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SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
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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 December 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-19640
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VERTEL CORPORATION
(Exact name of Registrant as specified in its charter)
California 95-3948704
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
21300 Victory Boulevard, Suite 700, Woodland Hills, California 91367
(Address of principal executive offices) (zip code)
(818) 227-1400
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 Par Value
(Title of Class)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period as the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past ninety days. Yes [X] No [_]
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 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. [_]
As of March 1, 2000 there were 27,463,756 shares of the Registrant's Common
Stock outstanding, and the aggregate market value of the stock held on that
date by non-affiliates was approximately $840,037,000 based on the closing
price of $30.69 per share. Shares of Common Stock held by each officer,
director and holder of 5% or more of the outstanding Common Stock of the
Registrant have been excluded in that such persons may be deemed to be
affiliates of the Registrant. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the definitive proxy
statement for the Registrant's Annual Meeting of Shareholders to be held on
May 18, 2000 (the "Annual Meeting"), to be filed with the Commission not later
than 120 days after the end of the fiscal year 1999.
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INTRODUCTORY STATEMENT
Except for the historical information presented, the matters discussed in
this Annual Report on Form 10-K are forward-looking statements that involve
risks and uncertainties, including the risks of timely and successful
development of products and technologies; successful introduction and customer
acceptance of new and enhanced products and technologies in existing and new
markets; the possible development and introduction of competitive products and
new and alternative technologies; loss of key customer, partner and alliance
relationships; pricing, currency and exchange risks; governmental and
regulatory developments affecting us and our customers; the ability to
identify, conclude, and integrate acquisitions on a timely basis; the ability
to attract and/or retain essential technical or other personnel; the length of
our sales cycle, size and timing of license fees closed during the quarter;
the likely continued significant percentage of quarterly revenues recorded in
the last month of the quarter which makes forecasting difficult and subject to
a substantial risk of variance with actual results; economic uncertainties
associated with conducting business on a worldwide basis; our ability to
control expenditures at a level consistent with revenues and the other risks
detailed from time to time in our public disclosure filings with the U.S.
Securities and Exchange Commission (SEC). Readers are cautioned not to place
undue reliance on these forward-looking statements, which reflect management's
opinions only as of the date hereof. We undertake no obligation to revise or
publicly release the results of any revision to these forward-looking
statements.
PART I
ITEM 1. BUSINESS
General
Vertel Corporation ("We," "Vertel," "the Company"), founded as Retix in
1985, is a provider of telecommunications software and middleware for network
management applications. We offer multiple software technologies supporting
end-to-end network and service management with high quality grade of service
for network operations support systems. Our solutions are deployed worldwide
by service providers, network operators, telecommunications equipment
manufacturers, independent software vendors and systems integrators. We
supplement our software and middleware products with engineering services
provided by our professional services unit, which delivers turnkey management
applications that fit individual customer requirements.
In December 1997, we discontinued further investment in our broadband
access equipment subsidiary, Sonoma Systems, Inc. As a result of the
successful completion of financing by outside private investors in early 1998,
our voting ownership in this subsidiary was reduced to 19.9%. In December
1998, we sold our holdings of Series B and Series C preferred stock in Sonoma
Systems to a party related to Newbridge Networks Corporation. We continue to
retain an investment in Sonoma Systems primarily consisting of $1.0 million of
Series A preferred stock that is non-convertible and non-voting and is due and
payable upon the consummation of a public offering of Sonoma Systems common
stock. Sonoma Systems filed a Form S-1 Registration on February 28, 2000 to
consummate such a public offering.
In March 1998, our shareholders approved a change in our name from Retix to
Vertel Corporation, the name of the only operating subsidiary of Retix at that
time. Concurrently, the subsidiary's name was changed to Vertel Corporation I.
In 1999, Vertel Corporation I merged into Vertel Corporation. Except where
specifically noted, Vertel includes the parent and all subsidiary companies.
We also changed our Nasdaq Stock Market ticker symbol to VRTL from RETX.
In March 1999, we acquired Expersoft Corporation (Expersoft). Expersoft
develops and markets standards-based, high performance Common Object Request
Broker Architecture (CORBA) software technology. The acquisition price was
approximately $3,225,000 and consisted of cash of $3,000,000 and acquisition
costs of $225,000. At December 31, 1999, we had paid $3,182,000 of the cash
consideration and acquisition costs. The acquisition was accounted for as a
purchase. Expersoft Corporation was merged into Vertel Corporation in 1999.
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We develop, market, and support vertically integrated, object-oriented
software solutions for the management of public telecommunications networks.
Our solutions cover the maturing Telecommunications Management Network (TMN)
software market and the emerging CORBA market. Our TMN products are based upon
the International Telecommunications Union's TMN standard and support seamless
network operation and management over diverse transmission media and
protocols. We believe that we offer the only commercially available, fully
interoperable suite of products and tools that span the network element,
element management, network management and service management layers of the
TMN model. We offer embedded software for network equipment and software
solutions to allow telecommunications service providers to integrate
proprietary, Simple Network Management Protocol (SNMP), TMN, and CORBA based
network management systems with standards-based solutions. In addition, we
offer object-oriented software platforms that facilitate the rapid development
of network and service management applications and features such as fault
detection and automatic response, remote improvement of network configuration,
automation of accounting and billing functions and optimization of network
traffic and security.
We also provide professional services that design, develop and support
turnkey management solutions in addition to product integration and product
application services. Our professional services include system analysis and
design, source code portation and interface, custom application development,
conformance and certification testing and technical support services.
Our software solutions reduce the complexity of management system
interoperability and provide systems that are more efficient and simpler to
build and deploy. In addition, our solutions utilize object-oriented
interfaces, with object definitions that serve as reusable building blocks.
The object interfaces mask the complexity of underlying implementations while
providing all the functionality of the services and protocols of that
implementation.
We believe that our software solutions allow telecommunications service
providers and their customers to reduce network operations costs, manage
diverse networks and network equipment with a single integrated management
system, derive incremental revenue by bringing new functionality and services
to market more rapidly, implement a complete network management solution and
preserve existing investments by integrating existing proprietary systems
including Bellcore's Transaction Language 1 (TL 1) and SNMP.
Our products enhance communications among service providers and customers
by enabling telecommunications service providers and enterprise network
operators to develop and deploy systems that manage new and existing services
across multiple service provider networks.
We believe that the broad adoption and deployment of standards based
technologies such as CORBA and TMN will be key to our success and that this
adoption will depend, in part, upon the ability of service providers to
implement management solutions quickly and cost-effectively. Therefore we
target telecommunications service providers and network equipment
manufacturers for adoption of our standards-based solutions, and at the same
time have committed and will continue to commit substantial resources to the
promotion of these standards for telecommunications network management. Our
customers include multi-national network equipment manufacturers, domestic and
international network operators, and independent software vendors. For the
year ended December 31, 1999, sales to Lucent Technologies comprised
approximately 11.6% of our net revenues, our only customer to exceed 10% of
our net revenues.
We are a California corporation incorporated in 1985. Our principal offices
are located at 21300 Victory Boulevard, Suite 700, Woodland Hills, California
91367 and our telephone number at that location is (818) 227-1400. Our Web
site address is www.vertel.com.
Highlights of 1999
Recognizing that the TMN market is maturing with relatively low growth
opportunities, in 1999 we moved to transform ourselves from a pure TMN product
company to a protocol independent supplier of network
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management software and middleware solutions. Our goals were to diversify into
other popular and emerging growth management middleware technologies such as
CORBA, expand our portfolio with value-added management applications, grow our
professional services practice, identify strategic acquisitions of
complementary businesses or technologies, and focus on broadband and wireless
markets as key growth sectors for telecom management products.
Our transformation began with the acquisition of San Diego, California
based Expersoft Corporation in March 1999 to add high performance CORBA
technology to our product portfolio. We leveraged this advanced object
distribution technology, designed by Expersoft specifically for carrier-grade
telecommunications applications, to provide next generation, multi-protocol
management solutions. With our expanded product suite, we are able to offer
integrated solutions across all TMN levels, including embedded technology,
where Expersoft's highly optimized technologies would provide new management
interface options for network elements and element management systems.
In June 1999, we announced an alliance with Atlantech Technologies for
their AccessVision Element Management Framework for us to provide turnkey
element and network management applications to network equipment providers.
This relationship with Atlantech allowed our professional services unit to
develop SNMP based management applications to our customers' specifications
much faster and more cost effectively than before. This solution set is
targeted at the telecom "Access Network," which is also referred to as "the
last mile."
During 1999, we also targeted the telecom Operation Support Systems (OSS)
integration market with our mediation framework. The multitude of network
management applications and protocols both standard and proprietary in use in
the field has created significant interoperability problems for network
equipment suppliers and service providers. In order to facilitate the
integration of new products into existing networks, and to address the time to
market demands of network equipment suppliers, our professional services unit
organization developed our mediation framework application designed to allow
us to complete these types of projects faster for our customers.
We also continued to expand our product capabilities for the TMN products.
In an alliance with IBM, we ported our TMNTelecore products to IBM's AIX
platform. This alliance has allowed us to target customers who have adopted
the AIX platform and participate in certain IBM co-marketing programs.
During the fourth quarter of fiscal 1999, we restructured our operations
and reduced our level of expenses, which included a reduction in our overall
workforce by approximately 20%. The TMN product development staff at our
headquarters location accounted for approximately half of our workforce
reduction. We intend to transition future TMN product development activities
to our Poland operations where labor costs are significantly lower when
compared to domestic labor costs. Following the restructuring, the majority of
our product development efforts are focused in the area of CORBA technology.
In December 1999, we launched our e*ORB CORBA product line at the
Telemanagement World Conference. Our e*ORB product line introduced to the
market CORBA technology specifically optimized for the performance and
reliability demands of the telecom market. CORBA technology is increasingly
used for interconnection of telecom OSS and telecom networking infrastructure.
Our e*ORB software products are designed to enable OSS and network
infrastructure to integrate in ways which will accelerate network and service
deployment and provide for the transition from TMN managed networks to CORBA
solutions.
Industry Background and Trends
The worldwide telecommunications industry continues to undergo significant
transformation. The Internet and corporate intranets are creating a new
networked economy with online versions of every conceivable product and
service. New market entrants as well as traditional companies are moving their
business online through e-commerce initiatives. Innovative business models are
capitalizing on the unique economics of the Internet.
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These developments have resulted in tremendous growth of the telecom industry
as companies in this industry attempt to meet the increased demand for network
bandwidth, reliability, data integrity and security.
Telecom equipment manufacturers are transforming their traditional product
lines to incorporate data and Internet technologies. Network operators are
expanding into new markets to create economies of scale and to ready
themselves for competition and market entry by global operators. Both
equipment manufacturers and network operators are building convergent network
infrastructure to add data network capability to their existing voice
business. Both groups have aggressively acquired other companies to achieve
these goals.
Global deregulation and international privatization has resulted in
numerous new entrants to the telecom industry and created intense intra-
industry, cross-industry and geographic competition in providing
telecommunications services. Long distance and local telecommunications
service providers compete in each other's markets. Wireless service providers,
cable television operators and utilities are leveraging existing
infrastructure to provide voice, video and data transmission and switching
networks. In addition, independent service providers are leasing transmission
facilities from long distance carriers; local telephone companies and emerging
network providers to provide competing voice, video and data services. At the
same time, the complexity and size of public networks have increased.
In this dynamic environment, telecom companies are being forced to
differentiate themselves on the basis of technological leadership, price,
responsiveness, services offered, reliability and security. Upgrading and
deploying new telecommunications networks and services requires the
integration of diverse transmission media and protocols, network equipment,
network operations platforms and network management systems. Moreover, the
competitive environment requires more effective network management, such as
detection of and automatic response to fault indications, remote configuration
of networks and equipment, automation of accounting and billing functions,
optimization of network performance and improvement of security. Network
management systems must operate seamlessly among service providers and
interface with customer network management systems.
Until recently, most telecommunications service providers managed their
voice networks exclusively with proprietary systems developed and supported by
internal development organizations. While these systems are tightly integrated
and can provide operating efficiencies within a single network, they are
expensive to develop, operate and maintain, and often require a large,
specialized and expensive technical organization. In addition, because these
systems are not based on a common standard, management among
telecommunications service providers and the provisioning of end-to-end
services are more difficult, and the equipment choices of service providers
are limited to vendors who conform to the provider's standard. Furthermore,
because these systems are proprietary and are based on older software
technologies, they generally do not easily scale, usually require substantial
development effort for new functionality and services, and are often
incompatible with the additional software and hardware service providers
require to upgrade networks. We believe that providers can no longer afford to
sustain these systems in the new competitive environment and are now looking
at commercial off-the-shelf software to manage their networks.
Service providers have augmented their proprietary systems by incorporating
the SNMP to manage their data networks. SNMP has been widely accepted as a
standard in private enterprise data networks. SNMP-based systems interoperate,
permit the addition of incremental functionality, hardware and software
without substantial additional development effort and are generally adequate
to manage equipment in enterprise data networks. A major drawback of SNMP-
based systems, however, is in bandwidth-constrained public networks, where
their architecture requires continuous communication among equipment and
management platforms; this communication can consume substantial bandwidth and
limit network scalability. In addition, SNMP provides for limited data
integrity, does not identify a security protocol and does not effectively
manage the flow of data on networks. While SNMP has permitted service
providers to begin their transition away from proprietary systems, it has also
created the need for a new family of systems that are highly scalable, cost-
effective and offer high bandwidth.
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In response to the shortcomings of available network management solutions,
the International Telecommunications Union (ITU), an organization of
telecommunications companies and governments, identified the need for a
standard that permitted interoperability among network management solutions.
The ITU recognized the need for this standard to provide a framework within
which network management systems could more cost-effectively be designed,
developed and deployed and at the same time provide functionality beyond that
enabled by proprietary and SNMP-based systems. The standard established by the
ITU is known as the TMN standard. The specifications comprising the TMN
standard divide the telecommunications management infrastructure into a
framework of five logical layers: network element (NEL) (equipment), element
management (EML), network management (NML), service management (SML) and
business management (BML). The TMN standard includes a set of interface
specifications for communicating within and among layers to enable
interoperability among service providers (and their customers), network
operating systems, network management systems and network equipment.
TMN continues as an international standard for public telecommunications
network management and is used in operational networks. The TMN architecture
is widely accepted for partitioning the operational functions of a
telecommunication network into system components. The TMN protocol standards
are used throughout the world in a number of modern network types such as
Global Systems Mobile (GSM) networks and Synchronous Optical
Network/Synchronous Digital Hierarchy (SONET/SDH) networks. However, the
adoption of TMN protocols are reaching maturity as service providers and
network equipment manufacturers begin to look to general computing
technologies, in particular CORBA, for the next phase of integrated management
solutions.
CORBA middleware technology is supported by a wider market base than the
telecom specific TMN technologies. The telecom industry hopes to reduce
implementation cost and increase the pace of technology innovation by using
CORBA. CORBA benefits from its use in a wide number of information-based
industries, greater availability of knowledgeable software engineers, and ease
of inter-operability through the Interface Definition Language (IDL). Today,
many telecom OSS companies have added CORBA interfaces to their OSS products
and major network equipment suppliers have started building CORBA interfaces
into their network elements.
Strategy and Products
We provide a broad suite of next-generation, telecommunication management
applications software and services that are facilitating the growth of
communications. These products provide CORBA and TMN capabilities through
configurable components and platforms. Our products incorporate easy-to-use,
high performance development environments, platforms, tools, applications and
components that provide solutions at the NEL, EML, NML and SML of the TMN
model. Products include CORBA and TMN-conformant management application
development environments, distributed platforms, RTOS (real-time operating
systems) based embedded software, and FCAPS (fault, configuration, accounting,
performance, security) network management applications.
We consider our engineering services, provided through our technical
support and professional services units, to be key to our success with our
customers. Our technical support department provides pre and post-sales
support, training and maintenance services, while our professional services
unit provides customized software design and engineering, including designing,
developing, deploying and maintaining turnkey telecommunications management
solutions.
Our network management solutions allow telecommunications service providers
and equipment manufacturers to:
Improve Time to Market. Our software solutions enable our customers to
produce standards compliant network management solutions for their products in
less time, and with fewer developers. Our products provide off-the-shelf
implementations of management standards that our customers can embed into
their products and OSS systems. Instead of developing the protocols and
management functions from scratch, our customers can
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simply integrate our off-the-shelf products to their system. This improves
developer productivity, reduces the overall development effort and improves
the quality of the end product. Our development tools increase engineering
productivity and thereby reduce development and test time and facilitate the
introduction of nonstandard protocols and management functions.
Reduce costs. Our software solutions enable telecommunications services
providers to reduce costs by efficiently managing diverse networks and network
equipment with a single, integrated management system. Equipment providers are
driven by service provider requirements to support these network management
standards. Unlike many proprietary systems, our solutions adhere to an object-
oriented architecture and do not require large, expensive technical
organizations for additional development and maintenance. Because our products
and solutions use standard interfaces, they allow multiple systems to work
with each other across applications, networks, vendors and systems. This
interoperability allows service providers to purchase the most cost-effective
equipment from a broad range of vendors.
Derive incremental revenue. Our network management solutions also enable
telecommunications service providers to bring new products, functionality and
services to market more rapidly by providing an integrated, standards-based
suite of tools that facilitate the rapid development and deployment of new
applications across heterogeneous networks. For example, our agent, manager
and adapter products have been used by telecommunications switch equipment
manufacturers, operation support system vendors and telecommunications service
providers to provide data collection information to support billing, trouble
ticketing and inter-service provider exchange of management information
(electronic bonding).
Implement complete solutions. Successful implementation requires seamless
vertical integration of all the layers of the TMN architecture. We believe
that we provide the only commercially available complete family of products
and services for implementing a fully integrated TMN network management
system. Network management systems based on our full suite of products and
services operate seamlessly with other TMN systems as well as with CORBA,
SNMP, and proprietary legacy systems.
Preserve existing investments. Our solutions enable telecommunications
services providers to continue to use and integrate their existing TL1,
proprietary ASCII message-based and SNMP-based network components in a total
network management solution. Our technology and solutions manage TL1, SNMP and
other legacy equipment and systems within our solution framework.
Strategy
Our goal is to position Vertel as a leading provider of critical object-
oriented middleware solutions to telecommunications service providers,
equipment manufacturers, platform vendors and independent software developers.
We are focused on next generation communication services and software
solutions that support multiple management technologies. These solutions are
targeted to provide public and Internet Protocol (IP) network operation
support systems, the key components required for end-to-end network and
service management with carrier-grade quality of service. Key elements of our
strategy include:
Extending Vertical Solutions. Our strategy is to provide complete suites of
software and services that enable businesses to implement telecommunications
management solutions efficiently. We intend to provide management applications
that leverage our experience in telecommunications specific CORBA and TMN
implementation across layers and use the unique features of the TMN
architecture.
Leveraging Technological Leadership. We believe that our technological
leadership, as evidenced by the breadth and functionality of our products and
services are, in part, the result of 12 years of experience deploying products
that implement the protocols and services that adhere to ITU and industry
specifications.
We plan to continue to invest significant resources in research and
development to extend our technological leadership in CORBA, and to a lesser
extent TMN, technologies, maintain a time to market advantage and develop
management solutions that leverage our object-oriented middleware expertise.
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Targeting Service Providers. We believe that increased focus on the
telecommunications service provider market is necessary to hasten the broad
application of our product solutions. To this end, we provide management
platforms, solutions for operation support systems, customization and
implementation services, software that is easy to use and install and high
quality training, consulting and support. Our customers include U.S. Regional
Bell Operating Companies, as well as many other service providers, network
operators worldwide and network element vendors worldwide.
Leveraging Existing Relationships with Equipment
Manufacturers. Historically, we have derived a significant portion of our
revenues from the sale of software to be embedded by telecommunications
equipment manufacturers. We believe that the availability of our products in
telecommunications equipment will facilitate the adoption of our solutions in
the marketplace by service providers.
Establishing Leadership in New Markets. One of the first industries to
adopt the TMN standard was the fiber optic transmission market, where new
networks were being deployed without the requirement to interoperate with
legacy systems. As data has become a greater portion of the traffic on
telecommunications networks and SNMP is proving inadequate for the performance
and traffic demands of public networks, we have also begun to target leading
data communications companies.
Expanding Global Sales and Distribution Capability. We currently sell our
products primarily through a direct sales force in the United States and
internationally. We intend to expand our sales and distribution infrastructure
in the United States and internationally to increase sales coverage and
position ourselves to capture market share. We plan to leverage our direct
sales efforts by pursuing sales prospects generated by partners and by selling
through select systems integrators and other indirect sales channels. In
addition, we plan to continue to license our software to service providers,
network equipment manufacturers and independent software developers. Our
customers have the right to distribute products, services and applications,
developed using our software, in exchange for royalty payments. We believe
that our distribution strategy will help to establish our solutions as the
premier object-oriented middleware products for network management.
Promoting the Deployment of CORBA and TMN. We believe that the broad
adoption and deployment of CORBA and TMN will be the key to our success.
Correspondingly, we commit substantial resources to the promotion of the CORBA
and TMN standard for telecommunications network management. We are working
with leading industry experts, forums and working groups to define, refine and
develop specifications for CORBA and TMN solutions. We use trade shows,
seminars and industry conferences to advance our market strategy.
Developing Strategic Relationships and Acquisitions. We believe that we can
expand our visibility, improve our product offerings and broaden our potential
market through the development of relationships with other companies within
the telecommunications network market. In 1999, we entered into a relationship
with Atlantech Technologies, a leading supplier of element management
framework software, as a strategic partner for supplying turnkey element
management solutions through our professional services organization. We are
also pursuing strategic acquisitions of complementary businesses or
technologies.
Expanding PSU Customer Base. We believe that there is a large market for
customized network management solutions. Our professional services unit
provides customized software design and engineering, including designing,
developing, deploying and maintaining turnkey telecommunications management
solutions. By utilizing or enhancing our existing products, our professional
services unit is capable of customizing and delivering carrier-grade quality
solutions that enable businesses to efficiently implement network management
solutions quickly and cost-effectively.
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Products
We generally license our binary code to customers who integrate it into
their products. Revenue is derived from initial developer license fees and
from ongoing usage-based royalties relating to the distribution of the
customer's integrated products.
We added three products to our portfolio in 1999. These products support
our growth strategies by addressing the emerging market demand for CORBA
products with e*ORB, and by adding application level products through the
Vertel Mediation Framework, and AccessVision Network Management.
e*ORB, which was launched commercially in December 1999, has received
substantial market attention since its introduction. CORBA is a popular and
widely deployed middleware telecommunications solution with roots in the
computer industry. CORBA technology is recognized for its ability to
interoperate across multiple and disparate computer platforms. Our CORBA
offering, e*ORB, is targeted at producing a carrier-grade CORBA product line
to address the performance and reliability requirements of CORBA telecom
customers.
Our traditional Common Management Information Protocol (CMIP)/TMN product
line spans the categories of development tools and platforms, server-based
communications stacks, and embedded products. These products incorporate easy-
to-use, high-performance applications and components into open standards-based
solutions. Our TMNTelecore(TM), and TMNAccess(TM) product lines, as well as
our Embedded Telecommunications Solutions (ETS), provide the telecom software
designer with tools and platforms for the development of traditional TMN-
compliant solutions. These tools and platforms conform to the latest
TeleManagement Forum (TMF) TMN/C++ Application Programming Interface (API)
specifications. Our TMN products are widely adopted by the industry.
New Product Offerings:
e*ORB
e*ORB provides a carrier-grade CORBA ORB targeted at the telecom OSS and
network management infrastructure market. Unlike other CORBA products on the
market, it focuses on delivering high performance and high scalability in a
lightweight implementation that supports a set of features applicable to our
targeted telecom customers.
A key driver for the adoption of CORBA technology by telecom OSS and
network management suppliers and users is CORBA's Interface Definition
Language (IDL). IDL provides a high-level method for interfaces to be defined
and agreed between two applications. Applications can integrate and share
information with each other simply by compiling the IDL interface into the
applications. Protocol integration is typically a time consuming and error
prone task. CORBA IDL provides software developers with a technology that
simplifies that task. Our e*ORB business leverages this attribute of CORBA to
provide rapid integration of management applications with other applications
and network elements.
In addition to Unix servers and other standard OSS and management
platforms, e*ORB has been designed to run on Personal Digital Assistant (PDA)
class machines like the PalmPilot(TM) and on high-end network elements such as
Optical Switches. This is because e*ORB is small enough to fit within the
memory and CPU constraints of a PDA, and fast enough to meet the performance
requirements of high-end product implementations.
e*ORB conforms to the Object Management Group's (OMG's) "minimum CORBA"
specification and supports product enhancements that make it more adaptable to
the telecom market. The e*ORB software architecture supports a pluggable
protocol framework. e*ORB supports the standard transport protocol, TCP/IP,
but through the pluggable protocol framework, it allows other networking
technologies such as Asynchronous Transfer Mode (ATM) and broadcast wireless
to be substituted for TCP/IP.
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e*ORB technology is not only being used by our customers but it is also
used in our own application level products. e*ORB is used in our mediation
framework to provide internal software distribution across our mediation
software components.
Vertel Mediation Framework
The Vertel Mediation Framework (VMF) is used to simplify and accelerate the
integration of network infrastructure with telecom OSS infrastructure. Our
professional services unit uses the VMF as a building block to integrate
network managers and element managers with other OSS systems without requiring
changes on the part of the managers or the OSS. OSS's are typically
applications that fall into three broad classes: Provisioning, Billing and
Service Assurance (Fault, Configuration, Performance, Accounting and
Security). VMF provides integration between all three OSS classes and the
underlying network equipment management systems.
As noted in the Industry Background and Trends section, telecom operators
are increasingly faced with integrating and combining multiple networks and
their associated components. In many cases, these components, or network
elements, were not designed to operate, or be managed, together. A variety of
incompatible protocols connect the network elements to their element
management systems, and their element management systems to their network
management systems. These disparate protocols must coexist and can be made to
do so through the use of a mediation solution.
There are too many combinations of transport and communications protocols
and target OSS systems to feasibly provide interfaces for each operator's
unique needs. Equipment vendors for network equipment and OSS systems have the
choice of re-coding the interface for each customer, or utilizing a mediation
framework that can provide the requisite "protocol-bridge" from their protocol
of choice to the one demanded by their customers.
The Vertel Mediation Framework is being employed in these situations. In
simple terms, the framework is composed of a series of modules that connect
via a CORBA bus (by way of using e*ORB). These modules convert the protocol
and application semantics used by the equipment manufacturer and the service
providers to a normalized format--the Vertel Normalized Protocol (VNP). By
using a combination of two protocol adapters, any protocol (standard or
proprietary) can be translated to another. As the number of protocol adapters
increase, the turn-around time for mediation solutions will naturally
decrease, reducing service providers network integration time, and equipment
vendor's time to market.
The VMF uses a rules-based mediation engine to accommodate changes to the
application or equipment without re-engineering the software. Mediation
solutions built with the Vertel Mediation Framework can be quickly updated to
adapt to changes in the protocol standards, to add additional network element
types, and to add other protocols to the solution. This "life-cycle-
management" of network mediation solutions helps our customers maintain their
network better and improves the quality of service to their end-users.
AccessVision Network Management Framework
We have entered into an alliance with Scotland-based Atlantech Technologies
to offer a flexible framework to deliver management solutions for the network
element layer (NEL) and the network management layer (NML) of the TMN
architecture. The AccessVision (AV) product family provides an open,
standards-based set of management building blocks that allow development,
configuration and deployment of specific management solutions for use within
these domains. Our professional services unit uses the AccessVision building
blocks to construct customized network managers and element managers for our
customers.
AccessVision has two main components: the AccessVision Management Toolkit
(AVMT) and the AccessVision Management Framework. AVMT simplifies the task of
developing network management applications. Our customers select their vendors
by how quickly turnkey manager projects can be completed and the functionality
of the resulting managers. AVMT makes it possible for our professional
services unit to deliver a competitively featured manager, cost effectively
and with a shortened development cycle.
9
The AccessVision Management Framework comes equipped with support for SNMP
and ASCII text based management interfaces and has several built-in management
applications for fault, configuration, performance, and security management. A
key consideration for carrier-grade management projects is the ability of the
management software to scale to large networks. We adopted AccessVision for
our product offerings because Atlantech demonstrated to our satisfaction that
AccessVision provided sufficient scalability to meet the needs of our
customers.
Historic TMN Products
Our two TMN product families, TMNTelecore(TM) and TMNAccess(TM), provide
full TMN capabilities through configurable components and platforms. The
products incorporate easy-to-use, high performance development environments,
platforms, tools, applications and components into open, standards-based
solutions. We supply fully implemented information models for OSI, ATM,
SONET/SDH and other telecommunications transport technologies. The platforms
incorporate object-oriented, fully integrated building blocks and development
environments. Our TMN Platforms and tools use the TMF TMN/C++ API as the upper
interface to the products. The TMN/C++ API masks the complexities of the
underlying agent or manager functionality behind easy-to-use C++ object
classes. Our communications stacks employ the seven-layer Open Systems
Interconnect (OSI) model and TCP/IP. Routing software packages and other
specialized stacks are also available. We produced the industry's first fully
functional, portable and/or ported, OSI protocols for all seven OSI stack
layers.
TMNTelecore Products
Our TMNTelecore product family provides comprehensive, telecom software
development environments and integrated deployment platforms for service
providers, network operators and system integrators. TMNTelecore facilitates
the quick deployment of TMN-conformant agents, managers, Q-adapters, and the
creation of analytical applications for network generated events.
TMNTelecore automates the various tasks associated with the deployment of
EMS, NMS, and OSS interconnection applications. TMNTelecore is available for a
variety of UNIX environments (Solaris, AIX and HP-UX) and now the Microsoft
Windows-NT environment.
The TMNTelecore product suite benefits telecommunication application
providers by offering shortened development cycles, improved application
quality and the reduction of ongoing support costs through the use of new and
integrated technologies. It provides a comprehensive platform that enables the
creation of integrated telecom management solutions. The environments offered
include:
Agent Development Environment (ADE) enables developers to build
customizable, dynamically configurable TMN-conformant agents. Our TMNTelecore
ADE automates most of the tasks associated with building an agent application,
leading each stage of application development--design, prototyping,
development, testing, and deployment. The resulting, fully functional TMN
Agent provides value added, agent role process for network elements, Q-
Adaptors, and mediation devices at all of the lower four layers of the TMN
model.
Manager Development Environment (MDE) enables developers to easily build
customizable, dynamically configurable, scalable, TMN-conformant manager
applications. TMNTelecore MDE automates most of the tasks associated with
building a manager application. The structure of the TMNTelecore MDE and its
integrated components leads the project team through each stage of manager
application development--design, prototyping, development, testing, and
deployment.
TMNTelecore Agent Simulator uses TCL scripts to emulate the behavior of a
fully implemented, Q3-conformant agent entity. It is easy to use and is a very
helpful tool to the system designer. During 1999, we added a new feature--code
generation--to this product. The Code Generation feature assists the designer
by "writing" portions of the complex code as analyzed by the simulator in the
testing environment. The TMNTelecore Agent Simulator allows the customer to
test during any stage of development, greatly reducing the time to market.
10
TMNTelecore Manager Simulator uses TCL scripts to emulate the behavior of a
fully implemented, Q3-conformant manager entity. It is easy to use and is a
very helpful tool to the system designer. During 1999, we also added the
aforementioned code generation feature providing the same benefits to the
TMNTelecore Manager Simulator as mentioned above for the TMNTelecore Agent
Simulator.
TMNAccess Products
Our TMNAccess products provide telephony and data communication equipment
vendors standards-based interoperability features in network elements.
TMNAccess consists of products and protocol options targeted for specific
industry technologies and markets, and acts as the bridge for mission critical
data transport from the network to the operation support systems. TMNAccess is
comprised of a range of products and solutions:
TMNAccess FTAM (File, Transfer, Access and Management) is the most common
file transfer protocol used to transfer call detail records (CDRs) from the
network switch to the service provider's billing system. Our FTAM products are
used throughout the world to provide trouble-free and consistent message
transfer for this financially critical application.
TMNAccess DMH (Data Message Handler) is a set of development tools and
applications for real-time billing record exchange between cellular service
providers. It is based on Telecommunications Industry Association's IS-124
standard and enables the equipment vendor and application developer to direct
and process billing information. These products allow equipment and systems in
a wireless network to format and communicate call detail information used in
billing. IS-124 components include the stacks, interfaces and platform tools
to lead project teams through IS-124/DMH function development, testing and
deployment.
TMNAccess ETS (Embedded Telecommunications Solutions) provides the most
complete and mature set of products for equipment vendors developing domestic
and international digital loop carrier (DLC) devices, SONET/SDH transport
equipment, ATM switches, DWDM devices, SM, CDMA, TDMA, CDPD base stations and
newer optical switching devices. Our Embedded Telecommunications Solutions
include embeddable agent development tools, protocol and communications
interfaces, and an embeddable CORBA ORB--e*ORB.
Wireless Products
During 1998, we sold our CDPD and pACT wireless products, technologies and
contracts to AMP Incorporated. This enabled us to strengthen core product
offerings and expand our solutions portfolio for the access, operations
support system and backbone vertical markets. The remaining wireless products
are now part of our TMNAccess DMH product line.
ATN Router Software Products
In June 1998, we granted a semi-exclusive license for our Aeronautical
Telecommunications Network (ATN) Router Software product line to Airtel ATN
plc, an independent supplier of communications software products and services
for the aeronautical industry. ATN router products are specifically designed
for routing end systems and intermediate systems in air-to-ground and ground
communication. The products provide complete ATN-compliant design,
implementation, test and deployment capabilities based on ATN standards.
Although we retain intellectual property rights in these products, we no
longer sell or support any of these ATN products.
Competition
We compete on the basis of product features and characteristics, including
quality, performance, ease of use, functionality, interoperability,
reliability, scalability and extensibility and speed of implementation, price,
implementation and development services, technical support, and training and
maintenance.
Competition in this market is intense and is characterized by rapidly
changing technologies, evolving industry standards, in-house or proprietary
solutions, frequent new product introductions and rapid changes in
11
customer requirements. Moreover, it is expected that this market will continue
to experience several new entrants in the foreseeable future. To maintain and
improve our competitive position, we believe that we must continue to develop
and introduce or acquire, in a timely and cost-effective manner, new services,
products and product features that keep pace with competitors' offerings,
technological developments and changing industry standards.
Our current and prospective competitors offer a variety of solutions to
address the telecommunications network management systems and management
applications market. These competitors generally fall within five categories:
Customers' internal design and development organizations that produce
telecommunications network management systems and management applications
for their particular needs (e.g., Bellcore-based systems);
Current TMN software providers including DSET and to a more limited
extent ONE, ISR Global, Object Stream and Bull;
Current CORBA software providers including IONA Technologies and Inprise
(Corel Corporation and Inprise announced a definitive merger agreement on
February 7, 2000;
Hardware and software vendors including IBM, Sun Microsystems and
Compaq; and
Providers of specific market applications including TCSI and Objective
Systems Integrators.
Many of our current and potential customers continuously evaluate whether
to design, develop and support their own telecommunications network management
systems and applications or purchase them from outside vendors. These
customers have traditionally designed and developed their own software
solutions internally for their particular needs and may therefore be reluctant
to purchase products offered by independent vendors like us. We estimate that
a significant percentage of telecommunications network management solutions
are still developed in-house. In addition, despite its limitations for
deployment in public or very large enterprise networks, SNMP continues to
serve as the de facto standard for managing enterprise data networks. As a
result, we believe that we must continuously educate existing and prospective
customers as to the advantages of TMN and related open management technology
versus internal, proprietary telecommunication network management systems and
management applications.
CORBA software providers such as IONA and Inprise supply their products to
a general computing market beyond the telecom market. These competitors also
serve the telecom CORBA market that is the focus of our CORBA business. The
global acceptance of CORBA and TMN could lead to increased competition as
third parties develop telecommunications network management systems and
management applications competitive with those offered by us. Any of these
competitors may be able to respond more quickly than we can to changes in
customer requirements or technology changes and be able to devote greater
resources to the development, promotion and sale of their products. There can
be no assurance that our current or potential competitors will not develop
products comparable or superior to those developed by us or adapt more quickly
than us to new technologies, evolving industry standards, new product
introduction or changing customer requirements. See "Risk Factors--Our Markets
are Very Competitive and Many of Our Competitors are Larger than We Are."
Proprietary Technology
We primarily rely on a combination of copyright, trade secret and trademark
laws and nondisclosure and other contractual restrictions on copying and
distribution to protect our proprietary technology. In addition, as part of
our confidentiality procedures, we generally enter into nondisclosure
agreements with our employees, consultants, distributors and corporate
partners and limit access to and distribution of our software, documentation
and other proprietary information. It may be possible for a third party to
copy or otherwise obtain and use our products or technology without
authorization, or to develop similar technology. Particularly in light of the
fact that we license portions of our source code to certain customers and
distributors, there can be no assurance that the foregoing measures are
adequate to protect our proprietary technology. In addition, our products are
licensed in other countries and the laws of such countries may treat the
protection of proprietary
12
rights differently from, and may not protect our proprietary rights to the
same extent as the law in the United States. See "Risk Factors--Our Current
Efforts to Protect Our Intellectual Property May Be Insufficient." We have
filed a provisional patent application in the United States Patent Office
establishing an early claim for protection of a number of our core e*ORB
technologies. In the near future, we plan to file regular U.S. national patent
applications for each of those core technologies, based on the provisional
patent application. Application for a patent offers no assurance that a patent
will be issued as applied for. Issuance of a patent offers no assurance that
the patent can be protected against any claims of invalidation or that the
patent can be enforced against any infringement. In addition, litigation of
patent issues can be costly and time-consuming.
Sales, Marketing and Customers
We market and sell our products and services through an internal sales and
marketing organization that consisted of 28 people as of December 31, 1999.
Our marketing efforts are focused on increasing awareness of Vertel, TMN,
CORBA and related technology solutions, and network management in general,
among telecommunications service providers, network equipment manufacturers,
independent software vendors, systems integrators and platform vendors, and on
positioning ourselves as the leading provider of TMN and CORBA software
solutions. Our marketing programs have three primary goals: market education
and awareness, sales effectiveness and product management. Our education and
awareness activities include seminars, speaking engagements, sponsorship of
conferences, articles in industry publications, participation in industry
forums and working groups, and inclusion in market studies by leading industry
analysts. In addition, to disseminate our marketing message and improve sales
effectiveness, we use direct mail, advertising, presentations, demos, press
releases, press/analyst tours, marketing literature, public relations, trade
shows and a website. Our product management staff works with customers and
industry experts to ensure that our products will satisfy market requirements.
The sales cycle for our products is lengthy and often requires us to
provide a significant level of education to prospective customers regarding
the use and benefits of our products. As a result, we sell our products
primarily through a direct sales organization of highly technical sales
people. See "Risk Factors--Lengthy Sales Cycles Make Predictions of Revenues
Difficult." Of the 28 people engaged in sales and marketing, 20 people
belonged to our direct sales organization as of December 31, 1999.
In addition, we sell software through distributors and agents in certain
other countries, and enable our customers through source code licenses to
distribute our products in exchange for royalty payments.
We typically transact business in U.S. currency worldwide. International
sales totaled approximately 49%, 43% and 40% of net revenues for the fiscal
years 1999, 1998 and 1997, respectively. See "Risk Factors--Our International
Sales are Subject to Factors Outside of Our Control" and "Our International
Sales are Subject to Currency Fluctuations."
Historically, we have not had a license backlog because we can fill
substantially all orders upon receipt of a firm purchase order.
Customer Service and Support
Professional Services
We believe that the adoption of our products will depend, in part, upon the
ability of service providers, network operators, network hardware and software
vendors, and systems integrators to implement TMN and CORBA solutions quickly
and cost-effectively. Our professional services unit works with systems
integrators, application developers and in-house customer engineers to enable
customers to deploy a complete TMN solution. Professional services include
system analysis and design, source code portation, conformance testing and
certification and custom application development. Many of our software
customers contract for professional services. We generally provide
professional services based on a detailed statement of work.
13
We have devoted substantial resources to the provision of professional
services in order to facilitate the implementation of our products by service
providers and to differentiate ourselves from competitors. As of December 31,
1999, our professional services unit consisted of 28 people.
Technical Support
In order to assist customers in fully designing and operating integrated
CORBA and TMN solutions, we believe that it is important to offer a broad
range of technical support services for our customers. Technical support
consists of the following services:
Training. We provide training to our customers on a per-product basis.
Training services range from detailed technical tutorials on technology
products to product configuration, management and administration training on
end user products.
Product Support and Maintenance. We can provide global coverage 24 hours
per day, seven days per week with direct access to technicians and product
support engineers on demand. In response to a high demand for expert-level,
on-site product support, we offer an on-demand service staffed by highly
competent product experts. Personnel primarily located in our California and
Germany facilities provide product support. Customers subscribing for product
support also receive software updates and maintenance releases. We typically
issue software updates every six to twelve months.
We typically warrant our products for 90 days. A maintenance support
program is available for support after the warranty period. For newer products
we begin the maintenance program from the date of sale in place of the initial
product warranty. To date, we have not encountered any significant product
maintenance problems. See "Risk Factors--We Need to Develop New Products to be
Successful" and "Our Software is Complex and Therefore is Prone to Bugs."
On-site Consulting. Our engineers travel to customer sites for an initially
specified period and provide expert level consultation including additional
system design, training, customization and development support.
As of December 31, 1999, our technical support organization consisted of 16
people.
Research and Product Development
We have made substantial investments in the development of our products. We
believe that our future success depends in a large part on our ability to
enhance existing products, develop new products, maintain technological
competitiveness and meet a wide range of customer needs. Accordingly, we
intend to continue to make substantial investments in research and development
for the foreseeable future. Overall product development efforts include:
CORBA products. Our recently introduced e*ORB products represent the core
of our product evolution. In 1999, the majority of our R&D investment in CORBA
went into the commercialization of the e*ORB technology. Our future plans
include the addition of value-added CORBA services to enhance our CORBA
product portfolio. In addition, the technology at the core of the e*ORB
product will be used for future management applications products.
TMN Managers and Agents. We deployed the industry's first TMN agent toolkit
in the early 1990's and the industry's first TMN agent and manager products
based upon the TMF TMN/C++ API (NMF API)--an emerging standard for a three-
tiered, object-oriented interface. The TMN Agent Development Environment (ADE)
and TMN Manager Development Environment (MDE) are two industry-leading
products in the market today.
Vertical Integration and Optimization. We believe that we are unique in
providing a single-vendor, object-oriented, integrated implementation of OSI
stacks, TMN agent and manager products, Q-adaption and MIB
14
translation. Our product software modules can be tightly integrated and
optimized for performance and efficient memory usage.
Portability. Our products can be ported in network elements, on UNIX and NT
platforms, in popular real-time operating systems (RTOS), in a wide range of
client-server, fault-tolerant architectures and environments. These products
provide: encapsulations of the underlying communication network portation
details, flexible OSI and transport stack interfaces and communication
networks. Portability allows us to implement changes and enhancements to the
core technology once and to host those changes to many environments
simultaneously. Currently, we support five RTOSs, Solaris, HP-UX, AIX and
Windows NT.
Standards Conformance. Our implementations have successfully undergone many
conformance tests in a variety of contexts and environments. Conformance
testing guarantees that the standards have been implemented properly and
enables interoperability to occur.
Our research and development organization is located principally in San
Diego, California. As of December 31, 1999, our research and development group
consisted of 38 people.
During late 1999, we restructured operations to reduce operating expenses.
As a result, our TMN development staff was significantly reduced. Future TMN
product development will be performed primarily by our Poland operations.
15
RISK FACTORS
Our Success is Dependent on Widespread, Timely Adoption of the CORBA and
TMN Standards. The majority of our software and services are based on the
CORBA and TMN standards. If different protocols become the standard in the
telecommunications industry, service providers are unlikely to purchase our
products. Traditionally, SNMP was used mainly in enterprise applications, but
in recent years, the SNMP standard has been used by telecommunications service
providers for managing their public data networks. In addition,
telecommunications service providers have historically depended on proprietary
systems, which do not rely on any standards. While we invest substantial
effort in encouraging service providers to adopt either CORBA or TMN
standards, we do not have direct control over this process and we cannot
provide any assurance either standard will be adopted. Telecommunications
service providers could adopt a competing standard or no standard at all.
Similarly, they could adopt the CORBA and/or TMN standards, but not do so
within the timeframe that we expect them to. If telecommunications service
providers adopt standards other than CORBA or TMN, adopt the CORBA or TMN
standards but not in a timely way or fail to adopt any standard at all, our
business, operating results, financial condition and strategic position would
be materially adversely affected.
We Need to Develop New Products to be Successful. The markets for our
products are characterized by rapidly changing technology and frequent new
product introductions. Therefore, we believe that our future success will
depend on our ability to enhance our existing products and to develop and
introduce in a timely fashion new products that achieve market acceptance. We
have, from time to time, experienced delays in developing new products and
enhancements, and while these have not had a material adverse effect on our
business, if in the future, we are unable to develop and introduce new
products or product enhancements in a timely manner, this could have a
material adverse effect on our business, financial condition and results of
operations. In addition, if the products we develop are not widely accepted by
customers, we are not able to identify, develop, manufacture, market or
support new products successfully or we are unable to respond effectively to
technological changes, revisions in industry standards or product
announcements by competitors, our business, operating results and financial
condition would be adversely affected.
We Expect Our Revenue to be Primarily from New Products. We expect that new
products and related services will account for a substantial portion of our
revenues in the foreseeable future. Since we expect to rely less on existing
products for revenue, factors adversely affecting the pricing of or demand for
our newer CORBA and TMN and related software and services, such as competition
for new products or lack of customer acceptance, could have a
disproportionately adverse effect on our business, operating results and
financial condition.
Potential Future Products May Limit Current Product Sales. From time to
time we announce new products, capabilities or technologies that have the
potential to replace or supplement our existing product offerings. These
announcements can cause customers to defer purchasing or licensing our
existing products, which would adversely affect our business, operating
results and financial condition.
Changes in Governmental Regulations Could Make our Products Less
Marketable. The telecommunications industry is subject to regulation in the
United States and other countries, and therefore our products and the busi-
nesses of our current and potential customers are required to receive regula-
tory approvals from multiple organizations using different standards. The en-
actment or amendment by federal, state or foreign governments of new laws or
regulations or changes in the interpretation of existing regulations could ad-
versely affect our products and the businesses of our current and potential
customers, and therefore affect our business, operating results and financial
conditions.
Our Products are Targeted at Undeveloped Markets; Our Success Depends on
their Maturation. As part of our corporate strategy, we have targeted product
markets that are in the early stage of their development, including the
telecom CORBA market, the telecom embedded CORBA market, and the TMN market.
If these markets do not mature as we expect them to, we will not have the
growth opportunities we currently hope for. We believe that these markets will
take years to develop and that development of these markets will require:
(1) a sufficient number of high quality, commercially successful
telecommunications applications based on the
16
CORBA and TMN Standards, (2) a general widespread telecom industry adoption
and use of CORBA, CORBA services and TMN software infrastructure products that
telecommunications equipment manufacturers and service providers will use to
implement and integrate OSSs from different manufacturers and/or different
areas of management (EML, NML, SML and BML) and (3) the widespread use of
embedded CORBA by telecom manufacturers in their devices for both network
management and for the service logic area. There can be no assurance that
these conditions will be met in a timely way, if at all. We cannot predict the
size of the market or the rate at which the market will grow and if the
markets fail to grow, grow more slowly than anticipated, or become saturated
with competitors, our business, financial condition and results of operations
would be materially adversely affected.
Our Quarterly Results are Based on a Small Number of Large Orders that are
Subject to Many Factors Outside of Our Control. A substantial portion of our
software revenues have been, and will continue to be, derived from a small
number of large orders placed by large organizations after extended
evaluation. The timing of orders and their fulfillment has caused and will
continue to cause material fluctuations in our operating results, particularly
on a quarterly basis. In addition, our quarterly operating results have in the
past and will in the future vary significantly depending upon factors such as:
. capital spending patterns of our customers;
. changes in pricing policies by ourselves and our competitors;
. increased competition;
. the cancellation of service or maintenance agreements;
. changes in operating expenses, personnel changes, demand for our
products;
. the number, timing and significance of new product and product
enhancement announcements by either ourselves or our competitors;
. our ability to develop, introduce and market new and enhanced versions
of our products on a timely basis;
. the mix between U.S. and international sales;
. seasonality; and
. the mix of direct and indirect sales and general economic factors.
Based upon all of these factors, we believe that quarterly revenues and
operating results are likely to vary significantly in the future and that
period-to-period comparisons of results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
There can be no assurance that our revenue will increase or be sustained in
future periods or that we will be profitable in any future period. Further, it
is likely that in some future quarter our revenue or operating results will be
below the expectations of investors. In such event, the price of our common
stock is likely to be materially adversely affected.
A Portion of Our Revenues Are Seasonal. Our sales in Europe are adversely
affected in the third quarter of each year as many customers and end-users
reduce their business activities during the summer months. These seasonal
factors may have an effect on our quarterly results of operations.
The Timing of Our Orders May Result in Large Swings in Quarterly Operating
Results. We typically realize a significant portion of our software license
revenues in the last month of a quarter, and frequently in the last weeks or
even days of a quarter. Since our revenues are based in large part on a
limited number of large orders, small delays in a limited number of orders can
have a dramatic effect on quarterly results.
Certain Portions of Our Costs are Fixed in the Short Term. Because only a
small portion of our expenses varies with revenue in the short term, net
income may be disproportionately affected by a reduction in revenue,
particularly since reductions in revenue may not be apparent until the last
days of a quarter. Similarly, to the
17
extent additional expenses are not subsequently followed by increased
revenues, our business, operating results and financial condition could be
materially and adversely affected. If revenue levels are below expectations,
operating results are likely to be materially adversely affected.
Lengthy Sales Cycles Make Predictions of Revenues Difficult. Our sales
cycle is subject to a number of significant delays over which we have little
control and which make forecasting difficult. Therefore, significant delays in
implementation, or delays in purchases by customers, whether or not such
delays are within our control, could materially adversely affect our business,
operating results and financial condition. Our products are complex and
generally involve significant investment decisions after extended evaluations
by prospective customers. Accordingly, we must engage in a lengthy sales cycle
to provide a significant level of education regarding the use and benefits of
our products to potential customers. Our customers often must secure executive
level approval to license our products and our license agreements often
involve lengthy negotiation. In addition, the implementation of our software
products involves a significant commitment by customers over an extended
period of time.
Our Fixed Price Arrangements Could Result in Losses. A majority of our
professional service contracts are fixed price arrangements. Fixed price
arrangements could in the future result in losses due to delays in the
implementation process or other complexities associated with completion of the
project underlying these arrangements, such as unknown characteristics of the
customer software for which we are providing services.
Price Erosion Due to Competition and the Impact of the Open Source Software
Model. We face price competition from our competitors. Our prices are subject
to negotiations where they may be discounted to meet the competition and win
the contract award. The emerging popularity of the open source freeware model
may also affect our ability to maintain our price levels. Our customers have
shown a willingness to use freeware in some applications and this may lead to
direct competition with freeware products.
Our Markets are Very Competitive and Many of Our Competitors are Larger
than We Are. We experience significant competition in telecommunications
network management from TCSI, OSI, IBM, Sun Microsystems, DSET and major
telecommunication vendors such as AT&T, all of whom have longer operating
histories and have greater financial, technical, sales, marketing and other
resources than we do. There can be no assurance that we will be able to
identify, develop, manufacture, market or support products successfully or
that we will be able to respond effectively to technological changes or
product announcements by our competitors. Moreover, our current and potential
competitors may respond more quickly to new or emerging technologies or
changes in customer requirements. In addition, as the market develops, a
number of companies with significantly greater resources than us could attempt
to increase their presence in the market by acquiring or forming strategic
alliances with our competitors resulting in increased competition. There can
be no assurance that we will be able to compete successfully with these
competitors.
Our Software is Complex and Therefore is Prone to Bugs. The development,
enhancement and implementation of our products entail risks of product defects
or failures. In the past we have discovered software bugs in certain of our
products and software solutions. Although to date we have not experienced
material adverse effects resulting from any bugs, there can be no assurance
that errors will not be found in existing or new products or releases after
commencement of commercial licensing, which may result in delay or loss of
revenue, loss of market share, failure to achieve market acceptance, or may
otherwise adversely impact our business, operating results and financial
condition. Moreover, the complexities involved in implementing and customizing
our software solutions entail additional risks of performance failures.
Our Stock Price is Volatile. Announcement of new products by us or our
competitors and quarterly variations in financial results could cause the
market price of our common stock to fluctuate substantially. In addition, the
stock market has experienced price and volume fluctuations from time to time
that have affected the market prices of many technology-based companies, which
are not necessarily related to the operating performance of these companies.
18
Our International Sales are Subject to Factors Outside of Our
Control. Sales to customers outside of the United States accounted for a
substantial portion of our net revenues for 1999, 1998 and 1997 and we expect
that international sales will continue to be a significant portion of our
business. International sales and operations are subject to many factors
outside of our control, such as the imposition of governmental controls,
export license requirements, restrictions on the export of critical
technology, political instability, trade restrictions and tariffs.
Furthermore, because we have to maintain sales offices in different countries
in order to make these sales, our management must address differences in
regulatory environments and cultures. If we are unable to address these
differences successfully, our business, financial condition and results of
operations would be adversely affected.
Our International Sales are Subject to Currency Fluctuations. Although our
international sales are typically denominated in U.S. Dollars, they still may
be adversely affected by exchange rate fluctuations if the relative cost of
our products becomes higher. Fluctuations in exchange rates could also result
in exchange losses. The impact of future exchange rate fluctuations cannot be
predicted adequately. To date, we have not sought to hedge the risks
associated with fluctuations in exchange rates, but may begin hedging in the
future. There can be no assurance that our results of operations will not be
materially adversely affected by exchange rate fluctuations.
We Depend on Third Parties for Key Elements of Our Technology. We license
certain technology included in our products. While we do not believe that any
of this technology could not be replaced, it might require substantial time
and effort to do so. If we become unable to utilize this technology our
operations could be adversely affected.
Losing a Limited Number of Key Employees Could Adversely Affect Our
Business. Our success depends to a significant degree upon the continued
contributions of key management, sales, marketing, engineering and research
and development personnel, many of whom would be difficult to replace. If
certain of these employees were to leave, we would be adversely affected.
Recruiting the Type of Employees We Require is Difficult. We believe our
future success will also depend in large part upon our ability to attract and
retain highly skilled software engineers, and managerial, sales and marketing
personnel. Competition for these types of personnel is intense and there can
be no assurance that we will be successful in attracting and retaining the
necessary personnel. To the extent we are not successful in attracting or
retaining key personnel, we could also be adversely affected.
Our Current Efforts to Protect Our Intellectual Property May Be
Insufficient. We regard our products as proprietary and rely primarily on a
combination of statutory and common law copyright, trademark and trade secret
laws, customer licensing agreements, employee and third party nondisclosure
agreements and other methods to protect our proprietary rights. We also
generally enter into confidentiality and invention assignment agreements with
our employees and consultants. Additionally, we enter into confidentiality
agreements with certain of our customers and potential customers and limit
access to, and distribution of, our source code and other proprietary
information. Despite these precautions, it may be possible for a third party
to copy or otherwise obtain and use our technologies without authorization, or
to develop similar technologies independently. Furthermore, the laws of
certain countries in which we do business, such as China and Korea, do not
protect our software and intellectual property rights to the same extent, as
do the laws of the United States. We do not include in our software any
mechanisms to prevent or inhibit unauthorized use, but generally either
require the execution of an agreement that restricts copying and use of our
products or provides for the same in a break-the-seal license agreement. If
unauthorized copying or misuse of our products were to occur to any
substantial degree, our business, financial condition and results of
operations could be materially adversely affected. We cannot provide any
assurance that our means of protecting our proprietary rights will be adequate
or that our competitors will not independently develop similar technology.
It is Possible that We Infringe the Intellectual Property of Third
Parties. While we have not received claims alleging infringement of the
proprietary rights of third parties which we believe would have a material
adverse effect on our business, financial condition or results of operations,
nor are we aware of any similar threatened claims, we cannot provide any
assurance that third parties will not claim that our current or future
19
products infringe the proprietary rights of others. Any claim, with or without
merit, could result in costly litigation or might require us to enter into
royalty or licensing agreements. Royalty or licensing agreements, if required,
may not be available on reasonable terms, or at all.
We May Have Difficulty Acquiring Businesses That Would Enhance Our
Business. To continue to develop our business and technology at a sufficiently
fast pace to remain competitive, we may need to acquire technology or assets
from other businesses, rather than grow internally. We may not be able to
identify acquisition targets, or targets we identify may not be available to
us on acceptable financial or other terms. Even if we are able to acquire
other businesses, we may not be able to integrate, manage and develop the new
businesses efficiently and successfully and without unanticipated expense. If
we are unable to acquire desirable businesses or fail to manage an acquisition
successfully, we could fail to grow as planned and could experience a material
adverse effect in our business, financial condition and results of operations.
Employees
As of December 31, 1999 we employed 127 persons, of whom 38 were primarily
engaged in research and development activities, 28 in professional services
activities, 28 in sales and marketing activities, 16 in technical support and
related activities, and 17 in general management, administration and finance.
We have no collective bargaining agreements with our employees. We believe
that we maintain competitive compensation, benefit, equity participation and
workplace policies that assist in attracting and retaining qualified
employees. We believe that our future success will depend, in part, on our
ability to attract and retain qualified personnel. We have experienced no work
stoppages and believe that our employee relations are good.
ITEM 2. PROPERTIES
Our principal administrative, sales and marketing, and support facilities
are located in Woodland Hills, California. Our principal research and
development facilities are located in San Diego, California. Our headquarters
and primary operations consist of approximately 22,000 square feet under a
lease that will expire in January 2002. Our field sales, research and
development, and service offices worldwide, exclusive of our headquarters,
consist of leased office space totaling approximately 32,000 square feet with
leases expiring between 2000 and 2003. We believe that our existing facilities
are adequate for presently foreseeable needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to certain legal proceedings and claims which arise
in the conduct of its business. In the opinion of management, the amount of
any liability with respect to these actions will not have a material effect on
the financial condition or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
20
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
SHAREHOLDER MATTERS
Market Information
Our Common Stock is traded on the Nasdaq National Market under the symbol
VRTL. Prior to April 1998, we were known as Retix and traded under the symbol
RETX. The low and high closing sales prices for our stock during each
quarterly period in the two fiscal years ended December 31, 1999 are as
follows:
1999 Fiscal Quarters Ended
----------------------------------------
March 31 June 30 Sept 30 Dec 31
--------- -------- --------- --------
Low ............................. $ 1 9/32 $1 9/32 $1 3/4 $1 3/16
High ............................ $2 13/32 $2 1/4 $2 31/32 $9
1998 Fiscal Quarters Ended
-------------------------------------
March 28 June 27 Sept 26 Dec 31
-------- -------- --------- -------
Low ................................ $4 $3 7/16 $ 29/32 $1 3/8
High ............................... $5 3/8 $6 3/16 $3 15/16 $2 1/2
We had approximately 420 shareholders of record on March 1, 2000.
Recent Sales of Unregistered Securities
On September 29, 1998, we sold 2,000,000 shares of our common stock in a
private placement for $1.50 per share ($3,000,000 in gross proceeds). The
price per share was determined as the greater of (a) the average closing price
of the common stock for the five days preceding the closing date and (b)
$1.50.
Of the total shares issued, 1,000,000 shares were purchased by Sierra
Ventures V, a venture capital firm. Jeffrey M. Drazan, a General Partner of
Sierra Ventures, is a member of our Board of Directors. The remaining shares
were purchased by Pequot Private Equity Fund, L.P. and Pequot Offshore Private
Equity Fund, Inc.
No underwriter was used in connection with the sale of such shares, which
was made in reliance upon Section 4(2) of the Securities Act of 1933 as exempt
from registration.
Dividend Policy
We have never paid cash dividends on our capital stock. We currently
anticipate that we will retain all available funds for use in our business and
do not anticipate paying any cash dividends in the foreseeable future.
21
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial information has been derived from Vertel's
Consolidated Financial Statements. The information set forth below is not
necessarily indicative of results of future operations and should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and
related notes thereto for the years ended 1999, 1998 and 1997 are included
elsewhere in this Form 10-K.
Selected Consolidated Financial Data
Five Years Ended December 31, 1999
Years Ended December 31,
---------------------------------------------
1999 1998 1997 1996 1995
------- ------- -------- ------- --------
(in thousands, except per share data)
Consolidated Statements of
Operations:
Net revenues:
License....................... $12,359 $12,564 $ 12,590 $11,714 $ 10,222
License-related party......... -- 737 -- -- --
Service and other............. 7,456 5,066 5,887 4,443 5,324
------- ------- -------- ------- --------
Net revenues................. 19,815 18,367 18,477 16,157 15,546
------- ------- -------- ------- --------
Cost of revenues:
License....................... 1,595 816 876 1,059 943
Service and other............. 5,726 4,784 4,845 3,010 3,167
------- ------- -------- ------- --------
Total cost of revenues....... 7,321 5,600 5,721 4,069 4,110
------- ------- -------- ------- --------
Gross profit.................... 12,494 12,767 12,756 12,088 11,436
------- ------- -------- ------- --------
Operating expenses:
Research and development...... 7,319 6,639 5,600 5,461 5,156
Sales and marketing........... 8,194 6,389 6,590 6,532 3,458
General and administrative.... 4,499 3,014 3,719 3,223 2,188
Goodwill amortization......... 754 -- -- -- --
Restructuring expense
(benefit).................... 641 -- 1,513 (197) 2,277
------- ------- -------- ------- --------
Total operating expenses..... 21,407 16,042 17,422 15,019 13,079
------- ------- -------- ------- --------
Operating loss from continuing
operations..................... (8,913) (3,275) (4,666) (2,931) (1,643)
Other income, net............... 727 10,998 171 591 1,046
------- ------- -------- ------- --------
Income (loss) from continuing
operations before provision for
income taxes................... (8,186) 7,723 (4,495) (2,340) (597)
Income tax benefit (provision).. 427 (446) -- -- --
------- ------- -------- ------- --------
Income (loss) from continuing
operations..................... (7,759) 7,277 (4,495) (2,340) (597)
Loss from discontinued
operations..................... -- -- (6,415) (1,501) (31,212)
------- ------- -------- ------- --------
Net income (loss)............... (7,759) 7,277 (10,910) (3,841) (31,809)
Other comprehensive income
(loss)......................... (40) 425 (42) (328) 121
------- ------- -------- ------- --------
Net comprehensive income
(loss)......................... $(7,799) $ 7,702 $(10,952) $(4,169) $(31,688)
======= ======= ======== ======= ========
Basic net income (loss) per
common share:
Income (loss) from continuing
operations..................... $ (0.31) $ 0.31 $ (0.21) $ (0.12) $ (0.03)
Loss from discontinued
operations..................... $ -- $ -- $ (0.31) $ (0.07) $ (1.75)
------- ------- -------- ------- --------
Net income (loss)............ $ (0.31) $ 0.31 $ (0.52) $ (0.19) $ (1.78)
======= ======= ======== ======= ========
Diluted net income (loss) per
common share:
Income (loss) from continuing
operations..................... $ (0.31) $ 0.29 $ (0.21) $ (0.12) $ (0.03)
Loss from discontinued
operations..................... $ -- $ -- $ (0.31) $ (0.07) $ (1.75)
------- ------- -------- ------- --------
Net income (loss)............ $ (0.31) $ 0.29 $ (0.52) $ (0.19) $ (1.78)
======= ======= ======== ======= ========
Consolidated Balance Sheet Data
(as of):
Working capital................. $ 9,514 $19,345 $ 6,401 $15,338 $ 12,145
Total assets.................... 23,827 28,317 13,731 23,622 22,584
Long term obligations, less
current portion................ -- -- -- 236 65
Shareholders' equity............ 16,882 22,172 7,733 17,602 14,360
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Our company was founded as Retix in 1985, and was originally concentrated
in the internetworking market. In 1996, our operating divisions were split
into three business units, each with its own management structure. These three
units focused on internetworking, network management software and wireless
applications software. In 1997, we merged the wireless applications software
subsidiary into our network management software subsidiary. Additionally, in
1997, our internetworking hardware subsidiary, Sonoma Systems, Inc.,
restructured to focus solely on broadband access equipment for the
telecommunications marketplace. In January 1998, we discontinued investing in
Sonoma Systems and our voting ownership was subsequently reduced from a
wholly-owned subsidiary to a 19.9% interest, as Sonoma Systems raised
additional capital from outside investors. In December 1998, we sold our
holdings of Series B and Series C preferred stock in Sonoma Systems to a party
related to Newbridge Networks Corporation, a significant Sonoma Systems
customer. We retained an investment in Sonoma Systems primarily consisting of
$1.0 million of Series A preferred stock that is non-convertible and non-
voting. Our results of operations for 1997 and prior years have been recasted
to present the operating results of Sonoma Systems as a discontinued
operation. We are now focused on network management software for the
telecommunications industry. Further references to the Company in Management's
Discussion and Analysis of Financial Condition and Results of Operations refer
solely to our continuing operations unless specifically identified otherwise.
Vertel Corporation (Vertel I) was organized as a wholly-owned subsidiary of
Retix in February 1996. In conjunction with the formation, Retix transferred
to Vertel I the net assets of Retix's TMN product line, including the direct
and indirect subsidiaries through which Retix historically conducted such
business. Vertel I released its first TMN software products and services in
1995. Vertel I merged into Vertel Corporation in 1999.
In March 1999, we acquired Expersoft Corporation (Expersoft), a developer
and marketer of standards-based, high performance Common Object Request Broker
Architecture (CORBA) software technology. The acquisition price was
approximately $3,225,000 and consisted of cash of $3,000,000 and acquisition
costs of $225,000. At December 31, 1999, we had paid $3,182,000 of the cash
consideration and acquisition costs. The acquisition was accounted for as a
purchase. Expersoft Corporation was merged into Vertel Corporation in December
1999.
We develop, market, and support vertically integrated, object-oriented
software solutions for the management of public telecommunications networks.
Our solutions cover the Telecommunications Management Network (TMN) market and
the emerging CORBA market. Our TMN products, are based upon the International
Telecommunications Union's TMN standard and support seamless network operation
and management over diverse transmission media and protocols. We believe that
we offer the only commercially available, fully interoperable suite of
products and tools that span the network element, element management, network
management and service management layers of the TMN model. We offer embedded
software for network equipment and software solutions to allow
telecommunications service providers to integrate proprietary, SNMP, TMN, and
CORBA based network management systems with standards-based solutions. In
addition, we offer object-oriented software platforms that facilitate the
rapid development of network and service management applications and features
such as fault detection and automatic response, remote improvement of network
configuration, automation of accounting and billing functions and optimization
of network traffic and security.
We also provide professional services to customers such as turnkey
management solutions in addition to product integration and product
application services. Our professional services include system analysis and
design, source code portation and interface, custom application development,
conformance and certification testing and technical support services.
We sell products and services primarily through a direct sales force in the
United States and abroad and, in certain territories, through third party
agents. Our customers include telecommunications service providers and their
customers, network equipment manufacturers, independent software developers
and software platform vendors.
23
We derive revenue primarily from software source license fees, royalties
and services, including professional services, technical support and
maintenance. Source license fees consist primarily of licenses of our software
solutions and development platforms. We recognize product revenue upon
shipment if a signed contract exists, the fee is fixed and determinable,
collection of the resulting receivables is probable and no significant
production, modification or customization of software is required. For
contracts with multiple elements (e.g., software products, maintenance
services and other services), we allocate revenue to each element of the
contract based on objective evidence of the element's fair value. This
objective evidence of fair value is specific to us and consists either of
prices derived from sales of elements when they are sold separately or the
price established by our management for sale of elements in the ordinary
course of business. To date, substantially all source license fees have been
recognized upon delivery to our customer. Source license agreements generally
do not provide for a right of return. We maintain reserves for returns and
potential credit losses, neither of which has had a material effect on our
results of operations or financial condition through December 31, 1999.
Pursuant to source code license agreements, licensees may distribute binary
or embedded versions of our software in our licensees' products. Royalties
become due upon shipment of products containing the binary or embedded code.
Generally, software license royalty revenue is recognized upon notification by
our licensee that products incorporating our software have been shipped by our
licensee or, for customers for which we have sufficient historical
information, upon estimated amounts which we expect the customer to report.
Because of the development times required for licensees to design and ship
products containing binary or embedded software, we generally do not receive
royalties from shipments of such products for at least three quarters from the
date we initially ship source code.
We separately offer professional services, including system design and
engineering, custom application development, source code portation,
conformance testing and certification and application development. Many of our
customers contract for professional services. These services are typically
based on a detailed statement of work. Professional services revenue varies
according to the size, timing and complexity of the project and is typically
billed based on satisfaction of certain milestones or on a per day fee.
Revenue from professional services is recognized using the percentage of
completion method, or on a time and materials basis. In certain cases,
customers reimburse us for non-recurring engineering efforts. Such
reimbursements are recognized as revenue and associated costs are reflected as
cost of revenues.
Our technical support services consist of product support and maintenance,
training and on-site consulting. Product support and maintenance fees have
constituted the majority of technical support revenue. Product support and
maintenance fees typically have ranged from 10-20% of the initial source
license fee and are recognized on a straight-line basis over the term of the
contract, which is generally six to twelve months. Other revenue from training
and on-site consulting is recognized as performed.
Our operating expenses have increased substantially since 1998 as we have
made investments related to the development and introduction of our TMN and
CORBA products, expanded our sales force and established additional general
and administrative functions. Additionally, we now incur goodwill amortization
arising from our acquisition of Expersoft in March 1999. In October 1999, we
announced a restructuring of our operations intended to reduce costs and make
us more competitive. As a result of the restructuring, we incurred a charge of
$641,000, net of a restructuring benefit of $123,000 that arose from the
reversal of excess restructuring reserves from prior years. During the fourth
quarter of 1999, we reduced our workforce by approximately 20%, moved some key
functions to foreign subsidiaries and consolidated our U.S. engineering
functions to our San Diego facility. Accordingly, we expect that our expenses
going forward in 2000 will be lower than those incurred in 1999.
While we are largely dependent on products complying with the TMN standard
and must be evaluated in light of the risks and uncertainties frequently
encountered by companies dependent upon such standards and products, we are
expanding our products and technologies to reduce our dependence on TMN. In
addition, our markets are new and rapidly evolving which heightens these risks
and uncertainties. To address these risks, we must, among other things,
successfully implement our marketing strategy, respond to competitive
developments,
24
continue to develop and upgrade our products and technologies more rapidly
than our competitors and commercialize our products and services incorporating
these enhanced technologies. There can be no assurance that we will succeed in
addressing any or all of these risks. See Item 1: Business; "Risk Factors--Our
Success is Dependent on Widespread, Timely Adoption of the CORBA and TMN
Standards."
Results of Operations
The following table sets forth certain items from our Statement of
Operations as a percentage of net revenues:
Years Ended
December 31,
---------------------
1999 1998 1997
----- ----- -----
Net revenues................ 100.0% 100.0% 100.0%
Cost of revenues............ 36.9 30.5 31.0
----- ----- -----
Gross margin................ 63.1 69.5 69.0
Operating expenses:
Research and development.. 36.9 36.1 30.3
Sales and marketing....... 41.4 34.8 35.7
General and
administrative........... 22.7 16.4 20.1
Goodwill amortization..... 3.8 -- --
Restructuring expense..... 3.2 -- 8.2
----- ----- -----
Total operating
expenses............... 108.0 87.3 94.3
----- ----- -----
Operating loss from
continuing operations...... (44.9)% (17.8)% (25.3)%
===== ===== =====
Net Revenues. Net revenues increased 7.9% to $19,815,000 in 1999 from
$18,367,000 in 1998 following a 0.6% decrease from $18,477,000 in 1997. The
increase in net revenues in 1999 compared to 1998 was due primarily to higher
revenues from professional service contracts and increased maintenance
revenues, which were partially offset by a decrease in license revenues. The
slight decrease in net revenues in 1998 compared to 1997 was primarily due to
lower revenues from professional service contracts and custom software
engineering services, which were partially offset by an increase in license
revenues.
License revenues consist primarily of license fees and royalties derived
from our software solutions and development platforms, and historically have
accounted for a substantial portion of total revenue in each quarter. Annual
license revenues decreased 7.1% to $12,359,000 during 1999 from $13,301,000 in
1998 following a 5.6% increase from $12,590,000 in 1997. The decrease in
license revenues in 1999 as compared to 1998 was due primarily to a $1,000,000
licensing fee arising out of a semi-exclusive licensing contract with a
customer for our Aeronautical Telecommunications Network (ATN) Router software
during the second quarter of 1998, approximately $800,000 of license revenue
attributable to certain Background Technology recognized in connection with
our sale of our CDPD and pACT technologies during the third quarter of 1998,
revenues during the first and second quarters of 1998 related to our ATN and
CDPD product lines which were sold in 1998 (approximately $550,000) and a one-
time licensing to a related party in the first quarter of 1998 ($737,000).
These decreases were partially offset by $2,200,000 in Expersoft licensing
revenues recognized in 1999. The increase in license revenues in 1998 as
compared to 1997 was primarily due to the $1,000,000 semi-exclusive ATN
licensing contract, approximately $800,000 license revenue associated with the
sale of our CDPD and pACT technologies and the related party license of
$737,000, as noted above. These increases were partially offset by the one
time final billing of $1,900,000 related to the discontinuance of the pACT-
based two-way paging messaging products in 1997.
Service and other revenues consist primarily of professional services,
maintenance, technical support, non-recurring engineering projects, training
and other revenues. Service and other revenues increased 47.2% to $7,456,000
during 1999 from $5,066,000 in 1998 following a 13.9% decrease from $5,887,000
in 1997. The increase in service and other revenues in 1999 as compared to
1998 was primarily the result of additional professional service contracts
($1,583,000) and additional maintenance revenues stemming from the acquisition
25
of Expersoft ($1,115,000), which were partially offset by lower custom
engineering service revenues ($121,000) and lower maintenance revenues
($187,000) as a result of the aforementioned sale of our ATN and CDPD product
lines. The decrease in service and other revenues in 1998 as compared to 1997
was primarily the result of fewer professional service contracts and lower
custom software engineering services.
Our sales to customers outside of the United States comprised approximately
48.6%, 42.9% and 40.3%, respectively, of net revenues in 1999, 1998 and 1997.
We have historically reported a high percentage of sales to customers outside
of the United States and we expect that trend to continue.
Gross Margin. Cost of revenues consists primarily of professional
engineering services and warranty and technical support, primarily comprised
of payroll and related costs, and royalties paid under third party software
licensing agreements. Gross margin decreased to 63.1% of net revenues in 1999,
from 69.5% in 1998 and 69.0% in 1997. The decrease in 1999 compared to 1998
was primarily due to a higher percentage of service and other revenues in the
product mix, which have a lower margin compared to license revenues.
Additionally, the lower margin in 1999 was the result of a license transaction
of Expersoft during the first quarter of 1999 valued at $402,000, of which
$385,000 in costs and estimated earnings had accrued to Expersoft prior to the
acquisition as a result of Expersoft completing substantially all of the
related software development. The slight increase in gross margin in 1998 as
compared to 1997 was primarily due to the decrease in professional service
revenues, which typically have lower margins than license revenues. We
anticipate that changes to pricing structures and distribution strategies may
occur, and that margins may fluctuate and could decline in future periods.
Research and Development. We have historically invested heavily in research
and development to expand our expertise in TMN-based software solutions
applications technologies and to continue sustaining support of our product
offerings. Through our Expersoft acquisition, we added CORBA technology to our
network management solutions and intend to develop embedded telecom specific
implementations of this technology. The major components of R&D expenses are
engineering salaries, employee benefits and associated overhead, fees to
outside contractors, the cost of facilities and depreciation of capital
equipment, which consists primarily of computer and test equipment. Costs
related to R&D in certain cases are offset by customer reimbursement of non-
recurring engineering efforts.
Total R&D expenses increased 10.2% to $7,319,000 in 1999 from $6,639,000 in
1998 and increased 18.6% in 1998 from $5,600,000 in 1997. As a percentage of
revenue, R&D expenses increased to 36.9% in 1999, as compared to 36.1% in 1998
and 30.3% in 1997. The increase in R&D expenses during 1999 was primarily the
result of the addition of Expersoft's product development organization
($1,659,000), as well as a lower charge-back to cost of revenues for non-
recurring engineering services ($379,000). These increases were partially
offset by reduced payroll, consulting and related costs of TMN product
development during the year, which was primarily the result of the
restructuring announced in October 1999 ($1,296,000). The increase in R&D
expense in 1998 as compared to 1997 was primarily the result of additional
salaries and related expenses due to additional personnel and an increase in
the average level of compensation, as well as a lower charge-back to cost of
revenues for non-recurring engineering services.
In October 1999, we announced a restructuring plan designed to reduce
operating costs, and reduced our overall workforce by approximately 20%. The
TMN product development staff in our headquarters accounted for approximately
half of the headcount reduction. We intend to transition future TMN product
development to our Poland operations, where our costs are lower. We expect to
continue to make significant investments in the development of new products
and feature enhancements to existing product lines but anticipate that
expenditures are likely to be lower in future periods.
Sales and Marketing. Sales and marketing expenses consist primarily of
personnel and associated costs related to selling, and marketing activities,
including marketing programs such as trade shows and other promotional costs.
We believe that substantial sales and marketing expenditures are essential to
developing the opportunities for revenue growth and to sustaining our
competitive position.
26
Sales and marketing expenses increased 28.3% to $8,194,000 in 1999 from
$6,389,000 in 1998 and decreased 3.1% in 1998 from $6,590,000 in 1997. Sales
and marketing expenses as a percentage of revenues increased to 41.4% in 1999
from 34.8% in 1998. The increase in sales and marketing expenses in 1999
compared to 1998 was due primarily to increased personnel and the associated
payroll, commissions, recruiting, relocation and travel costs ($1,143,000),
consulting expenses ($33,000), increased costs of trade shows ($150,000),
public relations ($82,000), advertising ($33,000) and the addition of
Expersoft's sales and marketing organization ($374,000). Sales and marketing
expenses decreased in 1998 as compared to 1997, and decreased as a percentage
of revenues to 34.8% in 1998 from 35.7% in 1997 due to lower promotional
expenses for trade shows during 1998 compared to the 1997. In addition, sales
salaries, commissions, and related expenses in the 1998 period were lower as a
result of certain staff reductions which occurred during 1997.
Sales and marketing expenses are expected to continue to comprise a
significant percentage of our total expenses because of costs associated with
supporting the worldwide sales and service functions necessary to meet the
needs of our customer base and respond to the opportunities in the CORBA and
TMN marketplaces.
General and Administrative. General and administrative expenses consist
primarily of salaries, rent and other related expenses of administrative,
executive and financial personnel as well as professional fees, investor
relations costs and insurance premiums. General and administrative expenses
increased 49.3% to $4,499,000 in 1999 as compared to $3,014,000 in 1998, and
decreased 19.0% in 1998 from $3,719,000 in 1997. The increase in 1999 is
primarily due to the addition of the Expersoft general and administrative
organization ($1,022,000), increased professional and consulting fees
($344,000) and a non-recurring charge related to the value of stock options
granted to three former officers in January 1999 ($192,000). These increases
were partially offset by lower recruiting fees ($53,000). The decrease in 1998
as compared to 1997 was due primarily to the elimination of certain corporate
overhead expenses incurred in 1997 when we had a holding company structure to
oversee the operations of our subsidiaries, including Sonoma Systems.
Goodwill Amortization. Goodwill amortization for 1999 was $754,000 compared
to zero in 1998 and 1997. Goodwill resulted from the purchase of Expersoft in
March of 1999 and is being amortized over five years at approximately $238,000
per quarter ($952,000 annualized).
Restructuring Expense. In October 1999, we announced a restructuring plan
designed to reduce operating costs, and reduced our overall workforce by 25
employees. The workforce reduction was concentrated in R&D but impacted all
areas. The estimated costs of restructuring recorded in the financial
statements for the year ended December 31, 1999 were $764,000 and included
costs of employee severance pay ($406,000) and the costs of vacating a
facility ($351,000). Of these costs, $246,000 was paid in 1999. It is
anticipated that severance costs amounting to $227,000 will be paid in the
first quarter of 2000. At December 31, 1999, facility reserves totaled
$212,000. Additionally, during the third and fourth quarters of 1999, we
recognized a benefit of $123,000, upon the reversal of certain restructuring
reserves originally recorded in 1995 and 1997, resulting in a net
restructuring expense recorded for fiscal 1999 of $641,000.
In December 1997, we announced plans to discontinue investment in our
broadband access equipment subsidiary, Sonoma Systems. As a result, our
management structure was reorganized and downsized by three officers to
reflect the reduction of the number of operating subsidiaries to one. The
estimated costs of restructuring recorded in the financial statements for the
year ended December 31, 1997 were $1,816,000 and included costs of officer
severance pay, acceleration of vesting for certain officer and director stock
options, facility consolidation, professional fees and other related charges.
These costs were paid in 1998 except for $119,000 related to facility
reserves. Additionally, during the fourth quarter of 1997, we recorded a
reversal of certain restructuring reserves and accruals originally recorded in
1995 totaling $303,000, resulting in a net restructuring expense recorded for
fiscal 1997 of $1,513,000.
Loss from Continuing Operations. We incurred a loss from continuing
operations of $8,913,000 in 1999, $3,275,000 in 1998, and $4,666,000 in 1997.
The increase in loss from continuing operations in 1999 as compared to 1998
was due to a combination of lower margins and higher operating expenses. The
decrease in
27
loss from continuing operations in 1998 as compared to 1997 is primarily
attributable to the restructuring expense in 1997, as the 1998 reductions in
sales and marketing and general and administrative expenses are partially
offset by the lower gross margin and increased research and development costs.
Other Income, Net. In 1999, other income, net decreased by $10,271,000 to
$727,000 as compared to $10,998,000 for 1998 and increased $10,827,000 in 1998
from $171,000 in 1997. Interest income increased by $297,000 in 1999,
primarily as a result of higher cash balances, but this increase was more than
offset by the gain on sale ($7,600,000) in December 1998 of our holdings of
Series B and Series C preferred stock in Sonoma Systems (a former subsidiary),
the non-recurring gain on the sale of our CDPD and pACT technologies
($2,200,000), the non-recurring gain on the sale of a certain software library
and the assignment of certain assets and liabilities of our ATN operations
($437,000), both in the third quarter of 1998, and by the non-recurring gain
of approximately $600,000 to reflect curtailment of a non-U.S. pension plan
that previously covered our Irish employees that was recorded in the first
three quarters of 1998. Other income, net, of $171,000 in 1997 was primarily
interest income.
Provision for Income Taxes. We recorded a benefit for income taxes of
$427,000 in 1999 due to the expiration of certain tax contingencies. In 1998,
we recorded a provision for income taxes of $446,000 on pre-tax income from
continuing operations of $7,723,000 in 1998. No income tax benefit was
recognized on pre-tax losses from continuing operations of $8,186,000 in 1999
or on pre-tax losses from continuing operations of $4,495,000 in 1997. Our
1998 tax provision was positively impacted by the utilization of approximately
$4,426,000 of net operating losses carried forward from prior years. Deferred
tax assets and liabilities are recognized based on differences between
financial statement and tax bases of assets and liabilities using presently
enacted rates. A valuation allowance equal to the total amount of our net
deferred tax assets of $27,523,000 at December 31, 1999, has been established.
The net deferred tax assets will be realized to the extent that we operate
profitably in the future during the respective carryforward periods.
Liquidity and Capital Resources
Net cash used for operating activities during 1999 was $7,308,000 compared
to $1,755,000 provided by operating activities during 1998 and $4,277,000 used
for operating activities in 1997. The negative cash flow from operations in
1999 was comprised primarily of a loss from continuing operations ($7,759,000)
and increases in accounts receivable ($1,611,000) and deferred revenue
($561,000). These amounts were partially offset by non-cash depreciation and
amortization ($2,184,000) and non-cash stock based compensation ($368,000).
The cash provided by operating activities in 1998 was primarily the result of
the proceeds from the sale of our CDPD and pACT technologies ($2,000,000),
non-cash depreciation and amortization ($1,124,000), a decrease in accounts
receivable ($360,000) and prepaid expenses and other current assets ($594,000)
and an increase in accrued taxes ($310,000). These amounts were partially
offset by payments in 1998 of restructuring expenses that were accrued in 1997
($1,263,000). The negative cash flow from operating activities in 1997 was
comprised primarily of the net loss from continuing operations ($4,495,000)
and an increase in accounts receivable ($1,038,000). These amounts were
partially offset by non-cash depreciation and amortization ($1,017,000) and a
decrease in prepaid expenses and other current assets ($243,000).
Net cash used for investing activities was $9,318,000 in 1999 and net cash
provided by investing activities was $7,881,000 and $7,899,000 for 1998 and
1997, respectively. The net cash used for investing activities in 1999 was due
to net purchases of short-term investments ($4,699,000), purchases of property
and equipment ($1,797,000) and cash paid for the acquisition of Expersoft, net
of cash acquired ($2,934,000), which was partially offset by a decrease in
other assets of $112,000. The net cash provided in 1998 was primarily due to
the sale of our holdings of Series B and Series C Preferred Stock of Sonoma
Systems ($10,093,000) which was partially offset by purchases of property and
equipment ($1,161,000) and net purchases of short-term investments ($978,000).
The net cash provided in 1997 was primarily due to sales of short-term
investments ($7,748,000) and a reduction in other assets ($631,000) which was
partially offset by purchases of property and equipment ($480,000).
28
Net cash provided by financing activities was $1,145,000, $3,338,000 and
$766,000 for 1999, 1998 and 1997, respectively. The net cash provided in 1999
was due to the exercise of stock options under the employee stock option plans
($1,760,000) which was partially offset by payments of capital lease
obligations ($615,000). The net cash provided in 1998 was primarily due to the
private placement of Common Stock ($2,971,000) and the exercise of stock
options under the employee stock option plans ($341,000). The net cash
provided in 1997 was due to the exercise of stock options and stock sales
under the employee stock purchase plans ($256,000) and cash received as the
result of the repayment of certain notes receivable originally issued from the
exercise of certain stock options ($510,000).
No net cash was provided by or used for discontinued operations in 1999.
Net cash provided by or (used for) discontinued operations was $281,000 and
($6,313,000) 1998 and 1997, respectively.
We believe that cash and short-term investment balances ($9,651,000 at
December 31, 1999) will be sufficient to meet our liquidity requirements for
the next twelve months. From time to time, we may also consider the
acquisitions of, or evaluate investments in, certain products and businesses
complementary to our business. Any such acquisitions or investments may
require additional capital resources.
The Company anticipates expenditures for capital equipment will approximate
$1,250,000 for the year ending December 31, 2000.
At December 31, 1999, our long-term liquidity needs consisted principally
of operating lease commitments related to facilities and office equipment.
European Monetary Union
In January 1999, eleven European countries, including France, Germany and
the Netherlands, where we maintain operations, implemented a single currency
(the "Euro") to replace their separate currencies. While transactions may
still be consummated in the individual currencies of the member countries, we
will be required to, and are currently in the process of, implementing
modifications to our payroll and benefits systems as well as our contracts and
other obligations in order to accommodate the Euro. We do not currently
believe that we will incur a material financial expense in connection with
such modifications. The introduction of the Euro, presents certain risks for
us including, risks associated with our reduced ability to adjust pricing of
our products based on local currencies, fluctuations in the Euro based on
economic turmoil in countries other than those in which we do business and
other risks normally associated with doing business in international
currencies, any of which could have an adverse effect on our business,
financial condition and results of operations.
29
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to market risk with respect to our investments in equity
securities and in the areas of interest rates and foreign currency exchange
rates. Market risk represents the risk of loss that may impact our
consolidated financial position, results of operations or cash flows. The
following discussion about our market risk contains forward-looking statements
that are subject to risks and uncertainties. Actual results could vary
materially as a result of a number of factors.
Interest Rate Risk
We are exposed to interest rate risk on our short-term investments. To
manage this risk we maintain an investment policy that limits our investments
to short-term, highly rated, fixed income facilities such as highly liquid
municipal bonds and high-grade commercial paper. We mitigate default risk by
investing in high credit quality securities and by constantly positioning our
portfolio to respond appropriately to a significant reduction in a credit
rating of any investment issuer or guarantor and by placing our portfolio
under the management of professional money managers who invest within
specified parameters established by the Board of Directors. The portfolio
includes only marketable securities with active secondary or resale markets to
ensure portfolio liquidity and maintains a prudent amount of diversification.
Historically, the effect of interest rate risk on us has not been
significant. We had short-term investments of $5,677,000, with a weighted-
average variable rate of 6.04%, as of December 31, 1999 and $978,000 with a
weighted-average variable rate of 5.34%, as of December 31, 1998. Although
these short-term investments consist primarily of highly liquid investments
with remaining maturities of less than 90 days, they are subject to interest
rate risk and will decrease in value if market interest rates increase. A 200
basis point change in interest rates at December 31, 1999 would have resulted
in a change in fair market value of less than $20,000. We are also exposed to
interest rate risks on our fixed rate debt obligations. At December 31, 1999,
we had $26,000 of short-term fixed rate debt. There was no fixed rate debt
outstanding at December 31, 1998. A hypothetical fluctuation in market
interest rates by 1% from the December 31, 1999 and 1998 rates would have
caused the fair value of our fixed rate debt to fluctuate by an insignificant
amount.
Foreign Exchange Risk
While our consolidated financial statements are prepared in United States
dollars, a portion of our worldwide operations have a functional currency
other than the United States dollar. In particular, we maintain operations in
France, Germany, Japan, Korea, the Netherlands, Poland and the United Kingdom,
where the functional currencies are: French Franc, Deutschemark, Yen, Won,
Dutch Guilder, Zloty and British Pound, respectively. Most of our revenues are
denominated in the United States Dollar. Fluctuations in exchange rates may
have a material adverse effect on our results of operations and could also
result in exchange losses. The impact of future exchange rate fluctuations
cannot be predicted adequately. To date, exchange fluctuations have not had a
material impact on our earnings and we have not sought to hedge the risks
associated with fluctuations in exchange rates, but may undertake such
transactions in the future. We do not have a policy relating to hedging. There
can be no assurance that any hedging techniques implemented by us would be
successful or that our results of operations will not be materially adversely
affected by exchange rate fluctuations. Our foreign assets are not material.
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
VERTEL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
December 31,
------------------
1999 1998
-------- --------
ASSETS
------
Current assets:
Cash and cash equivalents................................ $ 3,974 $ 19,495
Short-term investments .................................. 5,677 978
Trade accounts receivable (net of allowances of $486 for
1999 and $556 for 1998)................................. 6,289 4,477
Prepaid expenses and other current assets................ 519 540
-------- --------
Total current assets................................... 16,459 25,490
Property and equipment, net................................ 1,638 1,025
Investments................................................ 1,437 1,437
Goodwill................................................... 3,987 --
Other assets............................................... 306 365
-------- --------
$ 23,827 $ 28,317
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable......................................... $ 931 $ 426
Accrued wages and related liabilities.................... 1,672 1,351
Capital lease obligations................................ 26 --
Accrued restructuring expenses........................... 439 224
Accrued taxes payable.................................... 483 1,087
Other accrued liabilities................................ 1,773 1,942
Deferred revenue......................................... 1,621 1,115
-------- --------
Total liabilities...................................... 6,945 6,145
-------- --------
Shareholders' equity:
Preferred stock, par value $.01, 2,000,000 shares
authorized; none issued and outstanding.................
Common stock, par value $.01, 50,000,000 shares
authorized; shares issued and outstanding: 1999,
26,246,531; 1998, 24,954,545............................ 262 249
Additional paid-in capital............................... 82,049 79,553
Accumulated deficit...................................... (65,242) (57,483)
Accumulated comprehensive loss........................... (187) (147)
-------- --------
Total shareholders' equity............................. 16,882 22,172
-------- --------
$ 23,827 $ 28,317
======== ========
See accompanying notes to consolidated financial statements.
31
VERTEL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Years ended December 31,
--------------------------
1999 1998 1997
------- ------- --------
Net revenues:
License.......................................... $12,359 $12,564 $ 12,590
License-related party............................ -- 737 --
Service and other................................ 7,456 5,066 5,887
------- ------- --------
Net revenues................................... 19,815 18,367 18,477
------- ------- --------
Cost of revenues:
License.......................................... 1,595 816 876
Service and other................................ 5,726 4,784 4,845
------- ------- --------
Total cost of revenues......................... 7,321 5,600 5,721
------- ------- --------
Gross profit....................................... 12,494 12,767 12,756
------- ------- --------
Operating expenses:
Research and development......................... 7,319 6,639 5,600
Sales and marketing.............................. 8,194 6,389 6,590
General and administrative....................... 4,499 3,014 3,719
Goodwill amortization............................ 754 -- --
Restructuring expense............................ 641 -- 1,513
------- ------- --------
Total operating expenses....................... 21,407 16,042 17,422
------- ------- --------
Operating loss from continuing operations ......... (8,913) (3,275) (4,666)
Other income, net.................................. 727 10,998 171
------- ------- --------
Income (loss) from continuing operations before
provision for income taxes........................ (8,186) 7,723 (4,495)
Income tax benefit (provision)..................... 427 (446) --
------- ------- --------
Income (loss) from continuing operations........... (7,759) 7,277 (4,495)
Loss from discontinued operations (including
provision for operating losses of $100 during
phase out period in 1997)......................... -- -- (6,415)
------- ------- --------
Net income (loss).................................. (7,759) 7,277 (10,910)
Other comprehensive income (loss).................. (40) 425 (42)
------- ------- --------
Comprehensive income (loss)........................ $(7,799) $ 7,702 $(10,952)
======= ======= ========
Basic net income (loss) per common share:
Income (loss) from continuing operations ........ $ (0.31) $ 0.31 $ (0.21)
Loss from discontinued operations................ $ -- $ -- $ (0.31)
------- ------- --------
Net income (loss)................................ $ (0.31) $ 0.31 $ (0.52)
======= ======= ========
Diluted net income (loss) per common share:
Income (loss) from continuing operations......... $ (0.31) $ 0.29 $ (0.21)
Loss from discontinued operations................ $ -- $ -- $ (0.31)
------- ------- --------
Net income (loss)................................ $ (0.31) $ 0.29 $ (0.52)
======= ======= ========
Weighted average shares outstanding used in net
income (loss) per common share calculations:
Basic............................................ 25,425 23,321 21,120
Diluted.......................................... 25,425 24,698 21,120
See accompanying notes to consolidated financial statements.
32
VERTEL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share amounts)
Accumulated
Common Stock Additional Other
------------------ Paid-In Accumulated Comprehensive Notes
Shares Amount Capital Deficit Income (Loss) Receivables Total
----------- ------ ---------- ----------- ------------- ----------- --------
Balance at January 1,
1997................... 22,597,427 $226 $78,089 $(53,850) $(1,961) $(4,902) $ 17,602
Issuance of common
stock upon exercise of
warrants.............. 1,457,627
Issuance of common
stock upon exercise of
options............... 35,985 41 41
Payment of notes
receivable from
issuance of common
stock................. 510 510
Compensation expense
from acceleration of
stock options......... 317 317
Issuance of common
stock under employee
stock purchase plan... 55,479 1 214 215
Other comprehensive
loss.................. (42) (42)
Net loss............... (10,910) (10,910)
----------- ---- ------- -------- ------- ------- --------
Balance at December 31,
1997................... 24,146,518 227 78,661 (64,760) (2,003) (4,392) 7,733
Issuance of common
stock upon private
placement, net........ 2,000,000 20 2,951 2,971
Issuance of common
stock upon exercise of
options............... 394,277 18 323 341
Payment of notes
receivable from
issuance of common
stock................. 25 25
Cancellation of notes
receivable in exchange
for share repurchase.. (1,586,250) (16) (4,351) 4,367 --
Increase in value of
Sonoma Systems
investment............ 1,969 1,431 3,400
Other comprehensive
income................ 425 425
Net income............. 7,277 7,277
----------- ---- ------- -------- ------- ------- --------
Balance at December 31,
1998................... 24,954,545 $249 $79,553 $(57,483) $ (147) $ -- $ 22,172
Issuance of common
stock upon exercise of
options............... 1,102,557 11 1,749 1,760
Compensation expense
from issuance of stock
options............... 368 368
Issuance of common
stock to minority
shareholders in
connection with Vertel
Corporation I merger.. 189,429 2 379 381
Other comprehensive
income................ (40) (40)
Net loss............... (7,759) (7,759)
----------- ---- ------- -------- ------- ------- --------
Balance at December 31,
1999................... 26,246,531 $262 $82,049 $(65,242) $ (187) $ -- $ 16,882
=========== ==== ======= ======== ======= ======= ========
See accompanying notes to consolidated financial statements.
33
VERTEL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years ended December 31,
--------------------------
1999 1998 1997
-------- ------- -------
Cash flows from operating activities:
Net income (loss) from continuing operations..... $ (7,759) $ 7,277 $(4,495)
Adjustments to reconcile net income (loss) from
continuing operations to net cash provided by
(used for) operating activities:
Gain on sale of Sonoma Systems investment...... -- (7,641) --
Depreciation and amortization.................. 2,184 1,124 1,017
Loss on disposal of fixed assets............... 79 -- --
Reserve for returns and bad debts.............. (70) 104 84
Restructuring expense (benefit)................ (82) -- 1,513
Non-cash stock based compensation.............. 368 -- --
Changes in operating assets and liabilities
(Note 11)..................................... (2,028) 891 (2,396)
-------- ------- -------
Net cash (used for) provided by operating
activities.................................... (7,308) 1,755 (4,277)
-------- ------- -------
Cash flows from investing activities:
Net (purchases) sales of short-term investments.. (4,699) (978) 7,748
Proceeds from sale of Sonoma Systems investment.. -- 10,093 --
Purchases of property and equipment.............. (1,797) (1,161) (480)
Cash paid for business acquisition, net of cash
acquired........................................ (2,934) -- --
Change in other assets........................... 112 (73) 631
-------- ------- -------
Net cash (used for) provided by investing
activities.................................... (9,318) 7,881 7,899
-------- ------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock........... 1,760 3,338 766
Payments on capital lease obligations............ (615) -- --
-------- ------- -------
Net cash provided by financing activities...... 1,145 3,338 766
Net cash provided by (used for) discontinued
operations........................................ -- 281 (6,313)
-------- ------- -------
Effect of exchange rate changes on cash............ (40) (12) (42)
-------- ------- -------
Net (decrease) increase in cash and cash
equivalents....................................... (15,521) 13,243 (1,967)
Cash and cash equivalents, beginning of year....... 19,495 6,252 8,219
-------- ------- -------
Cash and cash equivalents, end of year............. $ 3,974 $19,495 $ 6,252
======== ======= =======
See accompanying notes to consolidated financial statements.
34
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
The consolidated financial statements include the accounts of Vertel
Corporation (formerly Retix) and its subsidiaries (the "Company").
Intercompany balances and transactions have been eliminated in consolidation.
The Company was founded in 1985 and develops, markets, and supports vertically
integrated, object-oriented software solutions for the management of public
telecommunications networks. Our solutions cover the telecommunications
management network ("TMN") and the Common Object Request Broker Architecture
("CORBA") market. In addition, the Company serves telecommunications equipment
manufacturers, computer systems original equipment manufacturers ("OEMs") and
Internet access providers. In conjunction with its annual shareholders'
meeting held in March 1998, the Company changed its name from Retix to Vertel
Corporation. Trading of the Company's common stock on the Nasdaq National
Market (symbol: VRTL, formerly RETX) commenced following the Company's initial
public offering in December 1991.
In March 1999, the Company acquired Expersoft Corporation, a developer and
marketer of standards-based, high performance CORBA software technology (see
Note 15).
Revenues are generated primarily from software licenses, royalty
agreements, professional services and maintenance contracts. For the year
ended December 31, 1999, sales to Lucent Technologies comprised approximately
11.6% of net revenues. For the year ended December 31, 1998, no individual
customer accounted for more than 10% of net revenues. For the year ended
December 31, 1997, AT&T Corp. comprised approximately 10.2% of net revenues.
At December 31, 1999, Lucent Technologies comprised 17% of accounts
receivable.
2. Summary of Significant Accounting Policies
Cash Equivalents
Cash equivalents consist of highly liquid investments with maturities of
three months or less at the date of acquisition. The carrying value
approximates fair market value due to the short maturity of these investments.
Property and Depreciation
Property and equipment are stated at cost. Depreciation is provided for
using the straight-line method over the estimated useful lives of one to two
years for machinery and computer equipment, three years for furniture and
fixtures and the term of the lease for leasehold improvements.
Software Development Costs
Development costs incurred in the research and development of software
products are expensed as incurred until the technological feasibility of the
products has been established. Subsequent to 1997, costs incurred after the
establishment of technological feasibility have not been material. Capitalized
software development costs were fully amortized in 1998. Accordingly, there
was no amortization of capitalized software development costs in 1999.
Amortization of capitalized software development costs for the years ended
December 31, 1998 and 1997 totaled $250,000 and $390,000, respectively.
Investments
Investments consist primarily of highly liquid municipal bonds and
commercial paper ("marketable securities") and equity securities. Marketable
securities are categorized as trading and are carried at fair value. Fair
value of marketable securities is determined by the quoted market prices for
each investment. Marketable securities with a maturity of less than one year
but greater than three months when purchased are
35
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
classified as short-term investments. Marketable securities with a maturity
greater than one year when purchased are classified as long-term investments.
Unrealized holding gains and losses on investments are recorded in the
Statement of Operations. Investments in equity securities for which fair
market values are not readily determinable, or for which sale is restricted
for periods exceeding twelve months, are carried at cost. The carrying value
of short term investments approximates fair market value.
Revenue Recognition
The Company derives revenue primarily from software license and royalty
fees, professional services, maintenance and customer support services and, to
a lesser extent, custom engineering consulting contracts. Software license
revenues are recognized in accordance with Statement of Position ("SOP") No.
97-2, "Software Revenue Recognition", as amended by SOP No. 98-4, when a
noncancelable license agreement has been signed, the software product has been
delivered, the fees are fixed and determinable, collectibility is probable and
vendor-specific objective evidence exists to allocate the total fee to
elements of the arrangement. Vendor-specific objective evidence is either
based on the price charged when an element is sold separately or, in the case
of an element not sold separately, the price established by authorized
management.
Software license royalty revenue is recognized upon notification by the
licensee that products incorporating the Company's software have been shipped
by the licensee or, for customers for which the Company has sufficient
historical information, upon estimated amounts which the Company expects the
customer to report. Revenues from maintenance and support contracts are
recognized on a straight-line basis over the term of the contract, which is
generally six to twelve months. Revenues from professional services are
recognized using the percentage of completion method of accounting or on a
time and materials basis. In certain cases, customers reimburse the Company
for non-recurring engineering efforts. Such reimbursements are recognized as
revenue and associated costs are reflected as cost of revenues.
Deferred revenues include unearned amounts received under maintenance and
support contracts and amounts billed to customers but not recognized as
revenue. An allowance for sales returns is accrued concurrently with the
recognition of revenue.
Stock-Based Compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," and complies with the
disclosure provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation." Under APB Opinion No. 25,
compensation expense is based on the difference, if any, on the date of grant,
between the fair value of the Company's stock and the exercise price. The
Company accounts for stock options issued to non-employees in accordance with
the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation."
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," which requires recognition of deferred income
tax liabilities and assets for the expected future income tax consequences of
events that have been included in the financial statements or income tax
returns. Under this method, deferred income tax liabilities and assets are
determined based on the temporary difference between the financial statement
and income tax basis of assets and liabilities using presently enacted tax
rates in effect. Valuation allowances are established when necessary to reduce
deferred income tax assets to the amounts that are more likely than not to be
realized.
36
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Earnings Per Share
The Company computes net income (loss) per share in accordance with SFAS
No. 128, "Earnings Per Share" which requires dual presentation of basic
earnings per share ("EPS") and diluted EPS. Basic EPS is computed using the
weighted average number of common shares outstanding during the period.
Diluted EPS is computed using the weighted average number of common shares and
potentially dilutive shares outstanding during the period. Potential common
shares consist of shares issuable upon the exercise of stock options and
warrants using the treasury stock method. Potentially dilutive shares are
excluded from the computation in loss periods, as their effect would be
antidilutive.
The following is a reconciliation of the numerator and denominator of basic
and diluted earnings per share computations for the years ended December 31,
1999, 1998 and 1997 (in thousands).
1999 1998 1997
------- ------- --------
Numerator:
Income (loss)-numerator for basic and
diluted income (loss) per share from
continuing operations ..................... $(7,759) $ 7,277 $ (4,495)
======= ======= ========
Net income (loss)-numerator for basic and
diluted net income (loss) per share........ $(7,759) $ 7,277 $(10,910)
======= ======= ========
Denominator:
Denominator for basic income (loss) per
common share weighted average shares....... 25,425 23,321 21,120
------- ------- --------
Effect of dilutive securities-stock options... -- 1,377 --
Denominator for diluted income (loss) per
common share................................. 25,425 24,698 21,120
======= ======= ========
Common shares related to stock options that are antidilutive amounted to
approximately 6,326,255, 2,001,613 and 102,301 for the years ended December
31, 1999, 1998 and 1997, respectively.
Other Comprehensive Income
The Company has reflected the provisions of SFAS No. 130, "Reporting
Comprehensive Income", in the accompanying consolidated financial statements
for all periods presented. The accumulated comprehensive loss and other
comprehensive income (loss) as reflected in the accompanying consolidated
financial statements, respectively, consist of foreign currency translation
adjustments.
International Currency Translation
Assets and liabilities of international subsidiaries are translated into
United States dollars at the exchange rate in effect at the close of the
period, and revenues and expenses of these subsidiaries are translated at the
weighted average exchange rate during the period. The aggregate effect of
translating the financial statements of international subsidiaries is included
with other comprehensive income as a separate component of shareholders'
equity. Substantially all of the Company's sales are denominated in U.S.
dollars and foreign exchange gains/losses have been insignificant.
37
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Concentration of Credit Risk
Financial instruments, which potentially subject the Company to
concentration of credit risk, consist principally of cash, cash equivalents,
investments and accounts receivable. The Company places its cash, cash
equivalents and investments with high credit quality institutions and limits
the amount of credit exposure to any one institution. The Company's accounts
receivable arise from sales directly to customers and indirectly through
resellers, systems integrators and OEMs. The Company performs ongoing credit
evaluations of its customers before granting uncollateralized credit and to
date has not experienced any material credit-related losses (See Note 1).
Goodwill
Goodwill of $4,742,000 arose from the acquisition of Expersoft Corporation
and the amount is being amortized over five years on a straight-line basis.
The accumulated amortization at December 31, 1999 was $754,000.
Impairment of Long-lived Assets
The Company evaluates long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying value of an asset may not
be recoverable. If the estimated future cash flows (undiscounted and without
interest charges) from the use of an asset are less than the carrying value, a
write-down would be recorded to reduce the related asset to its estimated fair
value.
Fair Market Value of Financial Instruments
The recorded values of the Company's financial instruments approximate
their fair values.
Use of Estimates in the Preparation of the Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported and disclosures herein. Due to the
inherent uncertainty involved in making estimates, actual results reported in
future periods may differ from these estimates.
Fiscal Year
In the fourth quarter of 1998, the Company adopted a calendar-year
convention for its fiscal year end and quarter ends. Accordingly, the fiscal
year end for 1999 and 1998 was December 31. Prior to the fourth quarter of
1998, the Company's fiscal year was the 52 or 53-week period ending on the
Saturday nearest to December 31, and the fiscal quarter ends ended on the
thirteenth Saturday of the quarter period. For simplicity of presentation, the
Company has described the 52 weeks ended December 27, 1997 as the year ended
December 31, 1997. As a result of this change, 1998 contained 369 days;
however, the effect on the Company's financial position and results of
operations was not significant.
Reclassification
Certain reclassifications have been made to the 1997 and 1998 consolidated
financial statements to conform to the 1999 consolidated financial statement
presentation.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities", which
the Company is required to adopt beginning in fiscal
38
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
year 2001. SFAS No. 133 will require the Company to record all derivatives on
the balance sheet at fair value. Changes in derivative fair values will either
be recognized in earnings as offsets to the changes in fair value of related
hedged assets, liabilities and firm commitments, or, for forecasted
transactions, deferred and recorded as a component of other comprehensive
income until the hedge transactions occur and are recognized in earnings. The
ineffective portion of a hedging derivative's change in fair value will be
immediately recognized in earnings. The Company does not believe the effect of
adopting SFAS No. 133 will be material to its financial position.
In December 1998, the American Institute of Certified Public Accountants
issued SOP No. 98-9, which provides certain amendments to SOP No. 97-2 related
to software revenue recognition, and is effective for transactions entered
into by the Company beginning January 1, 2000. The Company does not believe
the effect of adopting SOP No. 98-9 will be material to its financial position
or operations.
3. Investments
Investments at December 31, 1999 and 1998, consist of the following (in
thousands):
1999 1998
------ ------
Sonoma Systems, Inc. Series A Preferred Shares................. $1,000 $1,000
Airtel ATN plc Common Stock.................................... 437 437
------ ------
$1,437 $1,437
====== ======
The fair market values for these investments in equity securities are not
readily determinable and therefore they are carried at cost.
4. Property and Equipment
Property and equipment at December 31, 1999 and 1998 consist of the
following (in thousands):
1999 1998
------ ------
Machinery and equipment........................................ $5,287 $3,333
Furniture and fixtures......................................... 153 171
Leasehold improvements......................................... 241 211
------ ------
5,681 3,715
Less accumulated depreciation and amortization............... 4,043 2,690
------ ------
Property and equipment, net.................................. $1,638 $1,025
====== ======
During 1999 the Company disposed of or retired $2,226,000 of fully
depreciated assets.
5. Income Taxes
The components of (loss) income from continuing operations before income
taxes for the years ended December 31, 1999, 1998 and 1997, consist of the
following (in thousands):
1999 1998 1997
------- ------ -------
Domestic............................................ $(8,568) $7,405 $(5,429)
Foreign............................................. 382 318 934
------- ------ -------
Total............................................. $(8,186) $7,723 $(4,495)
======= ====== =======
39
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The (benefit) provision for income taxes consists of the following (in
thousands):
1999 1998 1997
----- ---- -----
Current:
Federal.................................................. $(417) $187 $ --
State.................................................... (8) 63 --
Foreign.................................................. (2) 196 --
----- ---- -----
Total.................................................. $(427) $446 $ --
===== ==== =====
The Company's effective income tax rate differs from the federal statutory
income tax rate applied to (loss) income from continuing operations before
provision for income taxes in 1999, 1998 and 1997, due to the following:
1999 1998 1997
----- ----- -----
Federal statutory income tax rate..................... (34.0)% 34.0% (34.0)%
Increases (reductions) in taxes resulting from:
Effects of foreign operations....................... (1.6) 1.1 (7.3)
State taxes, net of federal benefit................. (0.1) 5.5 0.1
Research and development tax credit................. (3.8) 2.8 (3.4)
Goodwill amortization............................... 3.1 -- --
Expiration of section 172F contingency.............. (4.3) -- --
Expiration of foreign tax credits................... 2.4 2.9 7.2
Utilization of NOL's................................ -- (37.6) --
Other............................................... (0.7) 2.8 (0.2)
Valuation allowance................................. 33.7 (5.7) 37.6
----- ----- -----
Effective tax rate.................................... (5.3)% 5.8% -- %
===== ===== =====
Current and noncurrent deferred income tax assets (liabilities) at December
31, 1999 and 1998 consist of the following (in thousands):
1999 1998
-------- --------
Current:
Accrued expenses....................................... $ 974 $ 1,015
-------- --------
Noncurrent:
Credit for research and development expenses........... 7,053 5,828
Credit for foreign taxes withheld...................... 62 260
Depreciation........................................... 275 408
Other.................................................. 174 220
Net operating loss carry-forwards...................... 16,014 12,743
-------- --------
23,578 19,459
-------- --------
Valuation allowance...................................... (24,552) (20,474)
-------- --------
Net deferred income tax assets........................... $ -- $ --
======== ========
40
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company's credits for research and development expenses, which may be
carried forward fifteen years, expire in 2005 through 2014; credits for
foreign taxes withheld, which may be carried forward five years, expire in
2004. The Company has net operating loss carryforwards for federal income tax
purposes of approximately $51,147,000, which expire in 2007 through 2019. The
Company also has net operating loss carryforwards for state purposes of
approximately $18,041,000, which expire in 2000 through 2004. The operating
loss carryforwards include approximately $5,800,000 for deductions arising
from the disposition and exercise of stock options. The Company's tax
provision for 1998 was positively impacted by the utilization of $4,426,000 of
net operating losses carried forward from prior years.
Tax benefits arising from the disposition of certain shares issued upon
exercise of stock options within two years of the date of grant or within one
year of the date of exercise by the option holder provide the Company with a
tax deduction equal to the difference between the exercise price and the fair
market value of the stock on the date of exercise. The tax effect of the
deduction, when realized, will be excluded from the provision (benefit) for
income taxes and credited directly to additional paid-in capital. The tax
benefit that will be credited directly to shareholders' equity upon
realization against taxable income totaled approximately $5,800,000 as of
December 31, 1999.
The Company has no plans to repatriate foreign retained earnings. The
Company has net operating loss carryforwards that could be used to offset any
related income taxes upon repatriation.
6. Commitments and Contingencies
Operating Leases
The Company leases its facilities and certain equipment under noncancelable
operating leases. At December 31, 1999, future minimum rental payments, net of
applicable sublease income, under leases that have initial or remaining
noncancelable lease terms in excess of one year are as follows (in thousands):
Commitments Lease Sublease Net
----------- ------ -------- ------
2000................................................ $1,314 $ (542) $ 772
2001................................................ 1,139 583 556
2002................................................ 382 394 (12)
2003................................................ 222 256 (34)
2004................................................ -- -- --
------ ------- ------
Total operating lease commitments................. $3,057 $(1,775) $1,282
====== ======= ======
Rent expense under operating leases for the years ended December 31, 1999,
1998 and 1997 was $1,127,000, $941,000, and $1,126,000, respectively.
Legal Proceedings
The Company is subject to certain legal proceedings and claims which arise
in the conduct of its business. In the opinion of management, the amount of
any liability with respect to these actions will not have a material effect on
the financial condition or results of operations of the Company.
7. Shareholders' Equity
Common Stock
On September 29, 1998, the Company sold 2,000,000 shares of common stock
for $1.50 per share ($2,971,000 net proceeds after expenses). The price per
share was determined as the greater of (a) the average
41
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
closing price of the common stock for the five days preceding the closing date
and (b) $1.50. Of the total shares issued, 1,000,000 shares were purchased by
Sierra Ventures V, ("Sierra") a venture capital firm. Jeffrey M. Drazan, a
General Partner of Sierra, is a member of the Company's Board of Directors.
In November 1998, the Company repurchased 1,586,250 shares of restricted
common stock from certain ex-officers and employees in exchange for the
cancellation of promissory notes originally issued in connection with the
issuance of the shares. The shares have been returned to the Company's
authorized pool of shares available for issuance. For purposes of computing
earnings per share prior to the fourth quarter of 1998, the common stock
issued subject to notes receivable were treated as options. These options were
excluded from the calculation of earnings per share prior to the third quarter
of 1998 because they were considered antidilutive.
In connection with the Company's 1997 restructuring (see Note 12), the
vesting of the restricted shares held by certain officers of the Company were
accelerated. Additionally, vesting of 50,000 options to purchase the Company's
common stock issued to a non-continuing director were also accelerated in
1997. The Company recorded a compensation charge of $317,000 in 1997 related
to the accelerated stock and options held by the officers and the director.
In April 1997, the Company's Board of Directors adopted a shareholders'
rights plan and distributed a dividend of one right (the "Right") to purchase
one one-thousandth of a share of Series A participating Preferred Stock
("Preferred Shares") for each outstanding share of common stock of the
Company. The rights become exercisable per share at an exercise price of
$25.00 ten days after a person or group announces acquisition of 20% or more
of the Company's outstanding common stock or the commencement of a tender
offer which would result in ownership by the person or group of 20% or more of
the outstanding common stock. The Preferred Shares have been approved by the
Board but are not made part of the Company's charter until needed; as a
result, the Preferred Shares have not been formally authorized. The Rights
expire on April 29, 2007.
Effective January 30, 1996, Sierra purchased 2,000,000 shares of the
Company's common stock in a private placement at $2.00 per share.
Additionally, Sierra was granted a warrant to purchase an additional
2,000,000 shares of the Company's common stock at prices ranging from $2.00 to
$5.00 per share over the three-year term of the warrant. During 1997, the
warrant was exercised with respect to 1,457,627 shares of common stock for no
cash consideration with the balance of the warrant being canceled and the
difference between the then market price of the Company's common stock and the
exercise price of the warrant serving as the consideration for the exercise of
the balance of the warrant.
Stock Purchase and Stock Option Plans
Under the Company's stock purchase and stock option plans in effect at
December 31, 1999, 8,260,000 shares of common stock may be issued to employees
directly or upon exercise of stock options issued to employees and in certain
cases to consultants. The Company has six stock and option plans that were in
effect at December 31, 1999. However, the Company is not currently granting
options under the 1990 Stock Option Plan for Irish Employees, the 1991
Employee Stock Purchase Plan, the 1991 Directors' Stock Option Plan, the 1995
Executive Stock Option Plan, but is granting options under the 1996 Directors'
Stock Option Plan and the 1998 Employee Stock Option Plan. Under the foregoing
option plans, options may be granted at an exercise price equaling the closing
price of the Company's shares on the Nasdaq National Market for the day prior
to the date of grant. Options under the 1990 Stock Option Plan for Irish
Employees become exercisable at a rate of 25% after one year from the date of
grant and 25% each year thereafter. Options granted under the 1995 Executive
Stock Option Plan and the 1998 Employee Stock Option Plan generally become
exercisable 25% after one year from date of grant, then ratably 1/48 per month
over the remaining thirty-six months based on continuous employment from the
date of grant. The initial options granted to a director under the 1991 and
1996 Directors'
42
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Option Plans become exercisable 25% on each of the first four
anniversaries of the date of grant. Each subsequent option grant under the
1996 Directors' Stock Option Plan becomes exercisable in whole on the fourth
anniversary of the date of grant. All options expire ten years from the date
of grant.
In 1999, certain options were granted outside the Company's stock option
plans. Options granted to employees become exercisable under the same terms as
those granted under the 1998 Employee Stock Option Plan. Options granted to
non-employees generally become exercisable based on specific performance
criteria and expire between one and ten years from the date of the grant.
The following summarizes option activity for the three years ended December
31, 1999:
1999 1998 1997
-------------------- ------------------- ------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Options Price Options Price Options Price
---------- -------- --------- -------- --------- --------
Outstanding at beginning
of year................ 4,476,226 $2.25 297,301 $4.92 385,384 $4.73
Granted............... 6,114,756 1.82 5,277,284 2.07 40,000 6.75
Exercised............. (1,102,557) 1.58 (394,277) 0.96 (35,985) 4.40
Canceled.............. (3,162,170) 2.19 (704,082) 2.71 (92,098) 5.10
---------- --------- -------
Outstanding at year
end.................... 6,326,255 $1.98 4,476,226 $2.25 297,301 $4.92
========== ========= =======
Included in options granted during 1998 were 4,127,752 options granted in
exchange for stock options of the Company's subsidiary (see "Subsidiary Stock
Option Plans" below). At December 31, 1999, 1,487,449 shares were available
for future grants under all option plans.
Additional information regarding options outstanding as of December 31,
1999 is as follows:
Options Outstanding Options Exercisable
---------------------------------------------------- ----------------------------
Weighted Average
Number Remaining Weighted Average Number Weighted Average
Range of Exercise Prices Outstanding Contractual Life (Yrs.) Exercise Price Exercisable Exercise Price
------------------------ ----------- ---------------------- ---------------- ----------- ----------------
$0.79................... 607,741 6.23 $0.79 599,603 $0.79
$1.38-1.50.............. 939,907 7.44 1.45 234,452 1.46
$1.60-1.99.............. 3,461,078 9.28 1.85 199,969 1.92
$2.00-2.77.............. 760,058 8.66 2.69 69,872 2.29
$3.41-6.75.............. 557,471 6.88 4.03 307,487 3.94
--------- ---------
$0.79-6.75.............. 6,326,255 8.43 $1.98 1,411,383 $1.82
========= =========
The 1991 Employee Stock Purchase Plan allows eligible employees (including
officers and employee directors) to purchase common stock of the Company
through payroll deductions. Employees are eligible to participate if employed
by the Company for at least twenty hours per week and more than five months
per year. The purchase price per share is the lower of 85% of the fair market
value of the common stock at either the beginning or end of the relevant six-
month offering period. The Board of Directors may alter the duration of the
offering periods without shareholder approval. Currently, the Company is not
operating its Employee Stock Purchase Plan.
43
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Subsidiary Stock Option Plans
During 1998, the Company exchanged employee and director options in its
sole remaining operating subsidiary (the "Subsidiary Options"), for options to
purchase common stock in the Company (the "Company Options"). The Company
exchanged 1.26 Company Options for each Subsidiary Option outstanding. The
option exchange ratio was determined by an independent valuation. The Company
exchanged 3,275,994 Subsidiary Options at a weighted average exercise price of
$2.68 per share for 4,127,752 options to purchase the Company's common stock
at a weighted average exercise price of $2.13 per share. The vesting
provisions and option period of the original subsidiary option grant remained
the same under the terms of the new options to purchase the Company's common
stock. The weighted average remaining contractual life of the options was 8.61
years before and after the exchange. The Subsidiary Options were canceled as a
result of the exchange. The exchange was structured in accordance with the
provisions of Emerging Issues Task Force Issue No. 90-9, "Changes to Fixed
Employee Stock Option Plans as a Result of Equity Restructuring," and as a
result, no compensation expense was recognized in connection with the
exchange.
Fair Value Information for Options Issued to Employees
SFAS No. 123, "Accounting for Stock-Based Compensation," requires expanded
disclosures of stock-based compensation arrangements with employees and
encourages (but does not require) compensation cost to be measured based on
the fair value of the equity instrument awarded. Under SFAS No. 123, the fair
value of stock-based awards to employees is calculated through the use of
option pricing models, even though such models were developed to estimate the
fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option
awards. These models also require subjective assumptions, including future
stock price volatility and expected time to exercise, which greatly affect the
calculated values. Companies are permitted, however, to continue to apply APB
Opinion No. 25, which recognizes compensation cost based on the intrinsic
value of the equity instrument awarded. The Company has elected to continue to
apply APB Opinion No. 25 in accounting for its employee stock-based
compensation arrangements.
The Company has adopted the disclosure-only provisions of SFAS No. 123. Had
the Company elected to measure compensation cost based on the fair value of
employee stock options awarded in 1999, 1998, and 1997, the income/(loss) from
continuing operations and income/(loss) per share would have been
$(10,369,000) and $(0.41), respectively, for the year ended December 31, 1999,
$4,647,000 and $0.20 ($0.19 diluted), respectively, for the year ended
December 31, 1998, and $(6,964,000) and $(0.33), respectively, for the year
ended December 31, 1997. The weighted average fair value of options granted to
employees during the years ended December 31, 1999, 1998, and 1997 were $1.41,
$0.75, and $4.59 per share, respectively. Stock options issued during 1999,
1998 and 1997 were valued using the Black-Scholes option-pricing model using a
risk-free interest rate of 6.0% in 1999, 4.7% in 1998 and 5.4% in 1997, an
expected life of 24 months in 1999 and 36 months in 1998, and expected
volatility of 165% in 1999, 54% in 1998 and 107% in 1997, and expected
dividends of zero for all years reported. However, because options vest over
several years and grants prior to 1995 are excluded from these calculations,
these amounts may not be representative of the impact on future years
earnings, assuming grants are made in those years.
Stock Options Issued to Non-employees
During the year ended December 31, 1999, the Company granted non-employees
815,156 common stock options, at a weighted average exercise price of $1.67,
for services performed and to be rendered in the future. In each period in
which the option shares are earned, stock option compensation will be
recorded. The amount of stock option compensation will be the fair value of
the option shares earned during the period. The fair value of the option
shares earned will be calculated using the Black-Scholes option-pricing model.
The primary
44
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
component in the Black-Scholes calculation is the value of the Company's
common stock at the time the option shares are earned. Since the fair value of
the Company's common stock in the future cannot be estimated, it is not
possible to estimate the amount of stock option compensation that could be
recorded in connection with the non-employee stock options granted and
outstanding as of December 31, 1999. During 1999, stock option compensation to
non-employees amounted to $408,000, of which $368,000 was recognized in the
accompanying consolidated statement of operations and $40,000 of which was
included in the Expersoft acquisition costs (see Note 15).
8. Employee Benefit Plans
Qualified employees are eligible to participate in the Company's 401(k) tax
deferred savings plan. Individual participants may contribute up to 15% of
their compensation, subject to certain limitations, and the Company may make
discretionary contributions. To date, the Company has made no contributions to
the plan. The Company does not provide any other post-retirement benefits to
its employees.
During 1998, the Company finalized the termination of a non-US pension
plan, which previously covered the Company's Irish employees. This action
resulted in a return of excess plan assets to the Company. The Company
recorded approximately $600,000 as other income upon final determination of
the amount of excess plan assets.
9. Other Income
Sale of Sonoma Systems Investment
In December 1998, the Company sold its holdings of Series B and Series C
preferred stock in Sonoma Systems, a former subsidiary of the Company (see
Note 12, Restructuring Expense). The sales price was $10,300,000 in cash, and
resulted in a gain of $7,600,000 million that is reflected in other income in
the accompanying 1998 consolidated statement of operations. The gain is net of
the recorded investment value of $2,400,000 and certain costs of the
transaction. The Company's remaining investment in Sonoma Systems consists of
2,363,636 shares of non-convertible and non-voting Series A redeemable
preferred stock bearing dividends at 6% per annum that is valued at $1,000,000
and is included in investments in the accompanying consolidated balance sheet
(see Note 3).
AMP Transaction
In July 1998, the Company entered into agreements with AMP Incorporated
("AMP") whereby AMP agreed to purchase the Company's CDPD and pACT products
and technologies (the "Wireless Products") as well as other telecommunications
management software. The agreements consisted of a License and Purchase
Agreement (the "Sale Agreement") valued at $2,500,000 for the sale of the
Wireless Products and a non-exclusive license to certain other related
technology sold in the ordinary course of business (the "Background
Technology"), and an agreement valued at $1,000,000 primarily for the
assignment of certain contracts related to the Wireless Products.
Approximately $800,000 of the Sale Agreement, representing the value of the
Background Technology licensed to AMP, was accounted for as license revenue
and approximately $2,500,000 (net of $200,000 of certain deferrals) was
included in other income in the accompanying 1998 consolidated statement of
operations.
45
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Airtel Transaction
In June 1998, the Company entered into a semi-exclusive royalty bearing
licensing contract with Symbol Software Limited ("Symbol"), a subsidiary of
Airtel ATN plc ("Airtel"), for our Aeronautical Telecommunications Network
("ATN") Router software as well as non-exclusive royalty bearing licenses for
various other TMN software products, for $1,000,000. During July 1998, the
Company sold substantially all of the assets and assigned the liabilities of
its Irish operations to Symbol in exchange for 10% of Airtel's common stock
(the "Airtel Transaction"). The Airtel Transaction substantially liquidated
the Company's investment in its Irish operation.
The Company's 10% ownership interest in Airtel, valued at $437,000,
reflected certain restrictions, including a requirement that prohibited the
Company from disposing of the Airtel shares until August 1999. The book value
of the software library and the net assets and liabilities assigned to Symbol
approximated zero and, as a result, the Company recognized a gain totaling
$437,000 related to the Airtel Transaction during 1998 which is reflected in
other income in the accompanying 1998 consolidated statement of operations.
The investment in Airtel is included in investments in the accompanying
consolidated balance sheet. As a result of the substantial liquidation of its
Irish operations, the Company recorded a charge of $436,000 to other income in
1998 representing the realization of foreign currency exchange losses
previously included as cumulative translation losses which is also a component
of accumulated comprehensive loss. The $436,000 charge recorded as a result of
the liquidation represents other comprehensive income and is classified as
such according to the provisions of SFAS No. 130 (See also Note 2).
10. Operations by Geographic Area
The Company operates in one industry segment and does not allocate
resources or compile management reports based on business units. The following
presents a summary of operations by geographic area (in thousands):
Years Ended December
31,
------------------------
1999 1998 1997
------- ------- -------
Net revenues:
U.S. operations................................. $19,815 $17,883 $17,722
Foreign operations.............................. -- 484 755
------- ------- -------
Consolidated.................................... $19,815 $18,367 $18,477
======= ======= =======
Transfers between operations.................... $ 4,928 $ 2,654 $ 2,909
------- ------- -------
Income (loss) from continuing operations:
U.S. operations................................. $(8,143) $ 7,155 $(5,429)
Foreign operations.............................. 384 122 934
------- ------- -------
Consolidated.................................... $(7,759) $ 7,277 $(4,495)
======= ======= =======
Identifiable assets at end of period:
U.S. operations................................. $23,513 $27,937 $13,505
Foreign operations.............................. 314 380 226
------- ------- -------
Consolidated.................................... $23,827 $28,317 $13,731
======= ======= =======
Included in U.S. operations are export sales of $9,632,000, $7,399,000 and
$6,687,000 for the years ended 1999, 1998, and 1997, respectively.
46
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Statement of Cash Flows
Increases (decreases) in operating cash flows arising from changes in
assets and liabilities consist of the following (in thousands):
Years Ended December
31,
-------------------------
1999 1998 1997
------- ------- -------
Trade accounts receivable........................ $(1,611) $ 360 $(1,038)
Prepaid expenses and other current assets........ 82 385 243
Accounts payable................................. 302 (307) (331)
Accrued wages and related liabilities............ 140 691 (243)
Cash payments for restructuring expenses......... 297 (1,263) (200)
Other accrued liabilities........................ (36) 131 (459)
Accrued taxes payable............................ (604) 310 (160)
Inventories...................................... 385 -- --
Customer deposits................................ (422) -- --
Deferred revenue................................. (561) 584 (208)
------- ------- -------
$(2,028) $ 891 $(2,396)
======= ======= =======
Supplemental Non-Cash Activities
In 1999, $381,000 was transferred from other accrued liabilities and
credited to additional paid-in capital upon the merger of Vertel Corporation I
with the Company.
In March 1999, the Company acquired all the stock of Expersoft Corporation
for $3,225,000 (see Note 15). In conjunction with the acquisition, liabilities
were assumed as follows:
Fair value of assets acquired.................................... $4,742,000
Cash paid for capital stock...................................... 3,225,000
----------
Liabilities assumed.............................................. $1,517,000
==========
Cash paid (received) for income taxes consists of the following (in
thousands):
Years Ended
December 31,
==================
1999 1998 1997
===== ----- ----
Income taxes.............................................. $(194) $(384) $18
12. Restructuring Expenses
In October 1999, the Company announced a restructuring of its operations
intended to reduce costs and make the Company more competitive. The estimated
cost of restructuring recorded in the financial statements for the year ended
December 31, 1999 was $641,000, net of a restructuring benefit of $123,000,
which consists primarily of severance pay ($406,000) for various employees,
and costs to vacate a facility ($351,000). In connection with the
restructuring, the Company reduced its workforce by 25 employees during the
fourth quarter of 1999, moved some key functions offshore and consolidated its
U.S. engineering function to its San Diego facility. The workforce reduction
was concentrated in research and development but impacted all areas.
47
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As discussed in Note 13, Discontinued Operations, in December 1997, the
Company announced plans to discontinue investment in its broadband access
equipment subsidiary, Sonoma Systems. As a result, the Company's management
structure was reorganized and downsized by three officers to reflect the
reduction of the number of operating subsidiaries to one. The estimated costs
of restructuring recorded in the financial statements for the year ended
December 31, 1997 was $1,816,000 and included costs of severance pay for three
of the Company's officers, acceleration of vesting for certain officer and
director stock options (see Note 7), facility and asset consolidation,
professional fees and other related charges. The majority of these costs were
paid in the first half of 1998.
In 1995, the Company announced a major restructuring of its operations,
resulting from the significant downsizing of its internetworking hardware
business unit, later known as Sonoma Systems. Subsequently, the Company
recorded the reversal of excess restructuring reserves totaling $123,000 and
$303,000 for the years ended December 31, 1999 and 1997, respectively.
Restructuring expenses and (benefit) for 1999, 1998 and 1997 are summarized
as follows (in thousands):
Restructuring
Expenses/(Benefit)
-------------------
1999 1998 1997
----- ----- ------
Severance and related costs........................... $ 406 $ -- $1,025
Stock option acceleration............................. -- -- 317
Professional fees..................................... 7 -- 176
Vacating costs of facilities.......................... 351 -- --
Other, net of reversal of $123,000 in 1999 and
$303,000 in 1997..................................... (123) -- (5)
----- ----- ------
$ 641 $ -- $1,513
===== ===== ======
Restructuring reserves for 1999, 1998, and 1997 are summarized as follows
(in thousands):
Years Ended
December 31,
--------------------
1999 1998 1997
---- ------ ------
Beginning reserve..................................... $224 $1,487 $ 491
Charge against reserve................................ (549) (1,263) (820)
Additions to reserve.................................. 764 -- 1,816
---- ------ ------
Remaining reserve..................................... $439 $ 224 $1,487
==== ====== ======
With respect to the 1999 restructuring charge, $411,000 of the remaining
$439,000 reserve as of December 31, 1999, is expected to be paid in 2000, and
is primarily comprised of severance and vacated facility costs. Facility
related reserves of $28,000 are expected to be utilized in 2001. As of December
31, 1999, all reserves related to the 1997 and 1995 restructuring charges had
been utilized or reversed.
13. Discontinued Operations
In December 1997, the Company's Board of Directors adopted a plan to
discontinue further investment in its subsidiary, Sonoma Systems. In early
1998, as the result of a series of financings by Sonoma Systems, the Company's
ownership interest in Sonoma Systems was reduced to that of a passive investor
with no significant influence over the former subsidiary's operations. Sonoma
raised an aggregate of approximately $9,000,000 by issuing preferred stock to
unrelated investors, thereby reducing the Company's voting ownership in Sonoma
Systems to 19.9%. As a result, the Company's financial statements and related
notes to financial statements for 1997 and prior years reflect the results of
operations and net liabilities of Sonoma Systems as a discontinued
48
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
operation. Beginning in 1998, the Company began accounting for its remaining
investment in Sonoma Systems using the cost method (see Note 3).
To reflect the effect of the Sonoma Systems financings, the Company
increased the recorded value of its net investment in Sonoma to $3,400,000
reflecting the Company's proportionate share of Sonoma Systems'
post-transaction equity with a corresponding credit to additional paid-in
capital of $1,969,000 and a credit to Accumulated Other Comprehensive Income
(Loss) of $1,431,000 in connection with a cumulative translation loss related
to a foreign subsidiary of Sonoma Systems. In December 1998, the Company sold
the majority of its equity stake in Sonoma Systems (see Notes 3 and 9),
resulting in a remaining investment value of $1,000,000 as of December 31,
1999.
Net assets and operating results from discontinued operations have been
segregated from the previously reported consolidated financial statements of
operations for the year ended December 31, 1997, and consist of the following
(in thousands):
1997
--------
Net revenues...................................................... $ 6,342
Cost of revenues.................................................. 3,094
Operating expenses................................................ 9,311
--------
Operating loss.................................................... (6,063)
Other income (expense)............................................ (252)
Provision for estimated losses during phase-out period............ (100)
--------
Net loss.......................................................... $(6,415)
========
Operating losses of Sonoma Systems during the phase out period did not
differ materially from the estimated amount of $100,000 provided for in the
1997 consolidated financial statements.
14. Related Party Transactions
During 1998, the Company recognized approximately $737,000 in license
revenue for certain software products licensed to Sonoma Systems (see Note
13). Sonoma Systems paid this amount in full during 1998.
15. Acquisition of Expersoft Corporation
Effective March 12, 1999, the Company acquired Expersoft Corporation
("Expersoft"). Expersoft develops and markets standards-based, high
performance Common Object Request Broker Architecture software technology. The
acquisition price was approximately $3,225,000 and consisted of cash of
$3,000,000 and acquisition costs of $225,000. At December 31, 1999, the
Company had paid $3,182,000 of the cash consideration and acquisition costs.
The acquisition was accounted for as a purchase.
The purchase resulted in goodwill of $4,742,000, which is being amortized
using the straight-line method over its estimated useful life of five years.
The operating results of Expersoft are included in the Company's
consolidated financial statements from the date of acquisition. The unaudited
pro forma consolidated information set forth below presents the consolidated
results of operations as if the acquisition had occurred at the beginning of
the periods presented.
These unaudited pro forma consolidated results have been prepared for
comparative purposes only and do not purport to be indicative of what would
have occurred if the acquisition had taken place at the beginning of the
period presented or the results that may occur in the future.
49
VERTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Unaudited pro forma consolidated results for 1999 and 1998 are as follows
(in thousands):
Years Ended
December 31,
--------------------
1999 1998
------- -------
Revenues................................................ $20,232 $21,713
Net (loss) income....................................... (8,059) 4,581
(Loss) income per share:
Basic................................................. $ (0.32) $ 0.20
Diluted............................................... $ (0.32) $ 0.19
Shares used in computation of
pro forma loss per share:
Basic ................................................ 25,425 23,321
Diluted............................................... 25,425 24,698
50
INDEPENDENT AUDITORS' REPORT
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF VERTEL CORPORATION:
We have audited the accompanying consolidated balance sheets of Vertel
Corporation and its subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Vertel Corporation and its
subsidiaries at December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1999 in conformity with accounting principles generally
accepted in the United States of America.
Deloitte & Touche LLP
Los Angeles, California
February 3, 2000
51
Results of Operations--Unaudited Quarterly Financial Information
The following tables present unaudited quarterly financial information for
the two years ended December 31, 1999. In the opinion of management, this
information contains all adjustments, consisting only of normal, recurring
adjustments, necessary for a fair presentation thereof. The operating results
are not necessarily indicative of results for any future periods.
1999 Quarters Ended
-----------------------------------
Sept.
March 31 June 30 30 Dec. 31
-------- ------- ------- -------
(in thousands, except per share
data)
Quarterly results of operations:
Net revenues............................. $ 4,522 $ 5,602 $ 4,690 $ 5,001
Gross profit............................. 2,538 3,684 2,815 3,457
Net loss................................. (1,458) (1,751) (3,035) (1,515)
Basic and diluted net loss per common
share................................... $ (0.06) $ (0.07) $ (0.12) $ (0.06)
1998 Quarters Ended
-----------------------------------
Sept.
March 28 June 27 26 Dec. 31
-------- ------- ------- -------
(in thousands, except per share
data)
Quarterly results of operations:
Net revenues............................. $ 4,918 $ 5,003 $ 4,908 $ 3,538
Gross profit............................. 3,591 3,442 3,603 2,131
Net income (loss)........................ 340 (172) 973 6,136
Basic net income (loss) per common
share................................... $ 0.02 $ (0.01) $ 0.04 $ 0.25
Diluted net income (loss) per common
share................................... $ 0.02 $ (0.01) $ 0.04 $ 0.24
The Company's future revenues and operating results may be subject to
quarterly fluctuations as a result of factors such as the timing of
significant licenses of, or orders for, the Company's products, shifts in
product mix, changes in distribution channels, the introduction of new
products by the Company or its competitors, competitive pricing, changes in
product demand resulting from fluctuations in foreign currency exchange rates,
decreased European business activity during the summer months and changes in
operating and material costs. Accordingly, quarter-to-quarter comparisons
should not be relied upon as indicators of future performance. See Item 1:
Business; "Risk Factors".
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
52
PART III
Certain information required by Part III is omitted from this report
because the Registrant will file a definitive proxy statement (within 120 days
after the end of its fiscal year) pursuant to Regulation 14(A) as promulgated
by the U.S. Securities and Exchange Commission (the "Proxy Statement") for its
annual meeting of shareholders to be held May 18, 2000, and the information
included therein is incorporated herein by reference to the extent detailed
below.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to our directors is incorporated by reference from
the information under the caption "Election of Directors--Nominees" in the
Registrant's Proxy Statement.
Executive Officers of the Company
Our principal executive officers and their ages as of March 1, 2000 are as
follows:
Name Age Position
---- --- --------
Bruce W. Brown....... 49 President and Chief Executive Officer
Gordon L. Almquist... 50 Vice President, Finance and Administration, Chief
Financial Officer and Secretary
Richard L. Hamilton.. 58 Vice President, Operations
Cyrus D. Irani....... 41 Vice President, Research and Development and
Professional Services Unit
Stephen J. McDaniel.. 37 Vice President, Worldwide Sales
Mr. Brown was elected to the position of President and Chief Executive
Officer of Vertel in January 1998. Prior to that, Mr. Brown was President and
Chief Executive Officer of Vertel Corporation I, a position to which he was
elected in November 1995. Mr. Brown joined Vertel Corporation I in August 1995
and served as a director of Vertel Corporation I from October 1995. Mr. Brown
also served as Chief Financial Officer of Vertel Corporation I from October
1995 to December 1996. Prior to joining Vertel, Mr. Brown served as President
of ADC Fibermux Corporation ("Fibermux"), a supplier of fiber optic networking
products from July 1993 until August 1995. Prior to his role at Fibermux, Mr.
Brown was Executive Vice President, Customer Operations at UB Networks
(previously named Ungermann-Bass) an enterprise networking company, from
October 1990 until July 1993.
Mr. Almquist has served as Vice President, Finance and Administration and
Chief Financial Officer of the Company since September 1998 and Secretary
since May 1999. Prior to joining Vertel, Mr. Almquist was with ChatCom, Inc.,
a manufacturer of application servers for the LAN/WAN industry, where he
served as Vice President, Finance and Chief Financial Officer from November
1997 through August 1998 and Chief Operating Officer from February 1998
through August 1998. From September 1991 through April 1997, Mr. Almquist was
Vice President, Finance and Chief Financial Officer of 3D Systems Corporation,
a developer, manufacturer and marketer of rapid prototyping systems to a broad
range of global industries. Mr. Almquist is a Certified Public Accountant.
Mr. Hamilton has served as Vice President, Operations, for Vertel since
October 1999. Prior to that, he served as Vice President, Customer Services
since joining Vertel in January 1999. Prior to joining Vertel, Mr. Hamilton
served as Principal Consultant for Hamilton Associates, a service management
and operations consulting firm, from May 1998 to January 1999. Previously, he
served as Vice President, Support Services, from January 1995 to May 1998 for
Xantel Corporation, a developer of priority call management products in the
computer telephony integration industry. He also served as Director of
Worldwide Support Services from September 1992 to October 1994 at UB Networks.
Prior to his position with UB Networks, Mr. Hamilton held various senior level
management positions with companies in the IBM plug-compatible products
industry.
53
Mr. Irani has served as Vice President, Research and Development and
Professional Services Unit for the Company since December 1999. Prior to that
he served as Vice President, Professional Services Unit from January 1999
until November 1999. Prior to that, he served as Vice President, Marketing
since rejoining Vertel in February 1996. Prior to joining Vertel, Mr. Irani
served as Vice President of Marketing and Sales for The Alchemy Group, a
network management software company, from August 1994 to February 1996.
Previously, he was Product Line Manager for AT&T Global Information Systems, a
telecommunications service provider, from March 1993 to August 1994. From
December 1989 to March 1993, he served as Director of Product Marketing for
the Company.
Mr. McDaniel has served as Vice President, Worldwide Sales of the Company
since November 1999. Prior to that, he served as Vice President, Americas
Sales from August 1999 to October 1999 and served as Managing Director, Europe
since joining the Company in April 1997. Prior to joining Vertel, Mr. McDaniel
served as Director of Sales, Northern Europe for Isocor, an electronic
messaging systems company from September 1993 until March 1997.
ITEM 11. COMPENSATION OF EXECUTIVE OFFICERS
Incorporated by reference from the information under the captions "Summary
Compensation Table," stock option tables and "Transactions with Management and
Others" in the Registrant's Proxy Statement.
ITEM 12. COMMON STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the information under the caption "Common
Stock Ownership of Certain Beneficial Owners and Management" in the
Registrant's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the information under the caption
"Transactions with Management and Others" in the Registrant's Proxy Statement.
54
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. The financial statements and supplementary financial information
listed below are filed as part of this annual report.
Consolidated Balance Sheets at December 31, 1998 and December 31, 1999.. 31
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 1999.................... .................... 32
Consolidated Statements of Shareholders' Equity for each of the three
years in the period ended December 31, 1999............. .............. 33
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1999.................... .................... 34
Notes to Consolidated Financial Statements.............................. 35
Independent Auditors' Report............................................ 50
2. The supplementary financial information listed below are filed as part
of this annual report.
Unaudited Quarterly Financial Information............................. 51
Schedule filed as part of Form 10-K:
Schedule II Valuation and Qualifying Accounts....................... S-1
Independent Auditors' Report on Supplemental Schedule............... S-2
Schedules have been omitted since the required information is not present
in amounts sufficient to require submission of the schedules, or because the
information required is included in the consolidated financial statements.
3. Exhibits included herein, numbered in accordance with Item 601 of
Regulation S-K.
Number Description
------ -----------
2.1 Share Purchase Agreement dated December 31, 1998 among the Registrant,
Newbridge (Barbados) Corporation and Sonoma Systems.(16)
2.2 Agreement and Plan of Merger and Reorganization between the Company,
Expersoft Acquisition Corporation and Expersoft Corporation dated
February 23, 1999 and Corresponding Amendment No. 1 dated March 12,
1999.(17)
3.3 Amended and Restated Articles of Incorporation of the Registrant.(5)
3.4 Bylaws of the Registrant, as amended to date.(13)
3.5 Certificate of amendment to Company's articles of incorporation, as
filed with the California Secretary of State on April 7, 1998,
changing the Company's name to Vertel Corporation.(14)
10.2 1988 Stock Option Plan and forms of option agreements thereunder.(6)
10.5 1991 Employee Stock Purchase Plan and form of subscription agreement
thereunder.(3)
10.6 Form of Indemnification Agreement.(2)
10.22 Lease Agreement between the Registrant and Moorpark Associates, a
California Limited Partnership, dated February 5, 1993.(4)
10.27 Lease Agreement between the Registrant and OMA El Segundo Properties, a
California general partnership, dated May 23, 1995.(7)
10.28 Employment Agreement between M.Y. Stephan and Retix, dated September
27, 1995.(7)
55
Number Description
------ -----------
10.29 Employment Agreement between Philip Mantle and Retix, dated November 1,
1995.(7)
10.30 Common Stock and Warrant Purchase Agreement by and between Retix and
Sierra Ventures V.LP., dated January 30, 1996.(7)
10.31 Master Agreement dated February 28, 1996 for Spin-Off of Open Systems
Interconnection Technology between Telaware Corporation and Retix.(7)
10.32 1996 Directors' Stock Option Plan and forms of option agreement
thereunder.(13)
10.45 Sublease Agreement dated May, 1996 between Value Behavioral Health and
Retix.(9)
10.46 Master Agreement between Retix and Internetworking Solutions dated May
31, 1996.(9)
10.47 Master Agreement between Retix and Wireless Solutions dated May 31,
1996.(9)
10.48 Lease Agreement between the Registrant and Nomura-Warner Center
Associates, L.P., dated November 26, 1996.(10)
10.49 Stock Transfer Agreement between Retix, Vertel Corporation and Wireless
Solutions dated June 10, 1997.(11)
10.50 Surrender of Lease between Cofton Irish Investments and Retix B.V.,
dated August 21, 1997.(12)
10.51 Sub-Sublease Agreement between TSN, L.L.C., and Retix, dated August 22,
1997.(12)
10.55 Amended and Restated Articles of Incorporation of Sonoma Systems, Inc.,
and related documents dated January 7, 1998.(13)
10.56 Sub-sublease between Retix and Sonoma Systems, Inc., dated December 28,
1997.(13)
10.57 Sale and License Agreement between the Company and AMP Incorporated,
dated July 27, 1998, and an Amendment dated October 9, 1998.(15)
10.58 Common Stock Purchase Agreement between the Company and Pequot Private
Equity Fund, L.P. and Pequot Offshore Private Equity Fund, Inc. and
Sierra Ventures V, L.P., dated September 29, 1998.(15)
10.59 Stock Repurchase Agreement between the Company and Joe Stephan dated
November 27, 1998.(17)
10.60 Stock Repurchase Agreement between the Company and Philip Mantle dated
November 27, 1998.(17)
10.61 Stock Repurchase Agreement between the Company and Steve Waszak dated
November 27, 1998.(17)
10.62 Consulting Agreement between the Company and Joe Stephan dated January
5, 1999.(17)
10.63 Notice of Stock Option Grant and Stock Option Agreement between the
Company and Joe Stephan dated January 5, 1999.(17)
10.64 Consulting Agreement between the Company and Philip Mantle dated
January 5, 1999.(17)
10.65 Notice of Stock Option Grant and Stock Option Agreement between the
Company and Philip Mantle dated January 5, 1999.(17)
10.66 Consulting Agreement between the Company and Steve Waszak dated January
5, 1999.(17)
10.67 Notice of Stock Option Grant and Stock Option Agreement between the
Company and Steve Waszak dated January 5, 1999.(17)
10.68 Form of Retention Agreement between the Company and each of its
officers.(17)
10.69 Employment Agreement between the Company and Bruce W. Brown dated,
dated January 12, 1999.(19)
10.70 Employment Agreement between the Company and Gordon L. Almquist dated,
dated January 12, 1999.(19)
10.71 Employment Agreement between the Company and Ruth Cox dated, dated
January 12, 1999.(19)
56
Number Description
------ -----------
10.72 Employment Agreement between the Company and Cyrus D. Irani, dated
January 12, 1999.(19)
10.73 Employment Agreement between the Company and Richard L. Hamilton dated,
dated January 18, 1999.(19)
10.74 Agreement and Plan of Merger and Reorganization, dated February 23,
1999, among Vertel Corporation, Expersoft Corporation and Expersoft
Acquisition Corp. and Corresponding Amendment No. 1 dated March 12,
1999.(18)
10.75 Amended 1996 Directors' Stock Option Plan and form of option agreement
thereunder.(19)
10.76 Amended 1998 Stock Option Plan and form of option agreement
thereunder.(19)
10.77 Employment Agreement between the Company and Stephen J. McDaniel dated,
dated November 1, 1999.(19)
10.78 Amendment No. 1, dated December 3, 1999 to the Employment Agreement
between the Company and Gordon L. Almquist.(19)
10.79 Amendment No. 1 dated December 3, 1999 to the Employment Agreement
between the Company and Richard L. Hamilton.(19)
10.80 Amendment No. 1, dated December 3, 1999 to the Employment Agreement
between the Company and Cyrus D. Irani.(19)
21.1 Subsidiaries of the Registrant.(19)
23.1 Independent Auditors' Consent.(19)
25.1 Power of Attorney (see page 59).(19)
27.1 Financial Data Schedule.(19)
- --------
(1) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 28, 1991.
(2) Incorporated by reference to identically numbered exhibits filed in
response to Item 16(a), "Exhibits," of the Registrants Registration
Statement on Form S-1 and Amendment No. 1 thereto (File No. 33-43544)
which became effective on December 9, 1991.
(3) Incorporated by reference to identically numbered exhibits filed in
response to Item 6(a), "Exhibits," of the Registrant's Quarterly Report
on Form 10-Q for the fiscal quarter ended September 26, 1992.
(4) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report
on Form 10-K for the fiscal year ended January 2, 1993.
(5) Incorporated by reference to identically numbered exhibit filed in
response to Item 6(a), "Exhibits," of the Registrant's Quarterly Report
on Form 10-Q for the fiscal quarter ended October 1, 1994.
(6) Incorporated by reference from Registrant's Registration Statement on
Form S-8 (No. 33-82154) filed on July 28, 1994.
(7) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1995.
(8) Incorporated by reference to identically numbered exhibit filed in
response to Item 6(a), "Exhibits," of the Registrant's Quarterly Report
on Form 10-Q for the fiscal quarter ended March 30, 1996.
(9) Incorporated by reference to identically numbered exhibit filed in
response to Item 6(a), "Exhibits," of the Registrant's Quarterly Report
on Form 10-Q for the fiscal quarter ended June 30, 1996.
(10) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 28, 1996.
(11) Incorporated by reference to identically numbered exhibit filed in
response to Item 6(a), "Exhibits," of the Registrant's Quarterly Report
on Form 10-Q for the fiscal quarter ended June 28, 1997.
57
(12) Incorporated by reference to identically numbered exhibit filed in
response to Item 6(a), "Exhibits," of the Registrant's Quarterly Report
on Form 10-Q for the fiscal quarter ended September 27, 1997.
(13) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 27, 1997.
(14) Incorporated by reference from registrant's report on Form 8-K as filed
with the Securities and Exchange Commission on April 7, 1998.
(15) Incorporated by reference to identically numbered exhibit filed in
response to Item 6(a), "Exhibits," of the Registrant's Quarterly Report
on Form 10-Q for the fiscal quarter ended September 26, 1998.
(16) Incorporated by reference from registrant's report on Form 8-K as filed
with the Securities and Exchange Commission on January 15, 1999.
(17) Incorporated by reference to identically numbered exhibits filed in
response to Item 14(a)(3), "Exhibits," of the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1998.
(18) Incorporated by reference from registrant's report on Form 8-K as filed
with the Securities and Exchange Commission on April 1, 1999.
(19) Filed herewith.
58
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report on Form 10-K to be signed on its behalf
by the undersigned, thereunto duly authorized.
VERTEL CORPORATION
Date: March 27, 2000 /s/ Gordon L. Almquist
By: _________________________________
Gordon L. Almquist
Vice President, Finance and
Administration,
Chief Financial Officer and
Secretary
Each person whose signature appears below constitutes and appoints Bruce W.
Brown and Gordon L. Almquist, 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
attorneys-in-fact, or his substitute or substitutes may do or cause to be done
by virtue hereof.
Pursuant to the requirements of the Securities 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/ Bruce W. Brown President, Chief March 27, 2000
______________________________________ Executive Officer and
Bruce W. Brown Director (Principal
Executive Officer)
/s/ Gordon L. Almquist Vice President, Finance March 27, 2000
______________________________________ and Administration,
Gordon L. Almquist Chief Financial
Officer (Principal
Financial and
Accounting Officer)
and Secretary
/s/ Jeffrey M. Drazan Director March 27, 2000
______________________________________
Jeffrey M. Drazan
/s/ Howard Oringer Director March 27, 2000
______________________________________
Howard Oringer
/s/ Jack P. Reily Director March 27, 2000
______________________________________
Jack P. Reily
/s/ Ralph K. Ungermann Director March 27, 2000
______________________________________
Ralph K. Ungermann
59
INDEPENDENT AUDITORS' REPORT ON SUPPLEMENTAL SCHEDULE
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF VERTEL CORPORATION:
We have audited the consolidated financial statements of Vertel Corporation
and subsidiaries as of December 31, 1999 and 1998, and for each of the three
years in the period ended December 31, 1999, and have issued our report
thereon dated February 3, 2000; such report is included elsewhere in this Form
10-K. Our audits also included the financial statement schedule of Vertel
Corporation and subsidiaries, listed in Item 14. Such financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion based on our audits. In our opinion, such financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
Deloitte & Touche LLP
Los Angeles, California
March 27, 2000
60
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
Additions
---------------------
Balance
at Charged to Charges Balance at
Beginning Costs & to Other End of
Description of Period Expenditures Accounts Deductions Period
----------- --------- ------------ -------- ---------- ----------
Allowance for doubtful
accounts and
sales returns:
Year ended December 31,
1999................... $556,000 $501,000 $571,000(a) $486,000
Year ended December 31,
1998................... $452,000 $161,000 $ 57,000(a) $556,000
Year ended December 31,
1997................... $368,000 $249,000 $165,000(a) $452,000
- --------
(a) Write-off of uncollectable accounts, net of recoveries.