... 38,236
-------
$46,835
=======
Our consolidated financial statements include the results of the operations
of U/Force from the date of the acquisition, June 30, 2000, the beginning of our
second quarter of fiscal 2001.
Odisei S.A.
In May 1999, we acquired Odisei, a privately held, development stage
company based in Sophia Antipolis, France, that was developing software for
managing voice-over IP networks. The consolidated financial statements reflect
the acquisition of Odisei on May 24, 1999 for approximately 2,868,000 shares of
Netergy's common stock and approximately 121,000 of contingent shares, which
were subsequently issued to Odisei employee shareholders in March 2000.
Approximately 30,000 of the shares issued to Odisei employees
18
21
are subject to repurchase as of March 31, 2001 if the employee departs prior to
vesting. The purchase price was approximately $13.6 million, which includes
approximately $295,000 of acquisition-related costs. The purchase price was
allocated to tangible assets acquired and liabilities assumed based on the book
value of Odisei's current assets and liabilities, which we believed approximated
their fair value. In addition, we engaged an independent appraiser to value the
intangible assets, including amounts allocated to Odisei's in-process research
and development. The in-process research and development related to Odisei's
initial product for which technological feasibility had not been established and
was estimated to be approximately 60% complete. The fair value of the in-process
technology was based on a discounted cash flow model, which discounted expected
future cash flows to present value, net of tax. In developing cash flow
projections, revenues were forecasted based on relevant factors, including
estimated aggregate revenue growth rates for the business as a whole,
characteristics of the potential market for the technology, and the anticipated
life of the technology. Projected annual revenues for the in-process research
and development projects were assumed to ramp up initially and decline
significantly at the end of the in-process technology's economic life. Operating
expenses and resulting profit margins were forecasted based on the
characteristics and estimated cash flow generating potential of the acquired
in-process technology. Associated risks include the inherent difficulties and
uncertainties in completing the project and thereby achieving technological
feasibility, and risks related to the impact of potential changes in market
conditions and technology. The resulting estimated net cash flows were
discounted at a rate of 27%. This discount rate was based on the estimated cost
of capital plus an additional discount for the increased risk associated with
in-process technology. Based on the independent appraisal, the value of the
acquired Odisei in-process research and development, which was expensed in the
fiscal year ended March 31, 2000, was $10.1 million. The excess of the purchase
price over the net tangible and intangible assets acquired and liabilities
assumed was allocated to goodwill. Amounts allocated to goodwill and workforce
are being amortized on a straight-line basis over five and three years,
respectively. The allocation of the purchase price was as follows (in
thousands):
In-process research and development........................ $10,100
Workforce.................................................. 200
Net tangible liabilities................................... (219)
Goodwill................................................... 3,481
-------
$13,562
=======
Our consolidated financial statements for the fiscal year ended March 31,
2000 include the results of Odisei from the date of acquisition.
Amortization of intangible assets charged to operations was $11.0 million
and $614,000 during the fiscal years ended March 31, 2001 and 2000,
respectively.
Restructuring Charges
During the fourth quarter of fiscal 2001, after a significant number of
employees had resigned, we discontinued our Canadian operations acquired in
conjunction with the acquisition of U/Force in June 2000. We closed our offices
in Montreal and Hull, Quebec and laid-off all remaining employees resulting in
the cessation of most of the research and development efforts and all of the
sales and marketing and professional services activities associated with the
U/Force business. As a result of the restructuring, we recorded a one-time
charge of $33.3 million in the quarter ended March 31, 2001. The restructuring
charges consisted of the following (in thousands):
Employee separation........................................ $ 765
Fixed asset losses and impairments......................... 2,084
Intangible asset impairments............................... 30,247
Lease obligation and termination........................... 220
-------
$33,316
=======
Employee separation costs represent severance payments related to the 96
employees in the Montreal and Hull offices who were laid-off.
19
22
The impairment charges for fixed assets of approximately $2.1 million
included write-offs of abandoned and unusable assets of approximately $1.4
million, a loss on sale of assets of $567,000, and a charge for assets to be
disposed of $172,000. The loss on sale of assets of $567,000 was attributable to
the sale of office, computer, and other equipment of the Montreal office. We
received common stock of the purchaser valued at approximately $412,000 as of
the date of sale. Fair value of assets to be disposed was measured based on
expected salvage value, less costs to sell. These assets are expected to be sold
or abandoned, depending on re-sale market conditions, within the next six to
twelve months.
The impairment charges for intangible assets represented the write-off of
the unamortized intangible assets recorded in connection with the acquisition of
U/Force. The charges of approximately $30.2 million included: $28.7 million for
the goodwill related to the acquisition, $739,000 for the assembled workforce,
and $789,000 related to a distribution agreement. The impairments were directly
attributable to the cessation of operations in Canada. We performed an
evaluation of the recoverability of the intangible assets related to these
operations in accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The lack of
estimated future net cash flows related to the acquired products necessitated an
impairment charge to write-off the remaining unamortized goodwill. The
distribution agreement asset was written off because we will no longer provide
products and services to customers under that agreement.
In March 2001 we terminated the lease for our primary facility in Montreal.
Pursuant to the lease termination agreement, we are obligated to pay rent on the
Montreal facility through May 31, 2001. We recorded charges for this rental
obligation as well as the related lease termination costs. We are actively
seeking a third party to sublet our vacant facility in Hull, Quebec, and have
recorded a charge for estimated lease termination and related costs.
Cash payments related to the restructuring, which included all employee
separation costs and certain lease termination costs, approximated $920,000
during our fourth fiscal quarter ended March 31, 2001. As of March 31, 2001, the
remaining estimated cash requirements of approximately $215,000 are related to
lease obligations and anticipated lease termination costs.
The restructuring and discontinuation of our Canadian operations will
reduce our operating expenses and cash used in operations beginning in fiscal
2002. From June 30, 2000 (date of acquisition of U/Force) to March 31, 2001, we
incurred operating expenses, excluding restructuring charges, of approximately
$7.0 million, and net cash outflows of approximately $10 million related to our
Canadian operations. As a result of the cessation of operations in Canada, we do
not expect to incur significant related operating expenses or cash outflows in
fiscal 2002.
Other Income, Net
In fiscal 2001, 2000, and 1999, other income, net, was approximately $2.6
million, $2.8 million, and $1.0 million, respectively. The decrease in other
income, net, in fiscal 2001 compared to fiscal 2000 was due primarily to a $1.7
million decrease in gains realized from the sale of equity investments, offset
by an increase in interest income resulting from higher average cash equivalent
and short-term investment balances as compared to fiscal 2000. The increase in
other income, net, in fiscal 2000 as compared to fiscal 1999 was due primarily
to a $1.9 million gain realized from the sale of an equity investment, offset by
approximately $205,000 of losses realized on the sale of certain of investments
classified as available-for-sale.
Interest Expense
Interest expense increased from $391,000 in fiscal 2000 to $1.4 million in
fiscal 2001 due primarily to an increase in interest charges and amortization of
both the debt discount and debt issuance costs associated with the convertible
subordinated debentures issued in December 1999.
20
23
Provision for Income Taxes
The provisions of $17,000 and $120,000 for the years ended March 31, 2001
and 2000, respectively, represent certain foreign taxes. There was no tax
provision for the year ended March 31, 1999 due to the net losses incurred.
At March 31, 2001, we had net operating loss carryforwards for federal and
state income tax purposes of approximately $61.4 million and $38.7 million,
respectively, which expire at various dates beginning in 2005. In addition, at
March 31, 2001, we had research and development credit carryforwards for federal
and state tax reporting purposes of approximately $2.9 million and $2.1 million,
respectively. The federal credit carryforwards will begin expiring in 2010 while
the California credit will carryforward indefinitely. Under the ownership change
limitations of the Internal Revenue Code of 1986, as amended, the amount and
benefit from the net operating losses and credit carryforwards may be impaired
or limited in certain circumstances.
At March 31, 2001, we had gross deferred tax assets of approximately $47.7
million. We believe that, based on a number of factors, the weight of objective
available evidence indicates that it is more likely than not that we will not be
able to realize our deferred tax assets, and thus a full valuation allowance was
recorded at March 31, 2001 and March 31, 2000.
Cumulative Effect of Change in Accounting Principle
In November 2000, the Financial Accounting Standards Board (FASB) Emerging
Issues Task Force reached several conclusions regarding the accounting for debt
and equity securities with beneficial conversion features, including a consensus
requiring the application of the "accounting conversion price" method, versus
the use of the stated conversion price, to calculate the beneficial conversion
feature for such securities. The Securities and Exchange Commission required
companies to record a cumulative catch-up adjustment in the fourth quarter of
calendar 2000 related to the application of the "accounting conversion price"
method to securities issued after May 21, 1999. Accordingly, we recorded a $1.1
million non-cash expense during the quarter ended December 31, 2000 to account
for a beneficial conversion feature associated with the convertible subordinated
debentures and related warrants issued in December 1999, and we have presented
it as a cumulative effect of a change in accounting principle.
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging
Activities." SFAS 133 establishes methods of accounting for derivative financial
instruments and hedging activities related to those instruments as well as other
hedging activities. We are required to adopt SFAS 133 in the first quarter of
fiscal 2002 pursuant to the issuance of SFAS 137, "Accounting for Derivative
Instruments and Hedging Activities -- Deferral of the Effective Date of FASB
Statement No. 133," which deferred the effective date of SFAS 133 by one year.
In June 2000, the FASB issued SFAS No. 138 (SFAS 138), "Accounting for Certain
Derivative Instruments and Certain Hedging Activities -- an amendment of FASB
statement No. 133," which amends certain terms and conditions of SFAS 133. We do
not expect that the adoption of SFAS 133, as amended, will have a material
impact on our consolidated financial statements.
Liquidity and Capital Resources
As of March 31, 2001, we had cash and cash equivalents totaling $24.1
million, representing a decrease of $24.5 million from March 31, 2000. We
currently have no borrowing arrangements.
Cash used in operations of $24.6 million in fiscal 2001 reflected a net
loss of $74.4 million, decreases in accounts payable and accrued compensation of
$2.2 million and $623,000, an increase in other current and non-current assets
of $1.3 million, and a non-cash adjustment for a gain on sale of investments of
$225,000. Cash used in operations was partially offset by cash provided by a
decrease in accounts receivable of $851,000, an increase in other accrued
liabilities of $378,000, and non-cash items, including restructuring charges of
$32.3 million, depreciation and amortization of $14.4 million, in-process
research and development of
21
24
$4.6 million, the cumulative effect of a change in accounting principle of $1.1
million, and stock compensation charges of $753,000. Cash provided by investing
activities in fiscal 2001 is primarily attributable to net proceeds from the
sale of assets and the license of technology associated with our video
monitoring line of $5.2 million, offset by acquisitions of property and
equipment of $6.1 million and cash paid for acquisitions, net, of $558,000. Cash
flows from financing activities in fiscal 2000 consisted primarily of proceeds
from sales of the Company's common stock totaling $2.8 million, offset by debt
repayments of $891,000 and repurchases of common stock and Exchangeable Shares
of $514,000. For the year, cash and cash equivalents decreased $24.5 million.
Cash used in operations of $4.1 million in fiscal 2000 reflected a net loss
of $24.8 million, a decrease in deferred revenue of $3.4 million, and a non-cash
adjustment for a gain on sale of investments, net, of $1.7 million. Cash used in
operations was partially offset by cash provided by a decrease in accounts
receivable of $3.5 million, a decrease in inventory of $2.5 million, and
non-cash items, including depreciation and amortization of $2.1 million,
in-process research and development of $10.1 million, and discount on issuance
of common stock of $7.4 million. Cash provided by investing activities in fiscal
2000 is attributable to proceeds from the sale of an investment of $1.9 million,
offset by acquisitions of property and equipment of $1.7 million and cash paid
for acquisitions, net, of $149,000. Cash flows from financing activities in
fiscal 2000 consisted primarily of proceeds from the sale of convertible
subordinated debentures of $7.5 million and sales of the Company's common stock
totaling $29.8 million, offset by debt issuance costs of $617,000. For the year,
cash and cash equivalents increased $32.8 million.
Cash used in operations of $10.4 million in fiscal 1999 reflected a net
loss of $19.2 million, an increase in accounts receivable of $1.4 million, and a
decrease in accounts payable of $708,000. Cash used in operations was partially
offset by cash provided by a decrease in inventory of $8.8 million, an increase
in deferred revenue of $1.6 million, and non-cash items, including stock
compensation expense of $416,000 and depreciation and amortization of $967,000.
Cash used in investing activities in fiscal 1999 is primarily attributable to
capital expenditures of $1.8 million. Cash flows from financing activities in
fiscal 1999 consisted primarily of net proceeds from the repayment of
stockholders' notes receivable and sales of the Company's common stock upon the
exercise of employee stock options. For the year, cash and cash equivalents
decreased by $10.9 million.
As of March 31, 2001, our principal commitments consisted of obligations
outstanding under noncancelable operating leases.
We believe that our current cash and cash equivalents, and cash generated
from operations, if any, will satisfy our expected working capital and capital
expenditure requirements through at least the next 12 months. We may, however,
need additional working capital shortly thereafter. Accordingly, we may raise
additional financing at some point during the next twelve months in order to
meet our cash requirements for fiscal 2003. We will be evaluating financing
alternatives prior to that time. We may also seek to explore business
opportunities, including acquiring or investing in complementary businesses or
products that will require additional capital from equity or debt sources.
Additionally, the development and marketing of new products could require a
significant commitment of resources, which could in turn require us to obtain
additional financing earlier than otherwise expected. We may not be able to
obtain additional financing as needed on acceptable terms, or at all, which may
require us to reduce our operating costs and other expenditures, including
reductions of personnel and suspension of salary increases and capital
expenditures. Alternatively, or in addition to such potential measures, we may
elect to implement other cost reduction actions as we may determine are
necessary and in our best interests, including the possible sale or cessation of
certain of our business lines. Any such actions undertaken might limit our
opportunities to realize plans for revenue growth and we might not be able to
reduce our costs in amounts sufficient to achieve break-even or profitable
operations.
22
25
FACTORS THAT MAY AFFECT FUTURE RESULTS
WE MAY NEED TO RAISE ADDITIONAL CAPITAL TO SUPPORT OUR GROWTH, AND FAILURE TO DO
SO IN A TIMELY MANNER MAY CAUSE US TO DELAY OUR PLANS FOR GROWTH OR CAUSE US TO
IMPLEMENT ADDITIONAL COST REDUCTION STRATEGIES
As of March 31, 2001, we had approximately $24.1 million in cash and cash
equivalents. We believe that our current cash and cash equivalents, and cash
generated from operations, if any, will satisfy our expected working capital and
capital expenditure requirements through at least the next twelve months. We
may, however, need additional working capital shortly thereafter. Accordingly,
we may seek additional financing at some point during the next twelve months in
order to meet our cash requirements in fiscal 2003. We may also seek to explore
business opportunities, including acquiring or investing in complementary
businesses or products that will require additional capital from equity or debt
sources. Additionally, the development and marketing of new products could
require a significant commitment of resources, which could in turn require us to
obtain additional financing earlier than otherwise expected. We may not be able
to obtain additional financing as needed on acceptable terms, or at all, which
may require us to reduce our operating costs and other expenditures, including
reductions of personnel and suspension of salary increases and capital
expenditures. Alternatively, or in addition to such potential measures, we may
elect to implement other cost reduction actions as we may determine are
necessary and in our best interests, including the possible sale or cessation of
certain of our business lines. Any such actions undertaken might limit our
opportunities to realize plans for revenue growth and we might not be able to
reduce our costs in amounts sufficient to achieve break-even or profitable
operations. If we issue additional equity or convertible debt securities to
raise funds, the ownership percentage of our existing stockholders would be
reduced. New investors may demand rights, preferences or privileges senior to
those of existing holders of our common stock.
WE HAVE A HISTORY OF LOSSES AND WE ARE UNCERTAIN AS TO OUR FUTURE PROFITABILITY
We recorded an operating loss of $74.4 million for the fiscal year ended
March 31, 2001 and had an accumulated deficit of $128.1 million at March 31,
2001. In addition, we recorded operating losses for the fiscal years ended March
31, 2000 and 1999. We expect that Netergy, as well as its subsidiaries
individually, will continue to incur operating losses for the foreseeable
future, and such losses may be substantial. We will need to generate significant
revenue growth to achieve profitability. Given our history of fluctuating
revenues and operating losses, we cannot be certain that we will be able to
achieve profitability on either a quarterly or annual basis.
THE GROWTH OF OUR BUSINESS AND FUTURE PROFITABILITY DEPENDS ON FUTURE IP
TELEPHONY REVENUE
We believe that our business and future profitability will be largely
dependent on widespread market acceptance of our IP telephony products. Our
videoconferencing semiconductor business has not provided, nor is it expected to
provide, sufficient revenues to profitably operate our business. To date, we
have not generated significant revenue from the sale of our IP telephony
products. If we are not able to generate significant revenues selling into the
IP telephony market, our business and operating results would be seriously
harmed.
Success of our IP telephony product strategy assumes that there will be
future demand for IP telephony systems. In order for the IP telephony market to
continue to grow, several things need to occur. Telephone service providers must
continue to invest in the deployment of high speed broadband networks to
residential and commercial customers. IP networks must improve quality of
service for real-time communications, managing effects such as packet jitter,
packet loss, and unreliable bandwidth, so that toll-quality service can be
provided. IP telephony equipment must achieve the 99.999% reliability that users
of the PSTN have come to expect from their telephone service. IP telephony
service providers must offer cost and feature benefits to their customers that
are sufficient to cause the customers to switch away from traditional telephony
service providers. If any or all of these factors fail to occur, our business
may not grow.
23
26
OUR FUTURE OPERATING RESULTS MAY NOT FOLLOW PAST OR EXPECTED TRENDS DUE TO MANY
FACTORS AND ANY OF THESE COULD CAUSE OUR STOCK PRICE TO FALL
Our historical operating results have fluctuated significantly and will
likely continue to fluctuate in the future, and a decline in our operating
results could cause our stock price to fall. On an annual and a quarterly basis,
there are a number of factors that may affect our operating results, many of
which are outside our control. These include, but are not limited to:
- changes in market demand;
- the timing of customer orders;
- competitive market conditions;
- lengthy sales cycles and/or regulatory approval cycles;
- new product introductions by us or our competitors;
- market acceptance of new or existing products;
- the cost and availability of components;
- the mix of our customer base and sales channels;
- the mix of products sold;
- the management of inventory;
- the level of international sales;
- continued compliance with industry standards; and
- general economic conditions.
Our gross margin is affected by a number of factors including, product mix,
the recognition of license and other revenues for which there may be little or
no corresponding cost of revenues, product pricing, the allocation between
international and domestic sales, the percentage of direct sales and sales to
resellers, and manufacturing and component costs. The markets for our products
are characterized by falling average selling prices. We expect that, as a result
of competitive pressures and other factors, gross profit as a percentage of
revenue for our videoconferencing semiconductor products will continue to
decrease for the foreseeable future. Average selling prices (ASPs) realized to
date for our IP telephony semiconductors have been lower than those historically
attained for our multimedia communication semiconductor products resulting in
lower gross margins. In the likely event that we encounter significant price
competition in the markets for our products, we could be at a significant
disadvantage compared to our competitors, many of whom have substantially
greater resources, and therefore may be better able to withstand an extended
period of downward pricing pressure.
Variations in timing of sales may cause significant fluctuations in future
operating results. In addition, because a significant portion of our business
may be derived from orders placed by a limited number of large customers,
including OEM customers, the timing of such orders can also cause significant
fluctuations in our operating results. Anticipated orders from customers may
fail to materialize. Delivery schedules may be deferred or canceled for a number
of reasons, including changes in specific customer requirements or international
economic conditions. The adverse impact of a shortfall in our revenues may be
magnified by our inability to adjust spending to compensate for such shortfall.
Announcements by our competitors or us of new products and technologies could
cause customers to defer purchases of our existing products, which would also
have a material adverse effect on our business and operating results.
As a result of these and other factors, it is likely that in some or all
future periods our operating results will be below the expectations of
securities analysts or investors, which would likely result in a significant
reduction in the market price of our common stock.
24
27
WE MAY NOT BE ABLE TO MANAGE OUR INVENTORY LEVELS EFFECTIVELY, WHICH MAY LEAD TO
INVENTORY OBSOLESCENCE THAT WOULD FORCE US TO LOWER OUR PRICES
Our products have lead times of up to several months, and are built to
forecasts that are necessarily imprecise. Because of our practice of building
our products to necessarily imprecise forecasts, it is likely that, from time to
time, we will have either excess or insufficient product inventory. Excess
inventory levels would subject us to the risk of inventory obsolescence and the
risk that our selling prices may drop below our inventory costs, while
insufficient levels of inventory may negatively affect relations with customers.
Any of these factors could have a material adverse effect on our business,
operating results, and financial condition.
WE DEPEND ON PURCHASE ORDERS FROM KEY CUSTOMERS AND FAILURE TO RECEIVE
SIGNIFICANT PURCHASE ORDERS IN THE FUTURE WOULD CAUSE A DECLINE IN OUR OPERATING
RESULTS
Historically, a significant portion of our sales has been to relatively few
customers, although the composition of these customers has varied. Revenues from
our ten largest customers for the fiscal years ended March 31, 2001, 2000, and
1999 accounted for approximately 48%, 35%, and 40%, respectively, of total
revenues. Substantially all of our product sales have been made, and are
expected to continue to be made, on a purchase order basis. None of our
customers has entered into a long-term agreement requiring it to purchase our
products. In the future, we will need to gain purchase orders for our products
to earn additional revenue. Further, substantially all of our license and other
revenues are nonrecurring.
THE IP TELEPHONY MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND WE DEPEND
ON NEW PRODUCT INTRODUCTION IN ORDER TO MAINTAIN AND GROW OUR BUSINESS
IP telephony is an emerging market that is characterized by rapid changes
in customer requirements, frequent introductions of new and enhanced products,
and continuing and rapid technological advancement. To compete successfully in
this emerging market, we must continue to design, develop, manufacture, and sell
new and enhanced semiconductor and IP telephony software products that provide
increasingly higher levels of performance and reliability at lower cost. These
new and enhanced products must take advantage of technological advancements and
changes, and respond to new customer requirements. Our success in designing,
developing, manufacturing, and selling such products will depend on a variety of
factors, including:
- the identification of market demand for new products;
- product and feature selection;
- timely implementation of product design and development;
- product performance;
- cost-effectiveness of products under development;
- effective manufacturing processes; and
- success of promotional efforts.
Additionally, we may also be required to collaborate with third parties to
develop our products and may not be able to do so on a timely and cost-effective
basis, if at all. We have in the past experienced delays in the development of
new products and the enhancement of existing products, and such delays will
likely occur in the future. If we are unable, due to resource constraints or
technological or other reasons, to develop and introduce new or enhanced
products in a timely manner, if such new or enhanced products do not achieve
sufficient market acceptance, or if such new product introductions decrease
demand for existing products, our operating results would decline and our
business would not grow.
THE LONG AND VARIABLE SALES AND DEPLOYMENT CYCLES FOR OUR IP TELEPHONY SOFTWARE
PRODUCTS MAY CAUSE OUR REVENUE AND OPERATING RESULTS TO VARY
Our IP telephony software products, including our hosted iPBX and SCE
products, have lengthy sales cycles, and we may incur substantial sales and
marketing expenses and expend significant management effort
25
28
without making a sale. A customer's decision to purchase our products often
involves a significant commitment of its resources and a lengthy product
evaluation and qualification process. In addition, the length of our sales
cycles will vary depending on the type of customer to whom we are selling and
the product being sold. Even after making the decision to purchase our products,
our customers may deploy our products slowly. Timing of deployment can vary
widely and will depend on various factors, including:
- the size of the network deployment;
- the complexity of our customers' network environments;
- our customers' skill sets;
- the hardware and software configuration and customization necessary to
deploy our products; and
- our customers' ability to finance their purchase of our products.
As a result, it is difficult for us to predict the quarter in which our
customers may purchase our products, and our revenue and operating results may
vary significantly from quarter to quarter.
IF OUR PRODUCTS DO NOT INTEROPERATE WITH OUR CUSTOMERS' NETWORKS, ORDERS FOR OUR
PRODUCTS WILL BE DELAYED OR CANCELED AND SUBSTANTIAL PRODUCT RETURNS COULD
OCCUR, WHICH COULD HARM OUR BUSINESS
Many of the potential customers for our hosted iPBX and unified messaging
products have requested that our products be designed to interoperate with their
existing networks, each of which may have different specifications and use
multiple standards. Our customers' networks may contain multiple generations of
products from different vendors that have been added over time as their networks
have grown and evolved. Our products must interoperate with these products as
well as with future products in order to meet our customers' requirements. In
some cases, we may be required to modify our product designs to achieve a sale,
which may result in a longer sales cycle, increased research and development
expense, and reduced operating margins. If our products do not interoperate with
existing equipment or software in our customers' networks, installations could
be delayed, orders for our products could be canceled or our products could be
returned. This could harm our business, financial condition, and results of
operations.
INTENSE COMPETITION IN THE MARKETS IN WHICH WE COMPETE COULD PREVENT US FROM
INCREASING OR SUSTAINING OUR REVENUE AND PREVENT US FROM ACHIEVING PROFITABILITY
We expect our competitors to continue to improve the performance of their
current products and introduce new products or new technologies. If our
competitors successfully introduce new products or enhance their existing
products, this could reduce the sales or market acceptance of our products and
services, increase price competition or make our products obsolete. To be
competitive, we must continue to invest significant resources in research and
development, sales and marketing, and customer support. We may not have
sufficient resources to make these investments or to make the technological
advances necessary to be competitive, which in turn will cause our business to
suffer.
In addition, our focus on developing a range of technology products,
including semiconductors and related embedded software, hosted iPBX solutions,
and service creation software, places a significant strain on our research and
development resources. Competitors that focus on one aspect of technology, such
as software or semiconductors, may have a considerable advantage over us. In
addition, many of our current and potential competitors have longer operating
histories, are substantially larger, and have greater financial, manufacturing,
marketing, technical, and other resources. For example, certain competitors in
the market for our semiconductor products maintain their own semiconductor
foundries and may therefore benefit from certain capacity, cost and technical
advantages. Many also have greater name recognition and a larger installed base
of products than us. Competition in our markets may result in significant price
reductions. As a result of their greater resources, many current and potential
competitors may be better able than us to initiate and withstand significant
price competition or downturns in the economy. There can be no assurance that we
will be able to continue to compete effectively, and any failure to do so would
harm our business, operating results, and financial condition.
26
29
IF WE DO NOT DEVELOP AND MAINTAIN SUCCESSFUL PARTNERSHIPS FOR IP TELEPHONY
PRODUCTS, WE MAY NOT BE ABLE TO SUCCESSFULLY MARKET OUR SOLUTIONS
We are entering into new market areas and our success is partly dependent
on our ability to forge new marketing and engineering partnerships. IP telephony
communication systems are extremely complex and no single company possesses all
the required technology components needed to build a complete end to end
solution. We will likely need to enter into partnerships to augment our
development programs and to assist us in marketing complete solutions to our
targeted customers. We may not be able to develop such partnerships in the
course of our product development. Even if we do establish the necessary
partnerships, we may not be able to adequately capitalize on these partnerships
to aid in the success of our business.
INABILITY TO PROTECT OUR PROPRIETARY TECHNOLOGY OR OUR INFRINGEMENT OF A THIRD
PARTY'S PROPRIETARY TECHNOLOGY WOULD DISRUPT OUR BUSINESS
We rely in part on trademark, copyright, and trade secret law to protect
our intellectual property in the United States and abroad. We seek to protect
our software, documentation, and other written materials under trade secret and
copyright law, which afford only limited protection. We also rely in part on
patent law to protect our intellectual property in the United States and
internationally. As of March 31, 2001, we held forty (40) United States patents,
including patents relating to programmable integrated circuit architectures,
telephone control arrangements, software structures, and memory architecture
technology, and had a number of United States and foreign patent applications
pending. We cannot predict whether such pending patent applications will result
in issued patents. We may not be able to protect our proprietary rights in the
United States or internationally (where effective intellectual property
protection may be unavailable or limited), and competitors may independently
develop technologies that are similar or superior to our technology, duplicate
our technology or design around any patent of ours. We have in the past licensed
and in the future expect to continue licensing our technology to others; many of
who are located or may be located abroad. There are no assurances that such
licensees will protect our technology from misappropriation. Moreover,
litigation may be necessary in the future to enforce our intellectual property
rights, to determine the validity and scope of the proprietary rights of others,
or to defend against claims of infringement or invalidity. Such litigation could
result in substantial costs and diversion of management time and resources and
could have a material adverse effect on our business and operating results. Any
settlement or adverse determination in such litigation would also subject us to
significant liability.
There has been substantial litigation in the semiconductor, electronics,
and related industries regarding intellectual property rights, and from time to
time third parties may claim infringement by us of their intellectual property
rights. Our broad range of technology, including systems, digital and analog
circuits, software, and semiconductors, increases the likelihood that third
parties may claim infringement by us of their intellectual property rights. If
we were found to be infringing on the intellectual property rights of any third
party, we could be subject to liabilities for such infringement, which could be
material. We could also be required to refrain from using, manufacturing or
selling certain products or using certain processes, either of which could have
a material adverse effect on our business and operating results. From time to
time, we have received, and may continue to receive in the future, notices of
claims of infringement, misappropriation or misuse of other parties' proprietary
rights. There can be no assurance that we will prevail in these discussions and
actions or that other actions alleging infringement by the Company of
third-party patents will not be asserted or prosecuted against the Company.
We rely on certain technology, including hardware and software licensed
from third parties. The loss of, or inability to maintain, existing licenses
could have a material adverse effect on our business and operating results. In
addition, we may be required to license technology from third parties in the
future to develop new products or product enhancements. Third-party licenses may
not be available to us on commercially reasonable terms, if at all. Our
inability to obtain third-party licenses required to develop new products and
product enhancements could require us to obtain substitute technology of lower
quality or performance standards or at a greater cost, any of which could
seriously harm our business, financial condition and operating results.
27
30
CONTINUED REDUCTIONS IN LEVELS OF CAPITAL INVESTMENT BY TELECOMMUNICATION
SERVICE PROVIDERS MIGHT IMPACT OUR ABILITY TO INCREASE REVENUE AND PREVENT US
FROM ACHIEVING PROFITABILITY
The market for the services provided by telecommunication service providers
who compete against traditional telephone companies has only begun to emerge,
and many of these service providers are still building their infrastructure and
rolling out their services. These telecommunication service providers require
substantial capital for the development, construction, and expansion of their
networks and the introduction of their services. Financing may not be available
to emerging telecommunication service providers on favorable terms, if at all.
The inability of our current or potential emerging telecommunication service
provider customers to acquire and keep customers, to successfully raise needed
funds, or to respond to any other trends such as price reductions for their
services or diminished demand for telecommunication services generally, could
adversely affect their operating results or cause them to reduce their capital
spending programs. If our current or potential customers are forced to defer or
curtail their capital spending programs, sales of our hosted iPBX and SCE
products to those telecommunication service providers may be adversely affected,
which would negatively impact our business, financial condition, and results of
operations. In addition, many of the industries in which telecommunication
service providers operate have recently experienced consolidation. The loss of
one or more of our current or potential telecommunication service provider
customers, through industry consolidation or otherwise, could reduce or
eliminate our sales to such a customer and consequently harm our business,
financial condition, and results of operations.
THE FAILURE OF IP NETWORKS TO MEET THE RELIABILITY AND QUALITY STANDARDS
REQUIRED FOR VOICE COMMUNICATIONS COULD RENDER OUR PRODUCTS OBSOLETE
Circuit-switched telephony networks feature very high reliability, with a
guaranteed quality of service. The common standard for reliability of
carrier-grade real-time voice communications is 99.999%, meaning that the
network can be down for only a few minutes per year. In addition, such networks
have imperceptible delay and consistently satisfactory audio quality. Emerging
broadband IP networks, such as LANs, WANs, and the Internet, or emerging last
mile technologies such as cable, DSL, and wireless local loop, may not be used
for telephony unless such networks and technologies can provide reliability and
quality consistent with these standards.
OUR PRODUCTS MUST COMPLY WITH INDUSTRY STANDARDS AND FCC REGULATIONS, AND
CHANGES MAY REQUIRE US TO MODIFY EXISTING PRODUCTS
In addition to reliability and quality standards, the market acceptance of
telephony over broadband IP networks is dependent upon the adoption of industry
standards so that products from multiple manufacturers are able to communicate
with each other. IP telephony products rely heavily on standards such as H.323,
SIP, SGCP, MGCP, H.GCP, and Megaco to interoperate with other vendors'
equipment. There is currently a lack of agreement among industry leaders about
which standard should be used for a particular application, and about the
definition of the standards themselves. We also must comply with certain rules
and regulations of the Federal Communications Commission (FCC) regarding
electromagnetic radiation and safety standards established by Underwriters
Laboratories as well as similar regulations and standards applicable in other
countries. Standards are continuously being modified and replaced. As standards
evolve, we may be required to modify our existing products or develop and
support new versions of our products. The failure of our products to comply, or
delays in compliance, with various existing and evolving industry standards
could delay or interrupt volume production of our IP telephony products, which
would have a material adverse effect on our business, financial condition and
operating results.
FUTURE REGULATION OR LEGISLATION OF THE INTERNET COULD RESTRICT OUR BUSINESS OR
INCREASE OUR COST OF DOING BUSINESS
At present there are few laws or regulations that specifically address
access to or commerce on the Internet, including IP telephony. We are unable to
predict the impact, if any, that future legislation, legal decisions or
regulations concerning the Internet may have on our business, financial
condition, and results of operations. Regulation may be targeted towards, among
other things, assessing access or settlement charges,
28
31
imposing tariffs or imposing regulations based on encryption concerns or the
characteristics and quality of products and services, any of which could
restrict our business or increase our cost of doing business. The increasing
growth of the broadband IP telephony market and popularity of broadband IP
telephony products and services heighten the risk that governments will seek to
regulate broadband IP telephony and the Internet. In addition, large,
established telecommunication companies may devote substantial lobbying efforts
to influence the regulation of the broadband IP telephony market, which may be
contrary to our interests.
WE MAY TRANSITION TO SMALLER GEOMETRY PROCESS TECHNOLOGIES AND HIGHER LEVELS OF
DESIGN INTEGRATION, WHICH COULD DISRUPT OUR BUSINESS
We continuously evaluate the benefits, on an integrated circuit,
product-by-product basis, of migrating to smaller geometry process technologies
in order to reduce costs related to the development and production of our
semiconductors. We believe that the transition of our products to increasingly
smaller geometries will be important for us to remain competitive. We have in
the past experienced difficulty in migrating to new manufacturing processes,
which has resulted and could continue to result in reduced yields, delays in
product deliveries, and increased expense levels. Moreover, we are dependent on
relationships with our foundries and their partners to migrate to smaller
geometry processes successfully. If any such transition is substantially delayed
or inefficiently implemented, we may experience delays in product introductions
and incur increased expenses. As smaller geometry processes become more
prevalent, we expect to integrate greater levels of functionality, as well as
customer and third party intellectual property, into our products. We cannot
predict whether higher levels of design integration or the use of third-party
intellectual property will adversely affect our ability to deliver new
integrated products on a timely basis, or at all.
WE DEPEND ON SUBCONTRACTED MANUFACTURERS TO MANUFACTURE SUBSTANTIALLY ALL OF OUR
PRODUCTS, AND ANY DELAY OR INTERRUPTION IN MANUFACTURING BY THESE CONTRACT
MANUFACTURERS WOULD RESULT IN DELAYED OR REDUCED SHIPMENTS TO OUR CUSTOMERS AND
MAY HARM OUR BUSINESS
We outsource the manufacturing of our semiconductor products to independent
foundries. Our primary semiconductor manufacturer is Taiwan Semiconductor
Manufacturing Corporation (TSMC). While TSMC has been a valuable and capable
supplier, there are no assurances or supply contracts guaranteeing that they
will continue to supply us with our required wafer supply. Furthermore, Taiwan
is always subject to geological or geopolitical disturbances that could
instantly cut off such supply. We also rely on other third party manufacturers
for packaging and testing of our semiconductors.
We do not have long-term purchase agreements with our subcontract
manufacturers or our component suppliers. There can be no assurance that our
subcontract manufacturers will be able or willing to reliably manufacture our
products, in volumes, on a cost effective basis or in a timely manner. For our
semiconductor products, the time to port our technology to another foundry, the
time to qualify the new versions of product, and the cost of this effort as well
as the tooling associated with wafer production would have a material adverse
effect on our business, operating results, and financial condition.
IF WE DISCOVER PRODUCT DEFECTS, WE MAY HAVE PRODUCT-RELATED LIABILITIES WHICH
MAY CAUSE US TO LOSE REVENUES OR DELAY MARKET ACCEPTANCE OF OUR PRODUCTS
Products as complex as those we offer frequently contain errors, defects,
and functional limitations when first introduced or as new versions are
released. We have in the past experienced such errors, defects or functional
limitations. We sell products into markets that are extremely demanding of
robust, reliable, fully functional products. Therefore, delivery of products
with production defects or reliability, quality or compatibility problems could
significantly delay or hinder market acceptance of such products, which could
damage our credibility with our customers and adversely affect our ability to
retain our existing customers and to attract new customers. Moreover, such
errors, defects or functional limitations could cause problems, interruptions,
delays or a cessation of sales to our customers. Alleviating such problems may
require significant expenditures of capital and resources by us. Despite our
testing, our suppliers or our customers may find errors, defects or functional
limitations in new products after commencement of commercial production. This
could result in additional development costs, loss of, or delays in, market
acceptance, diversion of technical and other
29
32
resources from our other development efforts, product repair or replacement
costs, claims by our customers or others against us, or the loss of credibility
with our current and prospective customers.
WE HAVE SIGNIFICANT INTERNATIONAL OPERATIONS, WHICH SUBJECT US TO RISKS THAT
COULD CAUSE OUR OPERATING RESULTS TO DECLINE
Sales to customers outside of the United States represented 63%, 47%, and
43% of total revenues in the fiscal years ended March 31, 2001, 2000, and 1999,
respectively. Specifically, sales to customers in the Asia Pacific region
represented 31%, 24%, and 26% of our total revenues for the fiscal years ended
March 31, 2001, 2000, and 1999, respectively, while sales to customers in Europe
represented 32%, 23%, and 17% of our total revenues for the same periods,
respectively.
Substantially all of our current semiconductor and system-level products
are, and substantially all of our future products will be, manufactured,
assembled, and tested by independent third parties in foreign countries.
International sales and manufacturing are subject to a number of risks,
including general economic conditions in regions such as Asia, changes in
foreign government regulations and telecommunication standards, export license
requirements, tariffs and taxes, other trade barriers, fluctuations in currency
exchange rates, difficulty in collecting accounts receivable, and difficulty in
staffing and managing foreign operations. We are also subject to geopolitical
risks, such as political, social, and economic instability, potential
hostilities, and changes in diplomatic and trade relationships, in connection
with our international operations. A significant decline in demand from foreign
markets could have a material adverse effect on our business, operating results,
and financial condition.
WE NEED TO HIRE AND RETAIN KEY PERSONNEL TO SUPPORT OUR PRODUCTS
The development and marketing of our IP telephony products will continue to
place a significant strain on our limited personnel, management, and other
resources. Competition for highly skilled engineering, sales, marketing, and
support personnel is intense because there are a limited number of people
available with the necessary technical skills and understanding of our market,
particularly in the San Francisco Bay area where we are principally located. Any
failure to attract, assimilate or retain qualified personnel to fulfill our
current or future needs could impair our growth. We currently do not have
employment contracts with nor maintain key person life insurance policies on any
of our employees.
WE ARE INVOLVED IN A LITIGATION MATTER THAT COULD SERIOUSLY HARM OUR FINANCIAL
CONDITION
On April 6, 2001, we, along with Sun Microsystems, Inc., Netscape
Communications Canada Inc., Burntsand Inc., and Intraware Canada Inc., were sued
by Milinx Business Services, Inc. and Milinx Business Group Inc. (collectively,
Milinx) in the Supreme Court of British Columbia, Canada (the Court). Milinx has
alleged that we failed to perform certain contractual obligations and knowingly
misrepresented the capabilities of its products. The lawsuit seeks general,
special, and aggravated damages totaling in excess of Canadian $65 million plus
interest, costs, and any other relief which the Court may choose to provide. We
believe we have valid defenses against the claims alleged by Milinx and intend
to defend this lawsuit vigorously. However, due to the nature of litigation and
because the lawsuit is in the very early pre-discovery stages, we cannot
determine the possible loss, if any, that may ultimately be incurred either in
the context of a trial or a negotiated settlement. Should we not prevail in any
such litigation, our operating results and financial condition could be
adversely impacted.
OUR STOCK PRICE HAS BEEN HIGHLY VOLATILE
The market price of the shares of our common stock has been and is likely
to be highly volatile. It may be significantly affected by factors such as:
- actual or anticipated fluctuations in our operating results;
- announcements of technical innovations;
- loss of key personnel;
30
33
- new products or new contracts by us, our competitors or their customers;
and
- developments with respect to patents or proprietary rights, general
market conditions, changes in financial estimates by securities analysts,
and other factors which could be unrelated to, or outside our control.
The stock market has from time to time experienced significant price and
volume fluctuations that have particularly affected the market prices for the
common stocks of technology companies and that have often been unrelated to the
operating performance of particular companies. These broad market fluctuations
may adversely affect the market price of our common stock. In the past,
following periods of volatility in the market price of a company's securities,
securities class action litigation has often been initiated against the issuing
company. If our stock price is volatile, we may also be subject to such
litigation. Such litigation could result in substantial costs and a diversion of
management's attention and resources, which would disrupt business and could
cause a decline in our operating results. Any settlement or adverse
determination in such litigation would also subject us to significant liability.
THE LOCATION OF OUR HEADQUARTERS FACILITY SUBJECTS US TO THE RISK OF EARTHQUAKES
Our corporate headquarters is located in the San Francisco Bay area of
Northern California, a region known for seismic activity. A significant natural
disaster, such as an earthquake, could have a material adverse impact on our
business, operating results, and financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial market risk consists primarily of risks associated with
international operations and related foreign currencies. We derive a significant
portion of our revenues from customers in Europe and Asia. In order to reduce
the risk from fluctuation in foreign exchange rates, the vast majority of our
sales are denominated in U.S. dollars. In addition, all of our arrangements with
our semiconductor foundry and assembly vendors are denominated in U.S. dollars.
We have foreign subsidiaries and are thus exposed to market risk from changes in
exchange rates. We have not entered into any currency hedging activities. To
date, our exposure to exchange rate volatility has not been significant;
however, there can be no assurance that there will not be a material impact in
the future.
We invest our surplus cash and cash equivalents in money market funds that
bear variable interest rates, and, accordingly, fluctuations in interest rates
do not have an impact on the fair values of such investments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
PAGE
----
FINANCIAL STATEMENTS:
Report of Independent Accountants......................... 32
Consolidated Balance Sheets at March 31, 2001 and 2000.... 33
Consolidated Statements of Operations for each of the
three years in the period ended March 31, 2001......... 34
Consolidated Statements of Stockholders' Equity for each
of the three years in the period ended March 31,
2001................................................... 35
Consolidated Statements of Cash Flows for each of the
three years in the period ended March 31, 2001......... 36
Notes to Consolidated Financial Statements................ 37
FINANCIAL STATEMENT SCHEDULE:
Schedule II -- Valuation and Qualifying Accounts.......... 58
Schedules other than the one listed above have been omitted because they
are inapplicable, because the required information has been included in the
financial statements or notes thereto, or the amounts are immaterial.
31
34
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Netergy Networks, Inc.
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Netergy Networks, Inc. and its subsidiaries at March 31, 2001 and
March 31, 2000, and the results of their operations and their cash flows for
each of the three years in the period ended March 31, 2001 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
San Jose, California
May 4, 2001
32
35
NETERGY NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS
MARCH 31,
---------------------
2001 2000
--------- --------
Current assets:
Cash and cash equivalents................................. $ 24,126 $ 48,576
Accounts receivable, net.................................. 2,907 1,546
Accounts receivable from related party.................... -- 1,000
Inventory................................................. 1,328 1,367
Other current assets...................................... 2,571 891
--------- --------
Total current assets.............................. 30,932 53,380
Property and equipment, net................................. 5,016 2,687
Intangibles and other assets................................ 3,197 3,916
--------- --------
$ 39,145 $ 59,983
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,387 $ 1,887
Accrued compensation...................................... 1,531 2,154
Accrued warranty.......................................... 525 694
Deferred revenue.......................................... 5,903 731
Other accrued liabilities................................. 1,623 1,245
Income taxes payable...................................... 306 384
--------- --------
Total current liabilities......................... 11,275 7,095
Convertible subordinated debentures....................... 6,238 5,498
--------- --------
Total liabilities................................. 17,513 12,593
--------- --------
Commitments and contingencies (Notes 10 and 15)
Stockholders' equity:
Convertible preferred stock, $0.001 par value:
Authorized: 5,000,000 shares;
Issued and outstanding: 1 share at March 31, 2001 and
none at March 31, 2000................................ -- --
Common stock, $0.001 par value:
Authorized: 100,000,000 shares at March 31, 2001 and
40,000,000 at March 31, 2000;
Issued and outstanding: 26,419,919 shares of common
stock and 260,807 Exchangeable Shares at March 31,
2001 and 22,958,921 shares of common stock at March
31, 2000.............................................. 27 23
Additional paid-in capital.................................. 150,015 101,559
Notes receivable from stockholders.......................... (1) (69)
Deferred compensation....................................... (174) (376)
Accumulated other comprehensive loss........................ (89) --
Accumulated deficit......................................... (128,146) (53,747)
--------- --------
Total stockholders' equity........................ 21,632 47,390
--------- --------
$ 39,145 $ 59,983
========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
33
36
NETERGY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED MARCH 31,
--------------------------------
2001 2000 1999
-------- -------- --------
Product revenues........................................... $ 12,808 $ 20,817 $ 26,189
License and other revenues................................. 5,420 4,567 5,493
-------- -------- --------
Total revenues................................... 18,228 25,384 31,682
-------- -------- --------
Cost of product revenues................................... 5,225 8,448 24,199
Cost of license and other revenues......................... 1,761 150 82
-------- -------- --------
Total cost of revenues........................... 6,986 8,598 24,281
-------- -------- --------
Gross profit..................................... 11,242 16,786 7,401
-------- -------- --------
Operating expenses:
Research and development................................. 18,736 11,909 9,922
Selling, general and administrative...................... 18,113 21,307 17,712
In-process research and development...................... 4,563 10,100 --
Amortization of intangibles.............................. 10,987 614 --
Restructuring charge..................................... 33,316 -- --
-------- -------- --------
Total operating expenses......................... 85,715 43,930 27,634
-------- -------- --------
Loss from operations....................................... (74,473) (27,144) (20,233)
Other income, net.......................................... 2,628 2,807 1,009
Interest expense........................................... (1,456) (391) --
-------- -------- --------
Loss before provision for income taxes..................... (73,301) (24,728) (19,224)
Provision for income taxes................................. 17 120 --
-------- -------- --------
Net loss before cumulative effect of change in accounting
principle................................................ (73,318) (24,848) (19,224)
Cumulative effect of change in accounting principle........ (1,081) -- --
-------- -------- --------
Net loss................................................... $(74,399) $(24,848) $(19,224)
======== ======== ========
Net loss before cumulative effect of change in accounting
principle per basic and diluted share.................... $ (2.95) $ (1.38) $ (1.28)
Cumulative effect of change in accounting principle........ (0.04) -- --
-------- -------- --------
Net loss per basic and diluted share....................... $ (2.99) $ (1.38) $ (1.28)
======== ======== ========
Basic and diluted shares outstanding....................... 24,846 18,071 15,018
The accompanying notes are an integral part of these consolidated financial
statements.
34
37
NETERGY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARES)
NOTES
PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLE
--------------- ------------------- PAID-IN FROM DEFERRED
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCKHOLDERS COMPENSATION
------ ------ ---------- ------ ---------- ------------ ------------
Balance at March 31, 1998......... -- $ -- 15,293,614 $15 $ 47,785 $(893) $(744)
Issuance of common stock under
stock plans..................... -- -- 389,823 -- 838 -- --
Repayment of notes receivable from
stockholders.................... -- -- -- -- -- 498 --
Repurchase of unvested common
stock........................... -- -- (257,685) -- (129) 129 --
Deferred compensation related to
stock options................... -- -- -- -- (131) -- 547
Change in unrealized loss on
investments..................... -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- --
Total comprehensive loss.......... -- -- -- -- -- -- --
---- ---- ---------- --- -------- ----- -----
Balance at March 31, 1999......... -- -- 15,425,752 15 48,363 (266) (197)
Acquisition of Odisei S.A. ....... -- -- 2,988,646 3 13,264 (76) --
Issuance of common stock to
STMicroelectronics, net......... -- -- 3,700,000 4 35,089 -- --
Issuance of warrants with
convertible subordinated
debentures...................... -- -- -- -- 2,467 -- --
Issuance of common stock under
stock plans..................... -- -- 906,119 1 2,079 -- --
Repayment of notes receivable from
stockholders.................... -- -- -- -- -- 240 --
Repurchase of common stock........ -- -- (61,596) -- (43) 33 --
Deferred compensation related to
stock options................... -- -- -- -- 340 -- (179)
Realized loss on investments...... -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- --
Total comprehensive loss.......... -- -- -- -- -- -- --
---- ---- ---------- --- -------- ----- -----
Balance at March 31, 2000......... -- -- 22,958,921 23 101,559 (69) (376)
Acquisition of UForce, Inc. ...... 1 -- 3,555,303 4 44,584 -- --
Issuance of common stock under
stock plans..................... -- -- 1,206,591 1 2,761 -- --
Repayment of notes receivable from
stockholders.................... -- -- -- -- -- 60 --
Repurchase of common stock and
Exchangeable Shares............. -- -- (1,040,089) (1) (521) 8 --
Deferred compensation related to
stock options................... -- -- -- -- 551 -- 202
Value of beneficial conversion
feature associated with the
convertible subordinated
debentures...................... -- -- -- -- 1,081 -- --
Change in unrealized loss on
investments..................... -- -- -- -- -- -- --
Cumulative translation
adjustment...................... -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- --
Total comprehensive loss.......... -- -- -- -- -- -- --
---- ---- ---------- --- -------- ----- -----
Balance at March 31, 2001......... 1 $ -- 26,680,726 $27 $150,015 $ (1) $(174)
==== ==== ========== === ======== ===== =====
ACCUMULATED
OTHER
COMPREHENSIVE ACCUMULATED
LOSS DEFICIT TOTAL
------------- ----------- --------
Balance at March 31, 1998......... $ (45) $ (9,675) $ 36,443
Issuance of common stock under
stock plans..................... -- -- 838
Repayment of notes receivable from
stockholders.................... -- -- 498
Repurchase of unvested common
stock........................... -- -- --
Deferred compensation related to
stock options................... -- -- 416
Change in unrealized loss on
investments..................... (148) --
Net loss.......................... -- (19,224)
Total comprehensive loss.......... -- -- (19,372)
----- --------- --------
Balance at March 31, 1999......... (193) (28,899) 18,823
Acquisition of Odisei S.A. ....... -- -- 13,191
Issuance of common stock to
STMicroelectronics, net......... -- -- 35,093
Issuance of warrants with
convertible subordinated
debentures...................... -- -- 2,467
Issuance of common stock under
stock plans..................... -- -- 2,080
Repayment of notes receivable from
stockholders.................... -- -- 240
Repurchase of common stock........ -- -- (10)
Deferred compensation related to
stock options................... -- -- 161
Realized loss on investments...... 193 --
Net loss.......................... -- (24,848)
Total comprehensive loss.......... -- -- (24,655)
----- --------- --------
Balance at March 31, 2000......... -- (53,747) 47,390
Acquisition of UForce, Inc. ...... -- -- 44,588
Issuance of common stock under
stock plans..................... -- -- 2,762
Repayment of notes receivable from
stockholders.................... -- -- 60
Repurchase of common stock and
Exchangeable Shares............. -- -- (514)
Deferred compensation related to
stock options................... -- -- 753
Value of beneficial conversion
feature associated with the
convertible subordinated
debentures...................... -- -- 1,081
Change in unrealized loss on
investments..................... (24) --
Cumulative translation
adjustment...................... (65) --
Net loss.......................... -- (74,399)
Total comprehensive loss.......... -- -- (74,488)
----- --------- --------
Balance at March 31, 2001......... $ (89) $(128,146) $ 21,632
===== ========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
35
38
NETERGY NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED MARCH 31,
--------------------------------
2001 2000 1999
-------- -------- --------
Cash flows from operating activities:
Net loss.................................................. $(74,399) $(24,848) $(19,224)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 14,355 2,118 967
Stock compensation expense.............................. 753 161 416
Cumulative effect of change in accounting principle..... 1,081 -- --
In-process research and development..................... 4,563 10,100 --
Discount on issuance of common stock.................... -- 7,400 --
Gain on sale of investments, net........................ (225) (1,687) --
Non-cash restructuring charges.......................... 32,331 -- --
Other................................................... (20) -- (148)
Changes in assets and liabilities, net of effects of
businesses acquired
and sold:
Accounts receivable....................................... 851 3,492 (1,359)
Inventory, net............................................ (85) 2,548 8,843
Other current and noncurrent assets....................... (1,281) (96) 102
Accounts payable.......................................... (2,197) (71) (708)
Accrued compensation...................................... (623) 583 (209)
Accrued warranty.......................................... (169) (349) (418)
Deferred revenue.......................................... 197 (3,358) 1,642
Other accrued liabilities................................. 378 (48) (197)
Income taxes payable...................................... (78) (27) (125)
-------- -------- --------
Net cash used in operating activities.............. (24,568) (4,082) (10,418)
-------- -------- --------
Cash flows from investing activities:
Acquisitions of property and equipment.................... (6,127) (1,693) (1,760)
Cash paid for acquisitions, net........................... (558) (149) --
Proceeds from sale of investment.......................... 225 1,880 --
Proceeds from the sale of video monitoring assets, net.... 5,160 -- --
Other..................................................... -- -- (25)
-------- -------- --------
Net cash provided by (used in) investing
activities....................................... (1,300) 38 (1,785)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of convertible subordinated
debentures.............................................. -- 7,500 --
Debt issuance costs....................................... -- (617) --
Debt repayments........................................... (891) -- --
Proceeds from issuance of common stock, net............... 2,763 29,763 838
Repayment of notes receivable from stockholders........... 60 240 498
Repurchase of common stock and Exchangeable Shares........ (514) (76) --
-------- -------- --------
Net cash provided by financing activities.......... 1,418 36,810 1,336
-------- -------- --------
Net increase (decrease) in cash and cash equivalents........ (24,450) 32,766 (10,867)
Cash and cash equivalents, beginning of year................ 48,576 15,810 26,677
-------- -------- --------
Cash and cash equivalents, end of year...................... $ 24,126 $ 48,576 $ 15,810
======== ======== ========
Supplemental disclosures:
Income taxes paid......................................... $ 25 $ 34 $ 126
======== ======== ========
Interest paid............................................. $ 308 $ -- $ --
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
36
39
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
Netergy Networks, Inc. and its subsidiaries (collectively, the Company or
Netergy) develop and market telecommunication technology for Internet Protocol
(IP) telephony and video applications. The Company has three product lines:
voice and video semiconductors and related software, hosted Internet Private
Branch Exchange (iPBX) solutions, and Voice-over-IP (VoIP) service creation
software.
During the fiscal year ended March 31, 2001, the Company formed two
subsidiaries, Netergy Microelectronics, Inc. (NME) and Centile, Inc. (Centile)
and reorganized its operations more clearly along its three product lines. NME
provides voice and video semiconductors and related communication software to
original equipment manufacturers (OEMs) of telephones, terminal adapters, and
other edge devices and to other semiconductor companies. NME's technologies are
used to make IP telephones and to voice-enable cable and digital subscriber line
(DSL) modems, wireless devices, and other broadband technologies. Centile
develops and markets hosted iPBX solutions that allow service providers to offer
private branch exchange (PBX) functionality to small and medium-sized businesses
over broadband networks. The Company is developing its third product line, a
VoIP service creation environment (SCE), at the parent company level. This
product is designed for use by telecommunication equipment manufacturers and
service providers.
The Company was incorporated in California in February 1987 and in December
1996 was reincorporated in Delaware. In August 2000 the Company changed its name
from 8x8, Inc. to Netergy Networks, Inc.
FISCAL YEAR
Effective beginning in fiscal 2001, the Company changed its fiscal year
from a year ending on the Thursday closest to March 31 to a year ending on March
31. Fiscal 2001 was 52 weeks and 2 days, while fiscal 2000 and fiscal 1999 were
53 week and 52 week years, respectively. For purposes of these consolidated
financial statements, the Company has indicated its fiscal year ends on March
31.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany accounts and transactions
have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
Product revenue -- The Company recognizes revenue from product sales upon
shipment to OEMs and end users. Reserves for returns and allowances for OEM and
end user sales are recorded at the time of shipment. The Company defers
recognition of revenue on sales to distributors where the right of return exists
until products are resold by the distributor to the end user.
License and other revenue -- The Company recognizes revenue from license
contracts when a non-cancelable, non-contingent license agreement has been
signed, the software product has been delivered, no uncertainties exist
surrounding product acceptance, fees from the agreement are fixed and
determinable, and collection is probable. The Company uses the residual method
to recognize revenue when a license agreement
37
40
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
includes one or more elements to be delivered at a future date if evidence of
the fair value of all undelivered elements exists. If evidence of the fair value
of the undelivered elements does not exist, revenue is deferred and recognized
when delivery occurs. When the Company enters into a license agreement requiring
that the Company provide significant customization of the software products, the
license and consulting revenue is recognized using contract accounting. Revenue
from maintenance agreements is recognized ratably over the term of the
maintenance agreement, which in most instances is one year. The Company
recognizes royalties upon notification of sale by its licensees. Revenue from
consulting, training, and development services is recognized as the services are
performed.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on applying generally accepted accounting
principles to revenue recognition issues in financial statements. The Company
adopted SAB 101 in the fiscal quarter ended March 31, 2001. The adoption of SAB
101 did not have a significant impact on the Company's revenue recognition
practices.
CASH, CASH EQUIVALENTS, AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Management determines
the appropriate classification of debt and equity securities at the time of
purchase and reevaluates the classification at each reporting date. The cost of
the Company's investments is determined based upon specific identification.
At March 31, 2001, the Company classified $388,000 of its investments,
consisting of marketable equity securities, as available-for-sale. The
investments are recorded in Other Current Assets in the Consolidated Balance
Sheets. Investments classified as available-for-sale are reported at fair value,
based upon quoted market prices, with unrealized gains and losses, net of
related tax, if any, included in Accumulated Other Comprehensive Loss in the
Consolidated Balance Sheet. Realized losses on investments classified as
available for sale were approximately $205,000 during the year ended March 31,
2000. Realized and unrealized gains and losses for all other investments were
not significant for the years ended March 31, 2001, 2000, and 1999.
INVENTORY
Inventory is stated at the lower of standard cost, which approximates
actual cost using the first-in, first-out method, or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed using the straight-line
method, based upon the shorter of the estimated useful lives, ranging from three
to five years, or the lease term of the respective assets as follows:
Machinery and computer equipment.... 3 years
Furniture and fixtures.............. 5 years
Licensed software................... 3 years
Leasehold improvements.............. Shorter of lease term or useful life
of the asset
Maintenance, repairs and ordinary replacements are charged to expense;
expenditures for improvements that extend the physical or economic life of the
property are capitalized. Gains or losses on the disposition of property and
equipment are reflected in income.
38
41
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangible assets are amortized using the straight-line
method over lives of two to five years. The Company periodically evaluates
whether events and circumstances have occurred that indicate the remaining
estimated useful life of goodwill and other intangible assets may warrant
revision or that the remaining balance may not be recoverable. When factors
indicate that goodwill and other intangible assets should be evaluated for
possible impairment, the Company uses an estimate of undiscounted future net
cash flows over the remaining life of the asset to determine if impairment has
occurred. Assets are grouped at the lowest level for which there are
identifiable cash flows that are largely independent from other asset groups. An
impairment in the carrying value of an asset is assessed when the undiscounted,
expected future operating cash flows derived from the asset are less than its
carrying value. If the Company determines an asset has been impaired, the
impairment is recorded based on the fair value of the impaired asset. See Note 4
regarding the charge for impairment of intangible assets recorded in the fourth
quarter of fiscal 2001. As of March 31, 2001, accumulated amortization of
intangible assets was approximately $1.4 million.
WARRANTY EXPENSE
The Company accrues for the estimated cost that may be incurred under its
product warranties upon revenue recognition.
RESEARCH AND SOFTWARE DEVELOPMENT COSTS
Research and development costs are charged to operations as incurred.
Software development costs incurred prior to the establishment of technological
feasibility are included in research and development and are expensed as
incurred. The Company defines establishment of technological feasibility as the
completion of a working model. Software development costs incurred subsequent to
the establishment of technological feasibility through the period of general
market availability of the product are capitalized, if material. To date, all
software development costs have been expensed as incurred.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of the Company's foreign subsidiaries are translated
from their respective functional currencies at exchange rates in effect at the
balance sheet date, and revenues and expenses are translated at average exchange
rates prevailing during the year. If the functional currency is the local
currency, resulting translation adjustments are reflected as a separate
component of stockholders' equity. If the functional currency is the United
States (U.S.) dollar, resulting conversion adjustments are included in the
results of operations. Foreign currency transaction gains and losses, which have
been immaterial, are included in results of operations. Total assets of the
Company's foreign subsidiaries were $3.8 million, $1.6 million, and $656,000 as
of March 31, 2001, 2000, and 1999, respectively. The Company does not undertake
any foreign currency hedging activities.
INCOME TAXES
Income taxes are accounted for using the asset and liability approach.
Under the asset and liability approach, a current tax liability or asset is
recognized for the estimated taxes payable or refundable on tax returns for the
current year. A deferred tax liability or asset is recognized for the estimated
future tax effects attributed to temporary differences and carryforwards. If
necessary, the deferred tax assets are reduced by the amount of benefits that,
based on available evidence, are not expected to be realized.
39
42
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
TAX CREDITS
Research and development and other tax credits are accounted for using the
cost reduction method. Under this method, tax credits relating to eligible
expenditures are accounted for as a reduction of related expenses in the period
during which the expenditures are incurred, provided there is reasonable
assurance of realization.
CONCENTRATIONS
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents
and trade accounts receivable. At March 31, 2001, approximately 96% of the
Company's cash equivalents were placed in an institutional money market fund of
a reputable, U.S. based financial institution. The Company has not experienced
any material losses relating to any investment instruments. The Company sells
its products to OEMs and distributors throughout the world. The Company performs
ongoing credit evaluations of its customers' financial condition, and for
certain transactions does require collateral from its customers. For each of the
three years ended March 31, 2001, the Company experienced minimal write-offs for
bad debts and doubtful accounts. At March 31, 2001, two customers accounted for
23% and 12% of accounts receivable, respectively. At March 31, 2000, two
customers accounted for 16% and 14% of accounts receivable, respectively.
The Company outsources the manufacturing, packaging, and testing of its
semiconductor products to independent foundries. The inability of any
manufacturer to fulfill supply requirements of the Company could materially
impact future operating results.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments is determined by the
Company, using available market information and valuation methodologies
considered to be appropriate The carrying amounts of the Company's cash
equivalents and accounts receivable approximate their fair values due to their
short maturity. The fair value of the Company's convertible subordinated
debentures (see Note 9) of approximately $6.9 million has been estimated using
discounted cash flow analysis, based on the incremental borrowing rate currently
available to the Company for debt with similar terms and maturity.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for employee stock-based compensation in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB Opinion No. 25). In March 2000, the Financial Accounting
Standards Board (FASB) issued Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation (an Interpretation of APB Opinion No.
25)," (FIN 44), which became effective July 1, 2000. The adoption of the
provisions of FIN 44 did not have a material impact on the Company's
consolidated financial position or results of operations. As required under
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," (SFAS 123) the Company provides pro forma disclosure
of net income and earnings per share.
COMPREHENSIVE LOSS
Comprehensive loss, as defined, includes all changes in equity (net assets)
during a period from non-owner sources. The difference between net loss and
comprehensive loss is due primarily to unrealized losses on short-term
investments classified as available-for-sale and foreign currency translation
adjustments. Comprehensive loss is reflected in the Consolidated Statements of
Stockholders' Equity.
40
43
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform with the
current year presentation.
NET LOSS PER SHARE
Basic net loss per share is computed by dividing net loss available to
common stockholders (numerator) by the weighted average number of vested,
unrestricted common and Exchangeable Shares (see Note 3) outstanding during the
period (denominator). Diluted net loss per share is computed using the weighted
average number of common shares and potential common shares outstanding during
the period. Potential common shares result from the assumed exercise, using the
treasury stock method, of common stock options, convertible subordinated
debentures, warrants, and unvested, restricted common stock having a dilutive
effect. The numerators for each period presented are equal to the reported net
loss. Additionally, due to net losses incurred for all periods presented,
weighted average basic and diluted shares outstanding for the respective periods
are the same. The following equity instruments were not included in the
computations of net loss per share because the effect on the calculations would
be anti-dilutive (in thousands):
MARCH 31,
-----------------------
2001 2000 1999
----- ----- -----
Common stock options........................................ 7,732 4,174 3,430
Warrants.................................................... 701 701 --
Convertible subordinated debentures......................... 638 638 --
Unvested restricted common stock............................ 30 516 143
----- ----- -----
9,101 6,029 3,573
===== ===== =====
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133 (SFAS 133), "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes methods of
accounting for derivative financial instruments and hedging activities related
to those instruments, as well as other hedging activities. The Company is
required to adopt SFAS 133 in its first quarter of fiscal 2002 pursuant to the
issuance of SFAS 137, "Accounting for Derivative Instruments and Hedging
Activities -- Deferral of the Effective Date of FASB Statement No. 133," which
deferred the effective date of SFAS 133 by one year. In June 2000, the FASB
issued SFAS No. 138 (SFAS 138), "Accounting for Certain Derivative Instruments
and Certain Hedging Activities -- an amendment of FASB statement No. 133," which
amends certain terms and conditions of SFAS 133. The Company does not expect
that the adoption of SFAS 133, as amended, will have a material impact on its
consolidated financial statements.
41
44
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 -- BALANCE SHEET COMPONENTS
MARCH 31,
------------------
2001 2000
------- -------
(IN THOUSANDS)
Accounts receivable...................................... $ 3,296 $ 1,988
Less: allowance for doubtful accounts.................. (389) (442)
------- -------
$ 2,907 $ 1,546
======= =======
Inventories:
Raw materials.......................................... $ 213 $ 65
Work-in-process........................................ 783 797
Finished goods......................................... 332 505
------- -------
$ 1,328 $ 1,367
======= =======
Property and equipment:
Machinery and computer equipment....................... $ 7,987 $ 4,841
Furniture and fixtures................................. 1,311 1,230
Licensed software...................................... 4,185 3,544
Leasehold improvements................................. 1,018 644
------- -------
14,501 10,259
Less: accumulated depreciation and amortization.......... (9,485) (7,572)
------- -------
$ 5,016 $ 2,687
======= =======
NOTE 3 -- ACQUISITIONS
U/Force, Inc.
The Company's consolidated financial statements reflect the purchase
acquisition of all of the outstanding stock of U/Force, Inc. (U/Force) on June
30, 2000 for a total purchase price of $46.8 million. U/Force, based in
Montreal, Canada, was a developer of IP-based software applications and a
provider of professional services. U/Force was also developing a Java-based
service creation environment (SCE) that is designed to allow telecommunication
service providers to develop, deploy, and manage telephony applications and
services to their customers. The purchase price was comprised of Netergy common
stock with a fair value of approximately $38.0 million comprised of: (i)
1,447,523 shares issued at closing of the acquisition, and (ii) 2,107,780 shares
to be issued upon the exchange or redemption of the exchangeable shares (the
Exchangeable Shares) of Canadian entities held by former employee shareholders
or indirect owners of U/Force stock. The Exchangeable Shares held by U/Force
employees are subject to certain restrictions, including the Company's right to
repurchase the Exchangeable Shares if an employee departs prior to vesting. See
Note 11 regarding the repurchase of certain of the Exchangeable Shares in the
fourth quarter of fiscal 2001. In addition, the Company also agreed to issue one
share of preferred stock (the Special Voting Share) that provides holders of
Exchangeable Shares with voting rights that are equivalent to the shares of
common stock into which their shares are convertible. Netergy also assumed
outstanding stock options to purchase 1,023,898 shares of U/Force common stock
for which the Black-Scholes option-pricing model value of approximately $6.6
million was included in the purchase price. Direct transaction costs related to
the merger were approximately $747,000. Additionally, the Company advanced $1.5
million to U/Force upon signing the agreement, but prior to the close of the
transaction. This amount was accounted for as part of the purchase price.
The purchase price was allocated to tangible assets acquired and
liabilities assumed based on the book value of U/Force's assets and liabilities,
which approximated their fair value. In addition, the Company engaged an
independent appraiser to value the intangible assets, including amounts
allocated to U/Force's in-
42
45
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
process research and development. The in-process research and development
related to U/Force's initial products, the SCE and a unified messaging
application, for which technological feasibility had not been established and
the technology had no alternative future use. The estimated percentage complete
for the unified messaging and SCE products was approximately 44% and 34%,
respectively, at June 30, 2000. The fair value of the in-process technology was
based on a discounted cash flow model, similar to the traditional "Income
Approach," which discounts expected future cash flows to present value, net of
tax. In developing cash flow projections, revenues were forecasted based on
relevant factors, including aggregate revenue growth rates for the business as a
whole, characteristics of the potential market for the technology, and the
anticipated life of the technology. Projected annual revenues for the in-process
research and development projects were assumed to ramp up initially and decline
significantly at the end of the in-process technology's economic life. Operating
expenses and resulting profit margins were forecasted based on the
characteristics and cash flow generating potential of the acquired in-process
technologies. Risks that were considered as part of the analysis included the
scope of the efforts necessary to achieve technological feasibility, rapidly
changing customer markets, and significant competitive threats from numerous
companies. The Company also considered the risk that if the products were not
brought to market in a timely manner, it could adversely affect sales and
profitability of the combined company in the future. The resulting estimated net
cash flows were discounted at a rate of 25%. This discount rate was based on the
estimated cost of capital plus an additional discount for the increased risk
associated with in-process technology. Based on the independent appraisal, the
value of the acquired U/Force in-process research and development, which was
expensed in the second quarter of fiscal 2001, approximated $4.6 million. The
excess of the purchase price over the net tangible and intangible assets
acquired and liabilities assumed was allocated to goodwill. Amounts allocated to
goodwill, the value of an assumed distribution agreement, and workforce were
being amortized on a straight-line basis over three, three, and two years,
respectively. The allocation of the purchase price was as follows (in
thousands):
In-process research and development........................ $ 4,563
Distribution agreement..................................... 1,053
Workforce.................................................. 1,182
U/Force net tangible assets................................ 1,801
Goodwill................................................... 38,236
-------
$46,835
=======
The consolidated results of the Company include the results of the
operations of U/Force from the date of the acquisition, June 30, 2000, the
beginning of our second quarter of fiscal 2001. The following unaudited pro
forma consolidated amounts give effect to the acquisition of U/Force as if it
had occurred at the beginning of each of fiscal 2001 and 2000 (in thousands,
except per share data):
YEAR ENDED MARCH 31,
--------------------
2001 2000
-------- --------
Revenue.......................................... $18,765 $25,874
Net loss......................................... $74,949 $41,155
Net loss per share............................... $ 2.97 $ 2.05
The above unaudited pro forma consolidated amounts are not necessarily
indicative of the actual results of operations that would have been reported if
the acquisition had actually occurred as of the beginning of the periods
described above, nor does such information purport to indicate the results of
our future operations. In the opinion of management, all adjustments necessary
to present fairly such pro forma amounts have been made.
43
46
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Odisei S.A.
On May 24, 1999, the Company acquired Odisei S.A. (Odisei), a privately
held, development stage company based in Sophia Antipolis, France, that was
developing software for managing voice-over IP networks. The consolidated
financial statements reflect the acquisition of Odisei for approximately
2,868,000 shares of the Company's common stock and approximately 121,000 of
contingent shares, which were subsequently issued to Odisei employee
shareholders in March 2000. Approximately 30,000 of the shares issued to Odisei
employees are subject to repurchase as of March 31, 2001 if the employee departs
prior to vesting. The purchase price was approximately $13.6 million, which
includes approximately $295,000 of acquisition-related costs. The purchase price
was allocated to tangible assets acquired and liabilities assumed based on the
book value of Odisei's current assets and liabilities, which approximated their
fair value. In addition, the Company engaged an independent appraiser to value
the intangible assets, including amounts allocated to Odisei's in-process
research and development. The in-process research and development related to
Odisei's initial product for which technological feasibility had not been
established and was estimated to be approximately 60% complete. The fair value
of the in-process technology was based on a discounted cash flow model, which
discounted expected future cash flows to present value, net of tax. In
developing cash flow projections, revenues were forecasted based on relevant
factors, including aggregate revenue growth rates for the business as a whole,
characteristics of the potential market for the technology, and the anticipated
life of the technology. Projected annual revenues for the in-process research
and development projects were assumed to ramp up initially and decline
significantly at the end of the in-process technology's economic life. Operating
expenses and resulting profit margins were forecasted based on the
characteristics and cash flow generating potential of the acquired in-process
technology. Associated risks include the inherent difficulties and uncertainties
in completing the project and thereby achieving technological feasibility, and
risks related to the impact of potential changes in market conditions and
technology. The resulting estimated net cash flows were discounted at a rate of
27%. This discount rate was based on the estimated cost of capital plus an
additional discount for the increased risk associated with in-process
technology. Based on the independent appraisal, the value of the acquired Odisei
in-process research and development, which was expensed in the fiscal year ended
March 31, 2000, was $10.1 million. The excess of the purchase price over the net
tangible and intangible assets acquired and liabilities assumed was allocated to
goodwill. The allocation of the purchase price consisted of the following (in
thousands):
In-process research and development........................ $10,100
Workforce.................................................. 200
Net tangible liabilities................................... (219)
Goodwill................................................... 3,481
-------
$13,562
=======
The Company's Consolidated Statement of Operations for the fiscal year
ended March 31, 2000 includes the results of Odisei from the date of
acquisition. Had the acquisition taken place as of the beginning of either
fiscal 2000 or fiscal 1999, the pro forma net loss for both periods would have
been substantially the same.
NOTE 4 -- RESTRUCTURING CHARGES
During the fourth quarter of fiscal 2001, after a significant number of
employees had resigned, the Company discontinued its Canadian operations
acquired in conjunction with the acquisition of U/Force in June 2000. The
Company closed its offices in Montreal and Hull, Quebec and laid-off all
remaining employees resulting in the cessation of most of the research and
development efforts and all of the sales and marketing and professional services
activities associated with the U/Force business. As a result of the
restructuring, the
44
47
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Company recorded a one-time charge of $33.3 million in the quarter ended March
31, 2001. The restructuring charges consisted of the following (in thousands):
Employee separation........................................ $ 765
Fixed asset losses and impairments......................... 2,084
Intangible asset impairments............................... 30,247
Lease obligation and termination........................... 220
-------
$33,316
=======
Employee separation costs represent severance payments related to the 96
employees in the Montreal and Hull offices who were laid-off.
The impairment charges for fixed assets approximated $2.1 million which
included write-offs of abandoned and unusable assets of approximately $1.4
million, a loss on sale of assets of $567,000, and a charge for assets to be
disposed of $172,000. The asset write-offs of $1.4 million included
approximately $850,000 related to leasehold improvements and $560,000 related to
computer equipment, furniture, and software. The loss on sale of assets of
$567,000 was attributable to the sale of office, computer, and other equipment
of the Montreal office. The Company received common stock of the purchaser
valued at approximately $412,000 at the date of sale. This common stock has been
accounted for as an available-for-sale security and included in Other Current
Assets. Fair value of assets to be disposed was measured based on expected
salvage value, less costs to sell. Assets to be disposed of consist of computer
equipment with a fair value of $57,000 at March 31, 2001. These assets are
expected to be sold or abandoned, depending on re-sale market conditions, within
the next six to twelve months.
The impairment charges for intangible assets represent the write-off of the
unamortized intangible assets recorded in connection with the acquisition of
U/Force. The charges of approximately $30.2 million included: $28.7 million for
the goodwill related to the acquisition, $739,000 for the assembled workforce,
and $789,000 related to a distribution agreement. The impairments were directly
attributable to the cessation of operations in Canada. The Company performed an
evaluation of the recoverability of the intangible assets related to these
operations in accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The lack of
estimated future net cash flows related to the acquired products necessitated an
impairment charge to write-off the remaining unamortized goodwill. The
distribution agreement asset was written off because the Company will no longer
provide products and services to customers under that agreement.
In March 2001 the Company terminated the lease for its primary facility in
Montreal. Pursuant to the lease termination agreement, the Company is obligated
to pay rent on its Montreal facility through May 31, 2001. The Company recorded
charges for these rental obligations as well as the related lease termination
costs. The Company is actively seeking a third-party to sublet its vacant
facility in Hull, Quebec, and has recorded a charge for estimated lease
termination and related costs.
At March 31, 2001 the remaining accrued obligations associated with the
above-referenced restructuring charges were approximately $212,000 and consisted
of obligations related to the leases.
NOTE 5 -- DISPOSITION OF VIDEO MONITORING BUSINESS
On May 19, 2000, the Company entered into an Asset Purchase Agreement with
Interlogix, Inc. (Interlogix) providing for the sale of certain assets
comprising the Company's video monitoring business (the Business) to Interlogix.
The assets sold included certain accounts receivable, inventories, technical
information, machinery, equipment, contract rights, intangibles, records, and
supplies. Concurrently with the execution of the Asset Purchase Agreement, the
Company and Interlogix entered into a Technology License Agreement (the License
Agreement) providing for the licensing of certain related intellectual property
to
45
48
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Interlogix, a Development Agreement providing Interlogix continuing rights in
certain products to be developed by the Company, a Transition Services Agreement
providing for certain services to be rendered by the Company to Interlogix in
respect of the Business, and a Supply Agreement providing for the continuing
sale of certain products to Interlogix by the Company (collectively, the
Agreements). The aggregate purchase price paid by Interlogix was approximately
$5.2 million in cash.
At the signing of the Agreements the Company's continuing obligations
included: (i) providing future updates and upgrades to the licensed technology,
if any, over the initial three-year term of the License Agreement, (ii) certain
warranty obligations related to video monitoring products manufactured prior to
May 19, 2000, and (iii) certain potential obligations under the Development
Agreement (the Development Obligations). The Company deferred the recognition of
the $3.9 million net gain from the transaction until the satisfactory completion
of the Development Obligations. Due to the expiration of the period for
completion of the Development Obligations, in the fourth quarter of fiscal 2001
the Company commenced recognition of the resulting net gain, the balance of
which is included in Deferred Revenue in the Consolidated Balance Sheet at March
31, 2001. The remaining net gain will be recognized to income over the remaining
term of the License Agreement, which expires in May 2003.
NOTE 6 -- STRATEGIC RELATIONSHIP WITH STMICROELECTRONICS
During the fourth quarter of fiscal 2000, the Company sold 3.7 million
shares of its common stock to STMicroelectronics NV (STM) at a purchase price of
$7.50 per share. In addition, the Company granted STM the right to a seat on the
Company's Board of Directors as long as it holds at least 10% of the Company's
outstanding shares. STM will have certain rights to maintain its percentage
ownership interest of the Company's outstanding voting securities provided,
however, that its total percentage ownership of the outstanding voting stock of
the Company shall not exceed 19.9%. The Company also granted to STM a
non-exclusive, royalty-bearing license to certain technology and has undertaken
certain joint development activities with a subsidiary of STM. Under the terms
of the agreement, STM guaranteed certain minimum payments to the Company
totaling $1.0 million for prepaid royalties and certain non-recurring
engineering services (the Minimum Payments). The Company received the Minimum
Payments in fiscal 2001.
Net proceeds from the sale of stock were $27.7 million, representing a
discount of approximately $7.4 million from the $35.1 million fair market value
of the stock on the date of the agreement. The discount, less the Minimum
Payments, was reflected in the fiscal 2000 Consolidated Statements of Operations
with a charge of $6.4 million to Selling, General, and Administrative Expense.
NOTE 7 -- TRANSACTIONS WITH RELATED PARTIES
The Company purchased $956,000 of components from Sanyo Semiconductor
Corporation (Sanyo) and an affiliate of Sanyo during the fiscal year ended March
31, 1999. An executive of Sanyo served on the Company's Board of Directors
through July 15, 1999.
During fiscal 2001, 2000, and 1999, the Company paid a member of the Board
of Directors approximately $22,000, $41,000, and $85,000, respectively, for
technical consulting services provided on behalf of the Company.
During fiscal 2001, the Company contributed $150,000 to a research program
of a major university which is managed by a director of the Company.
46
49
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8 -- INCOME TAXES
The Company's loss before income taxes includes $162,000, $160,500, and
$105,000 of foreign subsidiary income for the fiscal years ended March 31, 2001,
2000, and 1999, respectively. The components of the consolidated provision for
income taxes consisted of the following (in thousands):
YEAR ENDED MARCH 31,
--------------------
2001 2000 1999
---- ---- ----
Current:
Federal............................................. $ -- $ -- $(26)
State............................................... -- -- --
Foreign............................................. 17 120 26
---- ---- ----
$ 17 $120 $ --
==== ==== ====
Deferred tax assets are comprised of the following (in thousands):
MARCH 31,
--------------------
2001 2000
-------- --------
Research and development credit carryforwards.......... $ 4,455 $ 2,982
Net operating loss carryforwards....................... 22,625 11,678
Inventory valuation.................................... 650 1,104
Reserves and allowances................................ 1,181 697
Goodwill............................................... 15,584 --
Other.................................................. 3,155 2,162
-------- --------
47,650 18,623
Valuation allowance.................................... (47,650) (18,623)
-------- --------
Total........................................ $ -- $ --
======== ========
Management believes that, based on a number of factors, the weight of
objective available evidence indicates that it is more likely than not that the
Company will not be able to realize its deferred tax assets, and thus a full
valuation allowance was recorded at March 31, 2001 and March 31, 2000.
At March 31, 2001, the Company had net operating loss carryforwards for
federal and state income tax purposes of approximately $61.4 million and $38.7
million, respectively, which expire at various dates beginning in 2005. The net
operating loss carryforwards include approximately $4.3 million resulting from
employee exercises of non-qualified stock options or disqualifying dispositions
the tax benefits of which, when realized, will be accounted for as an addition
to additional paid-in capital rather than as a reduction of the provision for
income taxes. In addition, at March 31, 2001, the Company had research and
development credit carryforwards for federal and state tax reporting purposes of
approximately $2.9 million and $2.1 million, respectively. The federal credit
carryforwards will begin expiring in 2010 while the California credit will
carryforward indefinitely. Under applicable tax laws, the amount of and benefits
from net operating losses and credits that can be carried forward may be
impaired or limited in certain circumstances. Events which may cause limitations
in the amount of net operating loss carryforwards that the Company may utilize
in any one year include, but are not limited to, a cumulative ownership change
of more than 50% over a three year period.
47
50
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A reconciliation of the tax provision to the amounts computed using the
statutory U.S. federal income tax rate of 34% is as follows (in thousands):
YEAR ENDED MARCH 31,
------------------------------
2001 2000 1999
-------- ------- -------
Provision at statutory rate.......................... $(25,296) $(8,408) $(6,572)
State income taxes before valuation allowance, net of
federal effect..................................... (3,909) (251) (729)
In-process research and development.................. 1,551 3,434 --
Discount on issuance of common stock................. -- 2,176 --
Research and development credits..................... (1,162) (338) (483)
Valuation allowance.................................. 29,027 3,125 7,712
Non-deductible compensation.......................... 256 55 165
Foreign income taxes................................. 1 66 --
Other................................................ (451) 261 (93)
-------- ------- -------
$ 17 $ 120 $ --
======== ======= =======
NOTE 9 -- DEBT
Convertible Subordinated Debentures
In December 1999, the Company issued $7.5 million of 4% Series A and Series
B convertible subordinated debentures (the Debentures). The Debentures mature on
December 17, 2002 unless converted earlier. Repayment of the debentures may be
accelerated under certain circumstances. The $3.75 million Series A debentures
and $3.75 million Series B debentures are convertible into the Company's common
stock at a conversion price equal to $7.05 and $35.50, respectively. Interest is
payable semiannually.
For the Series A and Series B debentures, the lender received a three-year
warrant to purchase approximately 532,000 common shares of the Company at $7.05
per share and 106,000 shares at $35.50 per share, respectively. The Company also
issued warrants to the placement agent in conjunction with the Series A and
Series B debentures equal to approximately 53,000 shares and 11,000 shares,
respectively, at substantially the same terms granted to the lender. The
conversion prices of the Debentures and the exercise price of the warrants
issued to the lender may be adjusted under certain circumstances.
Using the Black-Scholes pricing model, the Company determined that the debt
discount associated with the fair value of the warrants issued to the lender
approximated $2.2 million. The amortization of the debt discount is being
reflected as a non-cash charge to interest expense over the term of the
warrants. The Company recognized interest expense associated with amortization
of the debt discount of approximately $740,000 and $218,000, respectively,
during the fiscal years ended March 31, 2001 and 2000. The debt discount, net of
accumulated amortization, is reflected as a reduction in the face value of the
Debentures.
The costs of issuing the Debentures totaled $864,000, including a non-cash
charge of $247,000 for the value of the warrants issued to the placement agent.
The deferred debt issuance costs were recorded in Intangibles and Other Assets
and are being amortized to interest expense over the term of the Debentures. The
Company recognized interest expense associated with amortization of the deferred
debt issuance costs of approximately $288,000 and $85,000, respectively, during
the fiscal years ended March 31, 2001 and 2000.
In November 2000, the FASB Emerging Issues Task Force reached several
conclusions regarding the accounting for debt and equity securities with
beneficial conversion features, including a consensus requiring the application
of the "accounting conversion price" method, versus the use of the stated
conversion price, to calculate the beneficial conversion feature for such
securities. The SEC required companies to record a cumulative catch-up
adjustment in the fourth quarter of calendar 2000 related to the application of
the
48
51
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
"accounting conversion price" method to securities issued after May 21, 1999.
Accordingly, the Company recorded a $1.1 million non-cash expense during the
quarter ended December 31, 2000 to account for a beneficial conversion feature
associated with the Debentures and related warrants. The Company has presented
the charge in the Consolidated Statements of Operations as a cumulative effect
of a change in accounting principle.
Other Debt
At June 30, 2000, the Company assumed certain capital lease and loan
obligations of U/Force. In February 2001, the Company paid approximately
$560,000 to purchase all equipment outstanding under the capital leases, and
repaid the bank loan of approximately $146,000.
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
The Company leases its primary facility in Santa Clara, California under a
noncancelable operating lease agreement that expires in May 2003. The Company
also has leased facilities in Canada, France, and the United Kingdom. The
facility leases include rent escalation clauses, and require the Company to pay
taxes, insurance, and normal maintenance costs. At March 31, 2001, future
minimum annual lease payments under noncancelable operating leases were as
follows (in thousands):
YEAR ENDING MARCH 31,
---------------------
2002........................................................ $1,656
2003........................................................ 1,517
2004........................................................ 521
2005........................................................ 327
2006........................................................ 329
2007 and thereafter......................................... 1,509
------
Total minimum payments............................ $5,859
======
Rent expense for the years ended March 31, 2001, 2000, and 1999 was $1.8
million, $1.3 million, and $890,000, respectively.
The Company is involved in various legal claims and litigation that have
arisen in the normal course of the Company's operations. While the results of
such claims and litigation cannot be predicted with certainty, the Company
believes that the final outcome of such matters will not have a significant
adverse effect on the Company's financial position or results of operations.
However, should the Company not prevail in any such litigation, its operating
results and financial position could be adversely impacted. See also Note 15.
NOTE 11 -- STOCKHOLDERS' EQUITY
Common Stock
In August 2000 the Company's stockholders authorized an amendment to the
restated certificate of incorporation to increase the authorized number of
shares of common stock to 100,000,000 shares from 40,000,000 shares.
Exchangeable Shares
During the fourth quarter of fiscal 2001, the Company repurchased 1,034,107
unvested Exchangeable Shares at an average price of $0.49 per share. These
Exchangeable Shares were issued to certain employees of U/Force in conjunction
with the U/Force acquisition (see Note 3) and were repurchased when the
employees resigned from the Company. In addition, 812,866 Exchangeable Shares
were converted into an equivalent
49
52
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
number of shares of the Company's common stock in the fourth quarter of fiscal
2001. There were 260,807 Exchangeable Shares issued and outstanding at March 31,
2001.
1992 Stock Option Plan
The Board of Directors has reserved 3,000,000 shares of the Company's
common stock for issuance under the 1992 Stock Option Plan (the 1992 Plan). The
1992 Plan provides for granting incentive and nonstatutory stock options to
employees at prices equal to the fair market value of the stock at the grant
dates. Options generally vest over four years.
Key Personnel Plan
In July 1995, the Board of Directors adopted the Key Personnel Plan. The
Board of Directors reserved 2,200,000 shares of the Company's common stock for
issuance under this plan. The Key Personnel Plan provides for granting incentive
and nonstatutory stock options to officers of the Company at prices equal to the
fair market value of the stock at the grant dates. Options generally vest over
four years.
1996 Stock Plan
In June 1996, the Board of Directors adopted the 1996 Stock Plan (the 1996
Plan) and reserved 1,000,000 shares of the Company's common stock for issuance
under this plan. The Company's stockholders subsequently authorized increases in
the number of shares of the Company's common stock reserved for issuance under
the 1996 Plan of 500,000 shares in June 1997 and 2,000,000 shares in August
2000. The 1996 Plan also provides for an annual increase on the first day of
each of the Company's fiscal years in an amount equal to 5% of the Company's
common stock issued and outstanding at the end of the immediately preceding
fiscal year, subject to certain maximum limitations. This provision resulted in
an increase of 1,000,000, 771,287, and 764,680 shares issuable under the 1996
Plan during the fiscal years ended March 31, 2001, 2000, and 1999, respectively.
The 1996 Plan provides for granting incentive and nonstatutory stock options to
employees at prices equal to the fair market value of the stock at the grant
dates as determined by the Company's Board of Directors. Options generally vest
over a period of not more than five years.
1996 Director Option Plan
The Company's 1996 Director Option Plan (the Director Plan) was adopted in
June 1996 and became effective in July 1997. A total of 150,000 shares of common
stock were initially reserved for issuance under the Director Plan. The
Company's stockholders subsequently authorized an increase in the number of
shares of common stock reserved for issuance under the Director Plan to 500,000
shares in August 2000. The Director Plan provides for both discretionary and
periodic grants of nonstatutory stock options to non-employee directors of the
Company (the Outside Directors). The exercise price per share of all options
granted under the Director Plan will be equal to the fair market value of a
share of the Company's common stock on the date of grant. Options generally vest
over a period of four years. Options granted to Outside Directors under the
Director Plan have a ten year term, or shorter upon termination of an Outside
Director's status as a director. If not terminated earlier, the Director Plan
will have a term of ten years.
1999 Nonstatutory Stock Option Plan
In fiscal 2000, the Company's Board of Directors approved the 1999
Nonstatutory Stock Option Plan (the 1999 Plan) with 600,000 shares initially
reserved for issuance thereunder. In fiscal 2001, the number of shares reserved
for issuance was increased to 3,600,000 shares by the Board of Directors. Under
the terms of the 1999 Plan, options may not be issued to either officers or
directors of the Company provided, however, that options may be granted to an
officer in connection with the officer's initial employment by the Company.
Vesting for certain options accelerates if certain predefined milestones are
met.
50
53
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
UForce Company -- Societe UForce Amended and Restated 1999 Stock Option Plan
In connection with the acquisition of U/Force (see Note 3), the Company
assumed the UForce Company -- Societe UForce Amended and Restated 1999 Stock
Option Plan (the U/Force Plan), and reserved 1,023,898 shares of the Company's
common stock related to options issued thereunder. The U/Force Plan provided for
the grant of nonstatutory stock options to employees and consultants of U/Force
at prices equal to the fair market value of the stock at the grant dates.
Options generally vested over four years and had a term of ten years unless
otherwise cancelled.
Option activity under the Company's stock option plans since March 31,
1998, excluding subsidiary stock option plans, is summarized as follows:
WEIGHTED AVERAGE
SHARES SHARES SUBJECT TO EXERCISE PRICE
AVAILABLE FOR GRANT OPTIONS OUTSTANDING PER SHARE
------------------- ------------------- ----------------
Balance at March 31, 1998......... 120,909 2,859,864 $5.26
Increase in options available for
grant........................... 764,680 -- --
Granted........................... (3,243,175) 3,243,175 $3.32
Exercised......................... -- (202,332) $1.00
Returned to plan.................. 2,470,397 (2,470,397) $6.74
---------- ----------
Balance at March 31, 1999......... 112,811 3,430,310 $2.60
Increase in options available for
grant........................... 1,371,287 -- --
Granted........................... (2,105,015) 2,105,015 $7.94
Exercised......................... -- (725,209) $2.12
Returned to plan.................. 636,354 (636,354) $3.40
---------- ----------
Balance at March 31, 2000......... 15,437 4,173,762 $5.25
Increase in options available for
grant........................... 7,373,898 -- --
Granted or assumed................ (8,116,100) 8,116,100 $6.26
Exercised......................... -- (925,008) $2.30
Returned to plan.................. 3,632,963 (3,632,963) $8.29
---------- ----------
Balance at March 31, 2001......... 2,906,198 7,731,891 $5.24
========== ==========
Significant option groups outstanding at March 31, 2001 and related
weighted average exercise price and contractual life information are as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE WEIGHTED AVERAGE
---------------------------- ---------------------------- REMAINING
WEIGHTED AVERAGE WEIGHTED AVERAGE CONTRACTUAL LIFE
RANGE OF EXERCISE PRICES SHARES EXERCISE PRICE SHARES EXERCISE PRICE (YEARS)
- ------------------------ --------- ---------------- --------- ---------------- ----------------
$ 0.01 to $ 3.16 3,918,727 $ 2.12 1,115,964 $ 2.40 8.8
$ 3.16 to $ 6.32 1,339,546 $ 4.09 524,839 $ 4.36 8.6
$ 6.32 to $ 9.49 983,701 $ 7.32 134,856 $ 7.17 9.0
$ 9.49 to $12.65 1,206,617 $11.86 57,560 $10.55 9.1
$12.65 to $15.81 129,250 $14.32 16,526 $14.50 8.1
$15.81 to $31.62 154,050 $21.54 39,408 $21.29 8.9
--------- ---------
7,731,891 $ 5.24 1,889,153 $ 4.03 8.8
========= =========
In September 1998, the Board of Directors approved a proposal under which
employees elected to cancel approximately 2,107,000 options in exchange for
grants of new options with an exercise price equal to the then current fair
market value. In consideration for such repricing, each participating employee
agreed that they
51
54
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
forfeit their right to exercise such options should they resign from the Company
within twelve months of the repricing date.
Shares issued under the Key Personnel Plan are subject to repurchase at the
original issuance price if the employee leaves the Company prior to vesting.
During fiscal 2001, 2000, and 1999, the Company repurchased 5,982, 46,296, and
257,685 unvested shares, respectively. As of March 31, 2001, all shares were
vested.
The Company recorded a deferred compensation charge of approximately
$7,267,000 with respect to options repriced and certain additional options
granted in fiscal 1997. In addition, the Company recorded deferred compensation
charges of approximately $503,000 and $406,000 in connection with certain
options granted to non-officer employees in fiscal 2001 and 2000, respectively.
The Company recognized $753,000, $161,000, and $416,000 of said amounts as
compensation expense in the fiscal years ended March 31, 2001, 2000, and 1999,
respectively. The Company recognizes deferred compensation over the related
vesting period of the options (which is generally forty-eight months). At March
31, 2001, the balance of deferred compensation was $174,000. Deferred
compensation is subject to reduction for any employee who terminates employment
prior to the expiration of such employee's option vesting period.
Netergy Microelectronics, Inc. 2000 Stock Option Plan
NME's 2000 Stock Option Plan (the NME Plan) was adopted in December 2000 by
the NME Board of Directors. The NME Plan provides for granting incentive stock
options (ISOs) to employees and nonstatutory stock options (NSOs) to employees,
directors, and consultants of NME. Options granted under the NME Plan may be
granted for periods up to ten years and at prices no less than 85% of the
estimated fair value of the shares on the date of grant as determined by the NME
Board of Directors, provided, however, that (i) the exercise price of an ISO and
NSO shall not be less than 100% and 85% of the estimated fair value of the
shares on the date of grant, respectively, and (ii) the exercise price of an ISO
and NSO granted to a 10% shareholder shall not be less than 110% of the
estimated fair value of the shares on the date of grant, respectively. To date,
options granted vest over four years. However, in the event of a change in
control (as defined in the NME Plan document) vesting for certain options will
be accelerated.
The following table summarizes information about stock options outstanding
at March 31, 2001:
WEIGHTED AVERAGE
SHARES AVAILABLE SHARES SUBJECT TO EXERCISE PRICE
FOR GRANT OPTIONS OUTSTANDING PER SHARE
---------------- ------------------- ----------------
Shares reserved at NME Plan's
inception........................... 5,000,000 -- $ --
Granted............................... (3,572,000) 3,572,000 0.50
Returned to plan...................... 400,000 (400,000) 0.50
---------- ---------
Balance at March 31, 2001............. 1,828,000 3,172,000 $0.50
========== ========= =====
As of March 31, 2001, no options were exercisable, the weighted average
remaining contractual life was approximately 9.8 years, and the weighted average
exercise price was $0.50 per share.
Centile, Inc. 2001 Stock Option Plan
Centile's 2001 Stock Option Plan (the Centile Plan) was adopted in March
2001 by the Centile Board of Directors. The Centile Plan provides for granting
incentive stock options (ISOs) to employees and nonstatutory stock options
(NSOs) to employees, directors, and consultants of Centile. Options granted
under the Centile Plan may be granted for periods up to ten years and at prices
no less than 85% of the estimated fair value of the shares on the date of grant
as determined by the Centile Board of Directors, provided, however, that (i) the
exercise price of an ISO and NSO shall not be less than 100% and 85% of the
estimated fair value of the shares on the date of grant, respectively, and (ii)
the exercise price of an ISO and NSO granted to a
52
55
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10% shareholder shall not be less than 110% of the estimated fair value of the
shares on the date of grant, respectively. To date, options granted vest over
four years.
The following table summarizes the information about stock options
outstanding at March 31, 2001:
WEIGHTED AVERAGE
SHARES AVAILABLE SHARES SUBJECT TO EXERCISE PRICE
FOR GRANT OPTIONS OUTSTANDING PER SHARE
---------------- ------------------- ----------------
Shares reserved at Centile Plan's
inception......................... 4,500,000 -- $ --
Granted............................. (4,107,000) 4,107,000 0.43
---------- ---------
Balance at March 31, 2001........... 393,000 4,107,000 $0.43
========== ========= =====
As of March 31, 2001, no options were exercisable, the weighted average
remaining contractual life was approximately 10 years, and the weighted average
exercise price was $0.43 per share.
1996 Employee Stock Purchase Plan
The Company's 1996 Stock Purchase Plan (the Purchase Plan) was adopted in
June 1996 and became effective upon the closing of the Company's initial public
offering in July 1997. Under the Purchase Plan, a total of 500,000 shares of
common stock were initially reserved for issuance. At the start of each fiscal
year, the number of shares of common stock subject to the Purchase Plan
increases so that 500,000 shares remain available for issuance. This provision
resulted in increases of 180,910 and 187,491 shares issuable under the Purchase
Plan during the fiscal years ended March 31, 2001 and 2000, respectively. During
fiscal 2001, 2000, and 1999, 281,583, 180,910, and 187,491 shares, respectively,
were issued under the Purchase Plan.
The Purchase Plan permits eligible employees to purchase common stock
through payroll deductions at a price equal to 85% of the fair market value of
the common stock at the beginning of each two year offering period or the end of
a six month purchase period, whichever is lower. The contribution amount may not
exceed ten percent of an employee's base compensation, including commissions but
not including bonuses and overtime, In the event of a merger of the Company with
or into another corporation or the sale of all or substantially all of the
assets of the Company, the Purchase Plan provides that a new exercise date will
be set for each option under the plan which exercise date will occur before the
date of the merger or asset sale.
For the purpose of providing pro forma disclosures, the estimated fair
value of stock purchase rights were estimated using the Black-Scholes pricing
model with the following weighted-average assumptions:
YEAR ENDED MARCH 31,
----------------------------------------
2001 2000 1999
----------- ----------- ----------
Expected volatility........................... 141% 70% 71%
Expected dividend yield....................... 0.0% 0.0% 0.0%
Risk-free interest rate....................... 4.92% 5.84% 4.49%
Weighted average expected option term......... 1.25 years 1.25 years 0.9 years
Weighted average fair value of options
granted..................................... $ 3.00 $ 5.52 $ 1.81
53
56
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Certain pro forma disclosures
The Company accounts for its stock plans in accordance with the provisions
of APB Opinion No. 25. Had compensation cost for the Company's stock plans been
determined based on the fair value of options at their grant dates, as
prescribed in FAS 123, the Company's net loss would have been as follows (in
thousands, except per share amounts):
YEAR ENDED MARCH 31,
--------------------------------
2001 2000 1999
-------- -------- --------
Net loss:
As reported...................................... $(74,399) $(24,848) $(19,224)
Pro forma........................................ $(87,233) $(30,670) $(24,175)
Basic and diluted loss per share:
As reported...................................... $ (2.99) $ (1.38) $ (1.28)
Pro forma........................................ $ (3.51) $ (1.70) $ (1.61)
For the purposes of the disclosure above, the fair value of each of the
Company's option grants, excluding those options issued under the NME and
Centile Plans, has been estimated on the date of grant using the Black-Scholes
pricing model with the following assumptions:
YEAR ENDED MARCH 31,
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
Expected volatility...................... 141% 70% 71%
Expected dividend yield.................. 0.0% 0.0% 0.0%
Risk-free interest rate.................. 4.7% to 6.8% 5.5% to 6.4% 4.2% to 5.6%
Weighted average expected option term.... 5 years 5.3 years 5.3 years
Weighted average fair value of options
granted................................ $5.17 $5.12 $2.76
Options granted under the NME and Centile Plans during fiscal year 2001
were also calculated using the Black-Scholes pricing model, with the following
assumptions: dividend yield of 0%, weighted average expected option term of five
years; volatility of 70%; and risk free interest rates of 4.7% to 5.1%. The
weighted average fair values of NME and Centile options granted during fiscal
2001 were $0.31 and $0.26, respectively.
NOTE 12 -- EMPLOYEE BENEFIT PLANS
401(k) Savings Plan
In April 1991, the Company adopted a 401(k) savings plan (the Savings Plan)
covering substantially all of its U.S. employees. Eligible employees may
contribute to the Savings Plan from their compensation up to the maximum allowed
by the Internal Revenue Service. The Company's matching contribution is $1,500
per employee per calendar year at a dollar for dollar rate of the employee
contribution. The matching contributions vest over three years. The Company
contributed $125,000, $124,000, and $144,000 to the Savings Plan during fiscal
2001, 2000, and 1999, respectively.
Profit Sharing Plan
The Company's profit sharing plan provides for payments of up to 15% of
total quarterly net income. Charges related to this plan were not significant
for the fiscal years ended March 31, 2001, 2000 or 1999.
54
57
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13 -- SEGMENT REPORTING
During the fourth quarter of fiscal year 2001, the Company changed its
internal reporting processes and determined that it had two new reportable
segments, NME and Centile. NME and Centile were new subsidiaries formed by the
Company in the third and fourth quarters, respectively, of fiscal 2001. The
Company's reportable segments have been determined based on the nature of the
operations and products offered to customers. The NME segment reflects the
activity associated with sales of semiconductors and related software focused on
the IP telephony and videoconferencing markets, as well as sales of media hub
systems. The Centile segment reflects activity associated with the development
and sales of a hosted iPBX solution. The Corporate and Other segment includes
the activities of the Company's Canadian operations (see Notes 3 and 4), its
discontinued ViaTV product line (see Note 14) and the video monitoring business
(see Note 5) which was sold in May 2000. Consequently, the reported results and
amounts for the Corporate and Other segment include historical activity of the
discontinued product lines and related operations as well as certain
transactions and residual amounts associated with their sale or cessation.
Intersegment revenues between the reportable segments were not significant
during the periods presented. Shared support service functions such as human
resources, facilities management, and other infrastructure support and overhead
are allocated between the segments. Accounting policies are applied consistently
to the segments, where applicable.
Due to limitations in the Company's internal reporting systems, it is not
practicable to disclose operating losses by segment for fiscal 2000 and 1999.
The following illustrates results by segment for the periods during which the
information was available:
YEAR ENDED MARCH 31,
-----------------------------
2001 2000 1999
------- ------- -------
Revenues:
NME................................................. $15,850 $16,308 $15,795
Centile............................................. 198 70 --
Corporate and Other................................. 2,180 9,006 15,887
------- ------- -------
Total revenues.............................. $18,228 $25,384 $31,682
------- ------- -------
Gross profit (loss):
NME................................................. $10,792 $13,137 $12,561
Centile............................................. 71 45 --
Corporate and Other................................. 379 3,604 (5,160)
------- ------- -------
Total gross profit.......................... $11,242 $16,786 $ 7,401
------- ------- -------
Operating losses for the NME, Centile and the Corporate and Other segments
for the fiscal year ended March 31, 2001 were $5.7 million, $13.0 million and
$55.8 million, respectively. There were no reconciling items between the
segments for the revenue, gross profit, and operating loss amounts.
55
58
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table illustrates net revenues by groupings of similar
products:
YEAR ENDED MARCH 31,
-----------------------------
2001 2000 1999
------- ------- -------
Videoconferencing semiconductors.................... $ 9,478 $11,323 $10,302
IP telephony semiconductors......................... 1,878 37 --
Consumer videophone systems......................... 105 3,000 12,935
Video monitoring systems............................ 915 6,006 2,952
Media hub systems................................... 432 451 --
------- ------- -------
Product revenues.......................... 12,808 20,817 26,189
------- ------- -------
Videoconferencing licenses and royalties............ 3,237 4,318 4,248
IP telephony licenses and royalties................. 825 179 --
Nonrecurring engineering fees....................... -- -- 1,245
Hosted iPBX licenses................................ 198 70 --
Professional services............................... 1,160 -- --
------- ------- -------
License and other revenues................ 5,420 4,567 5,493
------- ------- -------
Total revenues............................ $18,228 $25,384 $31,682
======= ======= =======
The following illustrates net revenues by geographic area. Revenues are
attributed to countries based on the destination of shipment (in thousands):
YEAR ENDED MARCH 31,
-----------------------------
2001 2000 1999
------- ------- -------
United States......................................... $ 5,632 $13,381 $18,116
Europe................................................ 5,862 5,808 5,393
Japan................................................. 1,188 2,351 4,227
Other................................................. 5,546 3,844 3,946
------- ------- -------
$18,228 $25,384 $31,682
======= ======= =======
No customer represented greater than 10% of total revenues for the fiscal
years ended March 31, 2001, 2000, and 1999.
NOTE 14 -- INVENTORY CHARGES
In the fourth quarter of fiscal 1999, the Company determined that a
combination of factors including the high cost of maintaining a consumer
distribution channel, the slower than expected growth rate of the consumer
videophone market, and the low gross margins typical of a consumer electronics
product made it unlikely that the consumer videophone business would be
profitable in the foreseeable future. As a result, the Company announced in
April 1999 that it would cease production of the ViaTV product line and withdraw
from its distribution channels over the subsequent several quarters. In
conjunction with this decision, the Company recorded a $5.7 million charge
associated with the write-off of ViaTV videophone inventories in the fourth
quarter of fiscal 1999.
NOTE 15 -- SUBSEQUENT EVENT
On April 6, 2001, the Company, along with Sun Microsystems, Inc., Netscape
Communications Canada Inc., Burntsand Inc., and Intraware Canada Inc., was sued
by Milinx Business Services, Inc. and Milinx Business Group Inc. (collectively,
Milinx) in the Supreme Court of British Columbia, Canada (the Court). Milinx has
alleged that the Company failed to perform certain contractual obligations and
knowingly misrepresented the capabilities of its products. The lawsuit seeks
general, special, and aggravated damages
56
59
NETERGY NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
totaling in excess of Canadian $65 million plus interest, costs, and any other
relief which the Court may choose to provide. Management believes that the
Company has valid defenses against the claims alleged by Milinx and intends to
defend this lawsuit vigorously. However, due to the nature of litigation and
because the lawsuit is in the very early pre-discovery stages, the Company
cannot determine the possible loss, if any, that may ultimately be incurred
either in the context of a trial or a negotiated settlement. Should the Company
not prevail in the litigation, its operating results and financial condition
would be adversely impacted.
57
60
NETERGY NETWORKS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
ADDITIONS WRITE-OFFS/
BALANCE AT CHARGED TO RECOVERIES OF
BEGINNING OF COSTS AND UNCOLLECTIBLE BALANCE AT
DESCRIPTION PERIOD EXPENSES ACCOUNTS END OF PERIOD
----------- ------------ ---------- ------------- -------------
Allowance for doubtful accounts:
March 31, 1999................................. $610 $ 86 $10 $686
March 31, 2000................................. 686 (200) 44 442
March 31, 2001................................. 442 25 78 389
58
61
CONSOLIDATED QUARTERLY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
QUARTER ENDED
-----------------------------------------------------------------------------------------
MARCH 31, DEC. 31, SEPT. 30, JUNE 30, MARCH 31, DEC. 31, SEPT. 30, JUNE 30,
2001 2000 2000 2000 2000 1999 1999 1999
--------- -------- --------- -------- --------- -------- --------- --------
Total revenues........................ $ 4,409 $ 4,104 $ 3,892 $ 5,823 $ 6,542 $ 6,238 $ 6,710 $ 5,894
Cost of revenues...................... 1,695 1,948 1,765 1,578 1,806 1,993 1,446 3,353
-------- -------- -------- ------- ------- ------- ------- --------
Gross profit.......................... 2,714 2,156 2,127 4,245 4,736 4,245 5,264 2,541
-------- -------- -------- ------- ------- ------- ------- --------
Operating expenses:
Research and development............ 4,866 4,868 4,788 4,214 3,772 2,854 2,860 2,423
Selling, general, and
administrative.................... 5,189 4,497 4,728 3,699 10,389 3,545 3,786 3,587
In-process research and
development....................... -- -- 4,563 -- -- -- -- 10,100
Amortization of intangibles......... 3,612 3,612 3,573 190 190 189 185 50
Restructuring charge................ 33,316 -- -- -- -- -- -- --
-------- -------- -------- ------- ------- ------- ------- --------
Total operating expenses...... 46,983 12,977 17,652 8,103 14,351 6,588 6,831 16,160
-------- -------- -------- ------- ------- ------- ------- --------
Loss from operations.................. (44,269) (10,821) (15,525) (3,858) (9,615) (2,343) (1,567) (13,619)
Other income (expense), net........... (94) 67 554 645 231 109 195 1,881
-------- -------- -------- ------- ------- ------- ------- --------
Loss before income taxes.............. (44,363) (10,754) (14,971) (3,213) (9,384) (2,234) (1,372) (11,738)
Provision for income taxes............ 5 -- -- 12 54 -- 66 --
-------- -------- -------- ------- ------- ------- ------- --------
Net loss before cumulative effect of
change in accounting principle...... (44,368) (10,754) (14,971) (3,225) (9,438) (2,234) (1,438) (11,738)
Cumulative effect of change in
accounting principle................ -- (1,081) -- -- -- -- -- --
-------- -------- -------- ------- ------- ------- ------- --------
Net loss.............................. $(44,368) $(11,835) $(14,971) $(3,225) $(9,438) $(2,234) $(1,438) $(11,738)
======== ======== ======== ======= ======= ======= ======= ========
Net loss per share:
Basic and diluted................... $ (1.67) $ (0.47) $ (0.60) $ (0.14) $ (0.47) $ (0.12) $ (0.08) $ (0.72)
Shares used in per share calculations:
Basic and diluted................... 26,541 25,337 24,923 22,582 20,023 18,035 17,886 16,341
59
62
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
PART III
Certain information required by Part III is omitted from this Report on
Form 10-K in that the Registrant will file its definitive Proxy Statement for
its Annual Meeting of Stockholders (the 2001 Proxy Statement) pursuant to
Regulation 14A of the Securities Exchange Act of 1934, as amended, not later
than 120 days after the end of the fiscal year covered by this Report, and
certain information included in the 2001 Proxy Statement is incorporated herein
by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this is included in the 2001 Proxy Statement
under the captions "Election of Directors -- Nominees," "Additional
Information -- Executive Officers" and "Additional Information -- Section 16(a)
Beneficial Ownership Reporting Compliance" and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is included in the 2001 Proxy
Statement under the captions "Election of Directors -- Compensation of
Directors," "Additional Information -- Executive Compensation" and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth in the 2001 Proxy
Statement under the caption "Additional Information -- Security Ownership" and
is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND TRANSACTIONS
The information required by this Item is set forth in the 2001 Proxy
Statement under the captions "Additional Information -- Certain Relationships
and Transactions," "Additional Information -- Employment Contracts and
Termination of Employment and Change in Control Arrangements," "Additional
Information -- Compensation Committee Interlocks and Insider Participation,"
"Additional Information -- Report of the Compensation Committee of the Board of
Directors" and "Additional Information -- Stock Performance Graph" and is
incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements.
The information required by this item is included in Item 8.
(a)(2) Financial Statement Schedules.
The information required by this item is included in Item 8.
(a)(3) Exhibits.
The documents listed on the Exhibit Index appearing at pages 63 - 64 of
this Report are filed herewith. Copies of the exhibits listed in the Exhibit
Index will be furnished, upon request, to holders or beneficial owners of the
Company's common stock.
60
63
(b) Reports on Form 8-K.
The Company filed two reports on Form 8-K during the quarter ended March
31, 2001. Information regarding the items reported on is as follows:
DATE ITEMS REPORTED ON
---- -----------------
February 7, 2001 The Company reported the resignations of Paul Voois, as
Chief Executive Officer, Robert Habibi, as Chief Operating
Officer and member of the Board of Directors, and Jean-Luc
Calonne, as Senior Vice President for Business Operations/
General Manager of the Company's Montreal office. The
Company also reported the resignations of approximately 50
employees of the Company's Montreal office.
The Company also reported the appointments of Joe Parkinson
as Interim Chief Executive Officer and Bryan Martin as Chief
Operating Officer and member of the Board of Directors.
The Company reported its results for the three and nine
month periods ending December 31, 2000.
January 3, 2001 The Company reported a change in its fiscal year from a year
ending on the Thursday closest to March 31 to a year ending
on the last calendar day of March, beginning in fiscal 2001.
61
64
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant, Netergy Networks, Inc., a Delaware
corporation, has duly caused this Report on Form 10-K to be signed on its behalf
by the undersigned, thereunto duly authorized, in the City of Santa Clara, State
of California, on May 24, 2001.
NETERGY NETWORKS, INC.
By: /s/ JOE PARKINSON
------------------------------------
Joe Parkinson,
Chairman & Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears
below constitutes and appoints Joe Parkinson and David M. Stoll, jointly and
severally, his attorneys-in-fact, each with the power of substitution, for him
in any and all capacities, to sign any amendments to this Report on Form 10-K,
and to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorney-in-fact, or his substitute or
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this Report on Form 10-K has been signed by the following persons in the
capacities and on the date indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JOE PARKINSON Chairman of the Board and May 24, 2001
- ----------------------------------------------------- Chief Executive Officer
Joe Parkinson (Principal Executive Officer)
/s/ DAVID M. STOLL Chief Financial Officer, May 24, 2001
- ----------------------------------------------------- Vice President, Finance and
David M. Stoll Secretary (Principal Financial
and
Accounting Officer)
/s/ LEE CAMP Director May 24, 2001
- -----------------------------------------------------
Lee Camp
/s/ BERND GIROD Director May 24, 2001
- -----------------------------------------------------
Bernd Girod
/s/ GUY L. HECKER Director May 24, 2001
- -----------------------------------------------------
Guy L. Hecker, Jr.
/s/ CHRISTOS LAGOMICHOS Director May 24, 2001
- -----------------------------------------------------
Christos Lagomichos
/s/ JOE MARKEE Director May 24, 2001
- -----------------------------------------------------
Joe Markee
/s/ BRYAN MARTIN Director, President and May 24, 2001
- ----------------------------------------------------- Chief Operating Officer
Bryan Martin
/s/ WILLIAM TAI Director May 24, 2001
- -----------------------------------------------------
William Tai
62
65
NETERGY NETWORKS, INC.
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT TITLE
- ------- -------------
2.1(c) Stock Exchange Agreement, dated as of May 13, 1999, by and
among 8x8, Inc., Odisei S.A. and the Security Holders named
therein and the agreements related thereto.
2.2(g) Share Exchange Agreement, dated as of May 19, 2000, by and
among Netergy, U/Force, all of the shareholders of U/Force
and indirect owners of the shares of U/Force.
3.1(a) Form of Amended and Restated Certificate of Incorporation of
Registrant.
3.2(a) Bylaws of Registrant.
3.3 Certificate of Amendment of Amended and Restated Certificate
of Incorporation.
4.1(d) Securities Purchase Agreement by and among Wingate Capital
Ltd. and Fisher Capital Ltd. (collectively the Buyers) and
8x8, Inc. dated December 15, 1999, with Schedule and
Exhibits.
4.2(d) Registration Rights Agreement by and among 8x8, Inc. and the
Buyers dated December 15, 1999.
4.3(d) Form of Series A Warrant by and among 8x8, Inc. and
FleetBoston Robertson Stephens, Inc. dated December 16,
1999.
4.4(d) Form of Series B Warrant by and among 8x8, Inc. and
FleetBoston Robertson Stephens Inc. dated December 16, 1999.
4.5(d) Registration Rights Agreement by and among 8x8, Inc. and
FleetBoston Robertson Stephens Inc. dated December 16, 1999.
4.6(f) Common Stock Purchase Agreement by and among 8x8, Inc. and
STMicroelectronics dated January 24, 2000.
4.7(f) Form of Investor Rights Agreement by and among 8x8, Inc. and
STMicroelectronics dated January 24, 2000.
10.1(a) Form of Indemnification Agreement.
10.2(a) 1992 Stock Option Plan, as amended, and form of Stock Option
Agreement.
10.3(a) Key Personnel Plan, as amended, and form of Stock Option
Agreement.
10.4(i) 1996 Stock Plan, as amended, and form of Stock Option
Agreement.
10.5(a) 1996 Employee Stock Purchase Plan, as amended, and form of
Subscription Agreement.
10.6(j) 1996 Director Option Plan, as amended, and form of Director
Option Agreement.
10.7(a) Amended and Restated Registration Rights Agreement dated as
of September 6, 1996 among the Registrant and certain
holders of the Registrant's Common Stock.
10.8(a) Facility lease dated as of July 3, 1990 by and between
Sobrato Interests, a California Limited Partnership, and the
Registrant, as amended.
10.9(a) Promissory Note between Sandra L. Abbott and Registrant
dated June 29, 1996.
10.10(a) Promissory Note between David M. Harper and Registrant dated
June 29, 1996.
10.11(a) Promissory Note between Bryan R. Martin and Registrant dated
June 29, 1996.
10.12(a) Promissory Note between Chris McNiffe and Registrant dated
June 29, 1996.
10.13(a) Promissory Note between Mike Noonen and Registrant dated
June 29, 1996.
10.14(a) Promissory Note between Samuel T. Wang and Registrant dated
June 29, 1996.
10.15(b) Warrant Number CS-01 issued by 8x8, Inc. to Stanford
University on February 17, 1998.
10.16(b) Fifth Amendment to Lease dated January 26, 1998 between
Sobrato Interests and the Registrant.
63
66
EXHIBIT
NUMBER EXHIBIT TITLE
- ------- -------------
10.17(b) Landlord's Consent to Sublease dated February 23, 1998 among
Sobrato Interests, Bay Networks, Inc. and the Registrant.
10.18(e) 1999 Nonstatutory Stock Option Plan, as amended, and form of
Stock Option Agreement.
10.19(h) Asset Purchase Agreement by and among 8x8, Inc. and
Interlogix, Inc. dated May 19, 2000.
10.20(h) Technology License Agreement by and among 8x8, Inc. and
Interlogix, Inc. dated May 19, 2000.
10.21(k) UForce Company -- Societe UForce Amended and Restated 1999
Stock Option Plan.
10.22 Settlement Agreement and Release by and between 8x8, Inc.
and Keith Barraclough dated July 10, 2000.
10.23 Severance Agreement and Mutual Release by and between
Netergy Networks, Inc., Netergy Networks Canada Corporation
and Dominique Pitteloud dated October 13, 2000.
21.1 Subsidiaries of Registrant.
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (see page 62).
- ---------------
(a) Incorporated by reference to identically numbered exhibits
filed in response to Item 16 (a), "Exhibits," of the
registrant's Registration Statement on Form S-1 (File No.
333-15627), as amended, declared effective on July 1, 1997.
(b) Incorporated by reference to identically numbered exhibits
filed in response to Item 14 (a), "Exhibits," of the
Registrant's Report on Form 10-K for the fiscal year ended
March 31, 1998.
(c) Incorporated by reference to identically numbered exhibits
filed in response to Item 7, "Exhibits," of the Registrant's
Report on Form 8-K dated June 7, 1999 and 8-K/A dated August
9, 1999.
(d) Incorporated by reference to identically numbered exhibits
filed in response to Item 6(a), "Exhibits," of the
Registrant's Report on Form 10-Q for the fiscal quarter
ended December 31, 1999.
(e) Incorporated by reference to exhibit 4.1 filed in response
to Item 8, "Exhibits," of the Registrant's Statement on Form
S-8 dated July 17, 2000.
(f) Incorporated by reference to identically numbered exhibits
filed in response to Item 7, "Exhibits," of the Registrant's
Report on Form 8-K filed on February 16, 2000.
(g) Incorporated by reference to identically numbered exhibits
filed in response to Item 7, "Exhibits," of the Registrant's
Report on Form 8-K filed on May 23, 2000.
(h) Incorporated by reference to identically numbered exhibits
filed in response to Item 7, "Exhibits," of the Registrant's
Report on Form 8-K filed on May 26, 2000.
(i) Incorporated by reference to exhibit 4.1 filed in response
to Item 8, "Exhibits," of the Registrant's Report on Form
S-8 dated November 7, 2000.
(j) Incorporated by reference to exhibit 4.2 filed in response
to Item 8, "Exhibits," of the Registrant's Report on Form
S-8 dated November 7, 2000.
(k) Incorporated by reference to exhibit 4.2 filed in response
to Item 8, "Exhibits," of the Registrant's Statement on Form
S-8 dated July 17, 2000.
64