Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997
OR
[x] 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 0-28450
NETOPIA, INC.
(Exact name of registrant as specified in its charter)
Formerly Farallon Communications, Inc.
DELAWARE 94-3033136
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2470 MARINER SQUARE LOOP
ALAMEDA, CALIFORNIA 94501
------------------------------------------------------------
(Address of principal executive offices, including Zip Code)
(510) 814-5100
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check X whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days
Yes x No
----- -----
Indicate by X if disclosure of delinquent filers pursuant to Item 405 of
regulation S-K is not contained herein, and will not be contained, to the best
of the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in this Form 10-K or any amendment to this Form 10-
K.
Yes x No
----- ------
As of December 1, 1997 there were 11,514,819 shares of the Registrant's
Common Stock outstanding. The aggregate market value of the Common Stock held
by non-affiliates of the registrant, based on the closing price of the Common
Stock as reported on The Nasdaq Stock Market (National Market System) on
December 1, 1997 was approximately $ 39,473,082.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's definitive Proxy Statement for its Annual Stockholders
Meeting to be held on February 16, 1998 is incorporated by reference in Part III
of this Form 10-K.
NETOPIA, INC.
FORM 10-K
INDEX
PART I. PAGE
ITEM 1. DESCRIPTION OF BUSINESS.............................................................. 2
ITEM 2. PROPERTIES........................................................................... 17
ITEM 3. LEGAL PROCEEDINGS.................................................................... 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS................................ 18
PART II.
ITEM 5. MARKET FOR NETOPIA, INC. COMMON STOCK................................................ 18
ITEM 6. SELECTED FINANCIAL DATA.............................................................. 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 20
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................. 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. 28
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................................... 28
ITEM 11. EXECUTIVE COMPENSATION............................................................... 28
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....................... 28
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................................... 28
PART IV.
ITEM 14. EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULE.............................. 29
INDEX TO EXHIBITS.............................................................................. 29
SIGNATURE...................................................................................... 31
1
PART I.
The discussion in this Report contains forward-looking statements that
involve risks and uncertainties. The statements contained in this Report that
are not purely historical are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended including statements regarding the
Company's expectations, beliefs, intentions or strategies regarding the future.
All forward-looking statements included in this document are based on
information available to the Company on the date hereof, and the Company assumes
no obligation to update any such forward-looking statement. The Company's
actual results could differ materially from those discussed herein. Factors
that could cause or contribute to such differences include, but are not limited
to, those discussed in "Other Factors Affecting Future Operating Results" as
well as those discussed in this section and elsewhere in this Report, and the
risks discussed in the Company's Securities and Exchange Commission Filings.
ITEM 1. DESCRIPTION OF BUSINESS
COMPANY BACKGROUND
Netopia, Inc. (the "Company" or "Netopia") (formerly Farallon Communications,
Inc.) develops, markets and supports complete, easy-to-use, plug-and-play
Internet connectivity and networking solutions and real-time collaboration
software. The Company's products are designed to increase the productivity and
efficiency of Internet, Intranet and Local Area Network ("LAN") users and to
target small businesses, geographically dispersed facilities of large
enterprises, home offices, mobile users, schools and other small organizations
that may not have access to sophisticated technical support. The Company's
Internet/Intranet products include its Netopia Internet connectivity hardware,
which provide high-speed Internet connectivity for individuals and workgroups,
as well as its Timbuktu Pro and Netopia Virtual Office software, which enable
real-time, peer-to-peer collaboration on the Internet, Intranets and LANs. To
assist users in configuring the Netopia Internet connectivity hardware products
and in arranging service from Internet and telecommunications service providers,
the Company offers its Up & Running, Guaranteed! program, which serves as a
single source for complete Internet connectivity. The Company's Farallon
Division provides LAN networking solutions, a substantial majority of which have
been sold to Mac OS customers.
The Company was founded in 1985 and initially focused on the development of
networking products for AppleTalk LANs, including the PhoneNET network system.
In 1993, the Company revised its business strategy to concentrate on the
Internet and Intranet markets through the utilization of its Transmission
Control Protocol/ Internet Protocol ("TCP/IP") and routing expertise. In the
first quarter of fiscal 1994, the Company released its first Timbuktu Pro
Internet/Intranet collaboration software product (TCP/IP enabled), and in the
first quarter of fiscal 1996, the Company introduced its Netopia family of
Internet connectivity products and services. During fiscal 1997, the Company
expanded it's Internet/Intranet product offerings with the introduction of
Netopia Fractional T1 / T1 and Frame Relay routers which complement the existing
Netopia ISDN routers, as well as Netopia Virtual Office software which allows
Internet users the ability to set-up their own virtual office on the Internet.
The Company was incorporated in California in 1986 as Farallon Computing,
Inc. and was reincorporated in Delaware in June 1996 as Farallon Communications,
Inc. In November 1997 the Company changed its name to Netopia, Inc. The Farallon
division of Netopia, Inc. continues to develop and support comprehensive LAN
connectivity solutions for the Macintosh platform. The Company's principal
executive offices are located at 2470 Mariner Square Loop, Alameda, California
94501.
INDUSTRY BACKGROUND
Small businesses, geographically dispersed facilities of large enterprises,
home offices, mobile users, schools and other small organizations are
increasingly using networks of computers to enhance productivity, access
information and communicate more effectively. A number of factors have
contributed to this increase in the use of networks, including increasing
personal mobility, the need for information access, a demand for immediate
information and advances in technology and infrastructure such as the
proliferation of communication-enabled PCs, the availability of intuitive
graphical software and the widespread implementation of distributed local and
wide area networks based on client/server architectures and peer-to-peer
architectures. These factors also have changed
2
substantially the way in which organizations and individuals communicate and use
PCs, generating growing demand for products that enhance network communications.
As networking technology has advanced, the scale, scope and functionality of
network communications and computing have increased, resulting in a
corresponding increase in the complexity of these systems. Headquarters offices
of large enterprises that have access to sophisticated technical support have
generally managed this complexity and realized the benefits of effective network
communications. However, individuals and smaller organizations typically do not
have access to the skills or resources required to manage the complexity of
advanced networking systems. As a result, these users are increasingly seeking
networking solutions that are complete, easy-to-use and cost-effective.
The emergence and continued expansion of the Internet as a viable
communications medium has substantially enhanced the value and potential of
network communications and computing. The Internet is a global, open network of
thousands of interconnected computer networks and millions of computer
connections that allow businesses, individuals and other organizations to
communicate worldwide. Large enterprises are increasingly adopting private
''Intranets'' that employ Internet data formats and communications protocols,
such as TCP/IP, to connect geographically dispersed networks and facilities.
Intranets enable network users to communicate and access information within an
organization, communicate with external users, such as suppliers, customers and
consultants, and use the World Wide Web (the ''Web'') to access information
available on the Internet. The emergence of the Internet and Intranets as well
as the increased affordability and availability of advanced hardware, software
and communications services has made network communications available to a
broader range of users.
As organizations and individuals expand the use of the Internet and Intranets,
the need for real-time collaboration and communication becomes increasingly
important to achieving increased user productivity and efficiency. Real-time,
peer-to-peer collaboration software enables users, such as those at
geographically dispersed facilities of large enterprises, remote sites,
traveling or working at home, to access information and enterprise applications,
and permits two or more users at disparate locations to view and work with the
same information at the same time. Productivity improvements are also derived
from peer-to-peer collaboration software that enables users to receive real-time
technical support and just-in-time training from a help desk or another
knowledgeable user on the Internet or Intranet.
The increasing utility of the Internet and Intranets and the availability of
high-performance infrastructures that enable advanced capabilities, such as
real-time collaboration, are compelling small businesses, geographically
dispersed facilities of large enterprises, home offices, mobile users, schools
and other small organizations to adopt complex network communications and
computing systems. However, these organizations typically do not have access to
sophisticated technical support and therefore may not be well-served by complex
networking systems requiring extensive technical knowledge or expertise. Today,
the tasks of installing and configuring systems, obtaining high-speed digital
services such as Integrated Service Digital Network ("ISDN"), frame relay,
fractional T1/T1 and arranging for an Internet connection from an Internet
Service Provider ("ISP") can be costly and burdensome for such users. In
addition, traditional vendors, resellers and systems integrators of networking
products historically have not offered products or services specifically
designed for users who may not have access to sophisticated technical support.
Accordingly, the absence of complete, easy-to-use, plug-and-play solutions for
affordable Internet/Intranet connectivity and real-time collaboration has
constrained the ability of these users to fully achieve the benefits of network
communications and computing.
THE NETOPIA SOLUTION
Netopia develops, markets and supports complete, easy-to-use, plug-and-play
Internet connectivity and networking solutions and real-time collaboration
software. The Company's products are designed to increase the productivity and
efficiency of Internet, Intranet and LAN users and to target small businesses,
geographically dispersed facilities of large enterprises, home offices, mobile
users, schools and other small organizations that may not have access to
sophisticated technical support. The Company's Internet/Intranet products
include its Netopia Internet connectivity hardware as well as Timbuktu Pro and
Netopia Virtual Office software. The Company's LAN products include a broad
range of Ethernet network connectivity devices.
3
The Company's Netopia Internet connectivity hardware provides plug-and-play,
high-speed Internet connectivity for workgroups and individuals. The Company
offers comprehensive customer service and technical support, including the Up &
Running, Guaranteed! program, which serves as a single source for complete
Internet connectivity by assisting the user in configuring Netopia routers and
in arranging service from ISPs and telecommunications service providers. The
Company's software family includes Timbuktu Pro and Netopia Virtual Office
collaboration software. Timbuktu Pro software enables real-time, peer-to-peer
communication and collaboration on the Internet, Intranets and LANs--viewing
other users' screens, revising information, transferring files, controlling
other computers and remotely accessing network resources. Netopia Virtual Office
software enables users to have a presence on the Internet and includes key
communication and collaboration capabilities of Timbuktu Pro. The Company's LAN
products allow users to easily and cost-effectively build 10Base-T Ethernet,
100Base-T Ethernet and LocalTalk networks, primarily for Mac OS customers.
THE NETOPIA STRATEGY
The Company's objective is to become the leading provider of complete, high-
speed Internet connectivity solutions and real-time, peer-to-peer
Internet/Intranet collaboration software for small businesses, geographically
dispersed facilities of large enterprises, home offices, telecommuting, mobile
users, schools and other small organizations that may not have access to
sophisticated technical support. Key elements of the Company's strategy include
the following:
Provide Complete, Plug-and-Play Internet/Intranet Connectivity Solutions. The
------------------------------------------------------------------------
Company focuses on providing complete, high-speed Internet connectivity
solutions emphasizing ease of use and plug-and-play functionality consistent
with Netopia's tradition of providing products that are simple to install, use
and support. The Netopia Internet connectivity hardware products are bundled
with Internet software and are supported with the Company's Up & Running,
Guaranteed! program, providing users a single source for complete Internet
connectivity. The Company intends to develop future generations of its Netopia
Internet connectivity hardware products that incorporate alternative
technologies for high bandwidth connectivity and increased throughput, while
retaining ease of use and plug-and-play features.
Leverage Collaboration Software Expertise. Utilizing expertise developed in
-----------------------------------------
pioneering collaboration software for the workgroup, remote user and help desk
administrator, the Company intends to continue to offer products that increase
user productivity and efficiency by enabling real-time, peer-to-peer
collaboration over the Internet, Intranets and LANs. Timbuktu Pro and Netopia
Virtual Office software expand the functionality of the Internet beyond e-mail
and Web browsing by enabling users in any location to remotely access an
enterprise network and to engage in real-time collaboration over intranets or
the Internet--viewing other users' screens, revising information, transferring
files, controlling other computers and remotely accessing network resources.
Netopia Virtual Office software allows users to establish an "office" presence
on the Internet and includes key communication and collaborations capabilities
of Timbuktu Pro Software, making their web-site interactive and productive
rather than static. The Company intends to expand the number of real-time
collaboration tools it offers.
Target Rapidly Growing Markets for Networking and Collaboration Solutions. The
-------------------------------------------------------------------------
Company targets those segments of the networking market that industry sources
have identified as the most rapidly growing such as small businesses,
geographically dispersed facilities of large enterprises, home offices, mobile
users, schools and other small organizations. These users generally do not have
access to sophisticated technical support and are not well-served by traditional
vendors of networking products, which have not historically offered products
specifically designed for these markets. The Company intends to leverage its
expertise in developing easy-to-use, plug-and-play LAN networking solutions to
more rapidly penetrate the market for the Company's Internet/ Intranet products.
Expand Strategic Alliances. The Company has formed a number of strategic
--------------------------
relationships that assist the Company in developing, distributing and marketing
its products. For example, to assist its customers in gaining Internet access
and to increase sales of it's Internet/intranet products, Netopia has formed
strategic relationships with PSINet, Bell Atlantic, France Telecom, Geocities
and over 150 other regional ISPs. The Company intends to sell it's Netopia
Internet Connectivity hardware and Netopia Virtual Office software through these
ISPs. The Company also intends to expand its current strategic relationships
and to form additional strategic relationships to augment its current product
development, distribution and marketing strategies.
4
Capitalize On Electronic Marketing Expertise. Netopia believes it is a leader
--------------------------------------------
among networking companies in the effective use of on-line electronic marketing
and distribution. The Company's on-line electronic marketing initiatives, which
Netopia believes represent a cost-effective form of promotion and sale of its
products, currently include the development and maintenance of two Web sites,
www.netopia.com and www.farallon.com, which provide customers product
information, a web store, technical support, bulletin board and File Transfer
Protocol ("ftp") service as well as Corporate information. These sites allow the
Company to email focused electronic bulletins for customers and partners,
providing information on the Company's most recent upgrades and promotions. The
Company intends to expand its use of on-line electronic advertising and commerce
including the on-line sale of Internet/Intranet collaboration software
products.
Leverage Distribution Channels and Customer Support Infrastructure. The
------------------------------------------------------------------
Company believes that its relationships with approximately 75 distributors in 60
countries are a valuable asset and that these distributors will significantly
enhance the marketing and sale of its Internet/Intranet products. In addition,
the Company believes that it is recognized in the industry as providing
outstanding customer service and support. The Company intends to leverage its
positive name recognition, long-standing distribution relationships and its
customer support organization to promote its Internet/Intranet products.
PRODUCTS
Netopia offers complete, easy-to-use, plug-and-play Internet connectivity and
networking solutions and real-time collaboration software designed for small
businesses, geographically dispersed facilities of large enterprises, home
offices, mobile users, schools and small organizations that may not have access
to sophisticated technical support. The Company's Internet/Intranet product
include Netopia Internet connectivity hardware which provide high-speed Internet
connectivity for workgroups and individuals, as well as Timbuktu Pro and Netopia
Virtual Office software, which enables real-time, peer-to-peer communication and
collaboration on the Internet, Intranets and LANs. The Company's LAN product
family includes Ethernet network connectivity devices as well as other products,
which allow users to easily and cost-effectively build 10Base-T Ethernet,
100Base-T Ethernet and LocalTalk networks.
INTERNET/INTRANET PRODUCTS
--------------------------
NETOPIA INTERNET CONNECTIVITY HARDWARE. Netopia's Internet connectivity
hardware_products enable cost-effective, plug-and-play, high-speed Internet
connectivity for individual users and workgroups who may not have access to
sophisticated technical support. These products include the Netopia Internet
Router Family, ISDN PC Cards, ISDN Modems and Netopia Care service programs
including the Up & Running, Guaranteed! service program.
The Company's Internet connectivity hardware products include the Netopia
Internet Router Family which enable Internet connectivity for multiple users
through a single connection at a savings relative to multiple analog
connections. Netopia routers connect at rates from ISDN to Frame Relay and T1.
The Netopia ISDN Routers include a basic rate interface (''BRI'') port with
built-in NT-1 interface, Point-to-Point Protocol (''PPP''), Multilink PPP and
4:1 compression. In addition, the Company's Netopia Internet Routers include
Netopia's patented EtherWave technology that enables connectivity to a 10Base-T
Ethernet network in a ''daisy-chain'' fashion with or without the use of an
Ethernet hub. The SO-Smart ISDN routers are optimized for small office and home
use and include SmartIP, a cost-saving, ease-of-use and security feature that
integrates Network Address Translation ("NAT") technology with Dynamic Host
Configuration Protocol ("DHCP") to map multiple IP addresses on the small office
LAN to a single static or dynamically assigned Internet IP address from the ISP,
two Plain Old Telephone Service ("POTS") interface ports, an integrated two-port
10Base-T Ethernet hub and two integrated PC Card slots, allowing for remote
troubleshooting, diagnostics, configuration and firmware upgrades in the event
of ISDN line failure. In June 1997, the Company announced support for frame
--
relay with the release of routers which support three different WAN interfaces:
Sync/Async Serial, 56K Digital Data Service ("DDS") and Fractional T1/T1. All
new models support Frame Relay, PPP and Cisco-HDLC protocols and offer a serial
interface supporting synchronous speeds of up to 1.5Mbps and asynchronous speeds
up to 230Kbps. The Synch/Async Serial (SA) models support speeds up to
Fractional T1/T1 (in North America) and E1 (outside of North America) through an
external CSU/DSU. The 56K DDS and Fractional T1/T1 models will be available in
North America only. These products provide a modular upgrade path from ISDN to
T1 high speed dedicated service.
5
The Netopia ISDN Modem provides individual users reliable, high-speed ISDN
Internet connectivity and telecommuting capabilities. The ISDN Modem includes
Internet connectivity software, Multilink PPP, 4:1 data compression and two POTS
interfaces that enable the integration of digital data transfer with traditional
analog telephone, fax or modem use over a single ISDN line. Additionally, the
Netopia Modem includes an ISDN assistant that automatically detects the switch
type at the telephone company, determines the SPID numbers and automatically
configures the modem. During fiscal 1997, the Company announced the Netopia ISDN
PC Card (PMCIA) for PC notebooks and Macintosh Powerbooks, allowing mobile users
access to their corporate LAN, Intranet or the Internet over high-speed digital
lines. The Netopia ISDN PC Card supports two ISDN B-channels, Multilink PPP,
4:1 data compression and provides up to 512 Kbps performance as well as PAP and
CHAP authentication services to protect user resources.
The Company offers users of Netopia Internet connectivity hardware products
the Customer Care, Guaranteed!, service programs including Up & Running,
Guaranteed! These service programs assist these users in ordering and
provisioning the telecommunication carrier line, obtaining and establishing
their ISP service, provides remote configuration of the Netopia Internet
Routers, assist in the installation and configuration of the client server
software, and provide technical support for the Netopia product line. Toll-free
technical support is included with this service program for one year.
INTERNET/INTRANET COLLABORATION SOFTWARE. The Internet/Intranet Collaboration
Software family of products enables real-time, peer-to-peer collaboration over
the Internet, Intranets and LANs. These products include Timbuktu Pro for
Windows and Mac OS, and Netopia Virtual Office for Windows.
Timbuktu Pro software enables users to collaborate with other Timbuktu Pro
users in real-time over the Internet, Intranets and LANS--viewing other users'
screens, revising information, transferring files, controlling other computers
and remotely accessing network resources. Timbuktu Pro products are also used by
help desk and information systems personnel to remotely solve technical
problems, update software and train users on new applications and operating
systems. The Company believes that the peer-to-peer collaboration features in
its Timbuktu Pro products bring additional functionality to the Internet,
Intranets and LAN's. Timbuktu Pro Enterprise edition was introduced in July of
1997 providing a comprehensive set of tools geared towards Information
Technology ("IT") professionals responsible for deploying and administering
remote control technology in the enterprise environment. The Timbuktu Pro
Enterprise edition includes the Timbuktu Pro Universal License which the Company
believes allows customers to leverage Timbuktu Pro's multi-platform
compatibility to reduce the cost of migrating between platforms and operating
systems within the enterprise environment. Additionally, Netopia pursued
integration opportunities with application developers focused on systems
management and help desk solutions for the large corporate customer. As a
result, Timbuktu Pro can be integrated with Remedy's ARS, Microsoft's SMS,
Platinum's ProVision, and Computer Associates' Unicenter TNG software to enhance
the help desk functionality. This integration is included with Timbuktu Pro
Enterprise and allows the IT organization to deploy Timbuktu Pro's remote
control functionality directly with these leading enterprise applications which
the Company believes provide seamless execution of remote control sessions from
within the applications themselves. Additional enhancements to the product line
included the launch of Timbuktu Pro 1.5.4 for Windows NT and Timbuktu Pro 4.0
for Mac OS. Timbuktu Pro for Mac OS added direct dial capability, text chat, and
an Internet "Intercom" feature providing voice over data on any network or dial
up connection.
NETOPIA VIRTUAL OFFICE SOFTWARE. The Company recently announced Netopia
Virtal Office 2.0 with web hosting service which provides 24 hour a day, 7 day a
week presence on the Internet in the form of a virtual office. Netopia, Inc. has
announced a partnership with GeoCities who will provide the hosting for the
Netopia virtual offices. The product gives the office owner a web site hosted at
GeoCities with In and Out baskets, business card, picture gallery, and real-time
collaboration capabilities. The first year of hosting offered by Geocities is
free with expected annual charges of $19.95 thereafter. Because the office is
hosted on a server, visitors can visit the office when the owner is off-line and
leave messages and files for the office owner to pick up when he is online. The
Company also intends to expand the distribution of this product through
additional channels including hosting by other ISPs. The hosting feature of
Netopia Virtual Office is dependent upon third party servers. The Company has
little or no control over the functionality of these servers which may from time
to time experience technological difficulties or other factors which may
interrupt the hosting feature. Failure of Netopia Virtual Office to perform as
anticipated could materially adversely affect the Company's business, operating
results and financial condition.
6
The Company's business is substantially dependent upon continued growth in
the sale of its Internet/Intranet products. Rapid growth in the use of the
Internet and Intranets is a recent phenomenon. There can be no assurance that
communication or commerce over the Internet will become widespread. In addition,
to the extent that the Internet continues to experience significant growth in
the number of users and level of use, there can be no assurance that the
Internet infrastructure will continue to be able to support the demands placed
upon it by such potential growth, or will not otherwise lose its utility due to
delays in the development or adoption of new standards and protocols required to
handle increased levels of activity, or due to increased government regulation.
Although the Company has experienced significant percentage growth rates in
Internet/Intranet revenues, the Company does not believe prior percentage growth
rates are sustainable or indicative of future operating results for these
products and services. The Company's limited Internet/Intranet operating history
and the dynamic market environment in which the Company operates makes the
prediction of future Internet/Intranet operating results difficult, if not
impossible. There can be no assurance that the Company will increase sales of
its Internet/Intranet products, that the Company's existing distribution
channels are appropriate for the sale of its Internet/Intranet products or that
sales of such products will reach levels significant enough to offset expected
declines in sales, average selling prices and gross margins of the Company's LAN
products. Accordingly, the failure of the Company's Internet/Intranet products
to gain market acceptance or to achieve significant sales would materially and
adversely affect the Company's business, operating results and financial
condition. The markets in which the Company competes currently are subject to
intense price competition and the Company expects additional price and product
competition as other established and emerging companies enter these markets and
new products and technologies are introduced. Additionally, a number of
competitors have substantially greater financial, technical, sales, marketing
and other resources than the Company, as well as greater name recognition and a
larger customer base. These companies may therefore be able to respond more
quickly to new or emerging technologies and changes in customer requirements or
to devote greater resources to the development, promotion and sales of its
products. Increased competition may result in further price reductions, reduced
gross margins and loss of market share, any of which could materially adversely
affect the Company's business, operating results and financial condition.
FARALLON DIVISION LAN PRODUCTS
- ------------------------------
ETHERNET AND FAST ETHERNET FAMILY. The Ethernet and Fast Ethernet family of
products enables users in schools and business workgroup environments to share
Internet connections, printers, access servers and quickly transfer large data
files over a LAN. These products are primarily for Mac OS computers. Fast
Ethernet products include the Fast EtherTX-10/100 Cards, the Fast Starlet
100TX/8 Hub, the Fast Starlet 10/100 Bridge, and new Starlet 10/100 Ethernet
Switches. The Company's dual speed, full duplex Fast EtherTX-10/100 Cards
include a single autosensing port, providing a flexible network speed migration
path from 10Base-T Ethernet, thus protecting existing network investments. The
Fast Starlet 100TX/8 Hub with the add-on 10/100 Bridge includes built-in
EtherWave connectivity ports connection to existing 10Mbps LANs. The family of
Starlet 10/100 Ethernet Switches provide economical high speed connectivity for
workgroups and schools by creating segmented LANs and isolating network
traffic.
The Company's range of 10Base-T Ethernet products provides 10Mbps connectivity
solutions for Apple Macintosh, MacOS server, AppleTalk printer, PowerBook, eMate
and Newton. Standard bus interface cards for PCI and PC Card systems also
provide support for Intel based Windows PCs. The Company's 10Base-T Ethernet
family includes transceivers and adapters that connect computers and printers to
10Base-T and 10Base-2 (Thinnet) Ethernet, as well as add-in and PCMCIA cards
that connect computers and PowerBooks to Ethernet. In addition, the Farallon
Division provides a family of managed and unmanged 10Base-T hubs to support
small workgroups, classrooms, labs, as well as large networks.
The Company offers a unique support program called Dr. Farallon Network
Performance Clinic, which provides free phone consultation (e-mail for
international customers). Designed for companies and schools that lack in-house
information technology and network management expertise, Dr. Farallon offers
consultation on how to design a network or increase the performance of an
existing network. Many pre-press and multi-media companies as well as schools
need information and help in order to upgrade all or part of their networks to
Ethernet and Fast Ethernet. Dr. Farallon offers the service of identifying
which elements of a customer's computing and networking environment should be
upgraded in order to achieve the greatest cost/performance benefits.
7
ETHERWAVE FAMILY. The EtherWave family of products enables users, who may lack
network expertise, to easily connect multiple computers and printers to each
other in a daisy-chain fashion, or to connect multiple devices per port on
standard 10Base-T hubs. These products, which are compatible with the 10Base-T
Ethernet standard, include transceivers, adapters and internal cards. The
Company's patented EtherWave technology enables the creation of small 10Base-T
Ethernet LANs of up to eight nodes without the use of network hubs, as is
required with traditional 10Base-T Ethernet, by simply plugging together
EtherWave products, thereby reducing the time and complexity of creating or
expanding a 10Base-T network. EtherWave can also be used to easily and flexibly
connect up to seven computers and printers per port to an existing hub on a
traditional 10Base-T Ethernet LAN.
LOCALTALK FAMILY. The LocalTalk family of products enables Mac OS users who
lack network implementation expertise to easily connect several computers or
printers. These products include patented PhoneNET connectors which feature an
easy-to-use, plug-and-play approach to creating LocalTalk networks using
standard telephone wiring. PhoneNET networks can be created without hubs by
daisy-chaining nodes. The Company's LocalTalk family also includes hubs and
adapters designed to expand existing LocalTalk networks and interconnect them to
Ethernet.
Historically, the Company has derived a substantial majority of its revenue
from LAN products, which represented 89%, 73% and 61% of total revenues for
fiscal years 1995, 1996 and 1997, respectively. These products have experienced
variable average selling prices and gross margins, and declining sales volumes.
The Company anticipates that the average selling prices and gross margins of its
existing LAN products will continue to decline. Accordingly, to the extent the
product mix for any particular period includes a substantial proportion of LAN
products, the Company's total gross margin will be adversely affected. To date,
the Company has been able to partially reduce the decline in total gross margin
by reducing the manufacturing cost of products and by introducing new products
with higher margins. There can be no assurance that the Company will achieve any
such reductions in the future or that new products will achieve market
acceptance. Although the Company's Internet/Intranet products currently carry a
higher average gross margin than its LAN products, the Company anticipates that
competitive pressures in its Internet/Intranet business may result in declining
average selling prices and gross margins in this business as well. Historically,
a substantial majority of the Company's LAN products revenue have been derived
from sales of products designed for Apple Mac OS and compatible computers. Net
revenues and operating results from the Company's LAN products fluctuated on a
quarterly basis during fiscal 1997. The Company expects that net revenues and
operating results from LAN products may decline in the future and the LAN
Products Division may experience losses as a result of declining sales and
average selling prices, Apple's incorporation of built-in Ethernet connectivity
into certain of its computers, declining sales of Mac OS computers, elimination
of a number of the Mac OS licenses issued by Apple, Apple's loss of market share
as well as competition in the LAN products market. As a result of technical
characteristics in the Mac OS environment, Fast Ethernet products, in general,
have not delivered expected performance levels. If these technical
characteristics are not addressed in the future, then Fast Ethernet product
sales in the Mac OS market segment will be below the Company's expectations, and
operating results may be materially and adversely affected.
Due to all of the foregoing factors, the Company continues to focus on the
development of its Internet/Intranet business. As a result, the Company's
future operating results are dependent upon continued and increasing market
acceptance and penetration of its Internet/Intranet products and enhancements
thereto, particularly in the Windows market. However, the Company's operating
results will continue to be adversely affected to the extent that declines in
revenues from LAN products are not offset by increases from other sources, such
as revenues from the Company's Internet/Intranet products. There can be no
assurance that the Company's increasing focus on its Internet/Intranet products
will offset the decline in revenues from its LAN products. Should the Company's
Internet/Intranet products and enhancements not continue to gain market
acceptance, particularly in the Windows market, the Company's business,
operating results and financial condition will by materially and adversely
affected.
To date, the Company has derived approximately 85% to 90% of its LAN products
revenue from products designed for networking the Apple Mac OS family of
personal computers. Accordingly, the Company is substantially dependent on the
market for Mac OS computers and the development and sale of new Apple computers,
particularly sales of such computers into business environments. There can be no
assurance that competitive personal computers will not displace the Mac OS
products or reduce sales of Mac OS products. In addition, sales of the Company's
products in the past have been adversely affected by the announcement by Apple
of new products with the potential to replace existing products. The inability
of Apple to successfully develop, manufacture, market or sell new products, and
any decrease in the sales or market acceptance of the Mac OS family of
computers, would have a
8
material adverse effect on the Company's business,operating results and
financial condition. For example, during fiscal 1997, the Company believes
revenues were adversely affected by declining sales of Macintosh computers and
Apple's loss of market share.
The Company relies on an informal working relationship with Apple in
connection with the Company's LAN product development efforts. Although the
Company and Apple have maintained a cooperative working relationship since the
Company's founding, Apple is under no obligation to continue to share product
information or otherwise cooperate with the Company. In addition, there can be
no assurance that Apple will continue to work cooperatively with the Company in
connection with the Company's product development efforts. The absence of such
cooperation in the future, as a result of the continued restructuring in process
at Apple, including but not limited to the search for a new chief executive
officer, or any other factors, could have a material adverse effect on the
Company's business, operating results and financial condition. Apple currently
offers products that compete directly with certain of the Company's products.
The Company anticipates that Apple will continue to incorporate additional
connectivity technologies into more of its products in the future, which will
adversely affect sales of the Company's LAN products. Since Apple has
substantially greater financial, technical, sales, marketing and other resources
than the Company, as well as greater name recognition and a significantly larger
customer base, Apple may be able to respond more quickly to new or emerging
technologies and changes in customer requirements or to devote greater resources
to the development, promotion and sales of their products. The Company believes
that it is likely that Apple will continue to sell separately or bundle with its
computers certain network connectivity products, such as 10Mbps and 100Mbps
adapters, similar to the Company's Ethernet and Fast Ethernet products. Any such
additional bundling or enhancement by Apple could have a material adverse effect
on the Company's business, operating results and financial condition.
STRATEGIC ALLIANCES
The Company has entered into strategic alliances to facilitate the
development, distribution, marketing and support of its products. These
alliances enhance the Company's ability to adapt effectively to technological
change and leverage shared distribution resources, thereby providing increased
utility to end users.
The Company relies on a number of strategic relationships to help achieve
market acceptance of the Company's products and to leverage the Company's
development, sales and marketing resources. Although the Company views these
relationships as important factors in the development and marketing of the
Company's products and services, a majority of the Company's agreements with its
strategic partners or customers do not require future minimum commitments to
purchase the Company's products, are not exclusive and generally may be
terminated at the convenience of either party. There can be no assurance that
the Company's strategic partners regard their relationship with the Company as
strategic to their own respective businesses and operations, that they will not
reassess their commitment to the Company or its products at any time in the
future, or that they will not develop and/or market their own competitive
technology.
The Company does not manufacture any of the components used in its products
and performs only limited assembly on some products. The Company relies on
independent contractors to manufacture to specification the Company's
components, subassemblies, systems and products. The Company also relies upon
limited source suppliers for a number of components used in the Company's
products, including certain key microprocessors and integrated circuits. There
can be no assurance that these independent contractors and suppliers will be
able to timely meet the Company's future requirements for manufactured products,
components and subassemblies. The Company generally purchases limited source
components pursuant to purchase orders and has no guaranteed supply arrangements
with these suppliers. In addition, the availability of many of these components
to the Company is dependent in part on the Company's ability to provide its
suppliers with accurate forecasts of its future requirements. However, any
extended interruption in the supply of any of the key components currently
obtained from a limited source would disrupt its operations and have a material
adverse effect on the Company's business, operating results and financial
condition. In addition, the Company anticipates that it will be necessary to
establish additional strategic relationships in the future, in particular with
additional national ISPs, and there can be no assurance that the Company will be
able to establish such alliances or that such alliances will result in increased
revenues.
9
SALES AND MARKETING
The Company's sales force assists end users by providing solutions for their
Internet connectivity, collaboration and LAN networking needs. In addition, the
sales force provides pre-sales and order management support to distributors,
resellers, and ISPs, identifies new opportunities for product development and
provides general market information to management. The Company's marketing
strategy is to achieve broad market penetration by utilizing multiple
distribution channels, including the use of two-tier distributors, direct sales,
mail order, ISPs and Internet Value Added Resellers ("VARs"), K-12 and
electronic marketing.
Two-Tier Distributors. Netopia's major distributors in North America are
---------------------
Ingram Micro ("Ingram") and Tech Data which distribute Netopia's products to
resellers, VARs, dealers and dealer chains. Internationally, Netopia distributes
its products through approximately 75 distributors in 60 countries. In Europe,
distributors sell primarily in the U.K., France, Germany and Sweden, and in the
Pacific Rim, distributors sell primarily in Japan. Netopia provides periodic
training in the development of network solutions to networking VARs who purchase
the Company's products primarily from distributors. The Company's agreements
with its distributors can generally be terminated without cause and do not
provide for minimum purchase commitments. Additionally, the agreements provide
price protection and grant the distributors limited rights to return unsold
inventories of the Company's products in exchange for new purchases.
Direct Sales / Telemarketing. Netopia's direct sales and telemarketing sales
----------------------------
force are primarily focused on the execution of high volume or site license
agreements with corporate accounts in North America. Internet/Intranet
collaboration software and Netopia Internet connectivity hardware products are
the primary products sold through this channel. In addition, certain higher
education institutions in North America have historically purchased LAN products
directly from the Company.
ISPs and Internet VARs. Netopia has formed strategic relationships with ISPs
----------------------
and VARs that assist the Company in developing, distributing and marketing its
products. For example, to assist its customers in gaining Internet access and
to increase sales of Netopia products, Netopia has formed strategic
relationships with PSINet, Bell Atlantic, France Telecom, Geocities and over 150
other regional ISPs. The Company also has recruited over 1,000 Internet VARs for
the sale of the Company's Internet/Intranet products.
Mail Order. Netopia markets its products in mail order catalogues, such as
----------
those offered by MicroWarehouse, to reach users who are generally more
technically sophisticated. Through lower overhead and service costs, mail order
catalogs are generally able to offer lower prices than dealers and retailers.
K-12 Marketing. The Company also sells through a group of regional VARs
--------------
known as Apple Education Sales Agents (''AESAs'') which are Apple's exclusive
North American resellers of Macintosh computers to K-12 educational
institutions. The Company maintains relationships with all 13 AESAs and believes
these VARs represent an effective channel for sales to the K-12 market. AESAs
resell the full line of the Company's LAN products, Netopia Internet
connectivity hardware products and Internet/Intranet collaboration software
products. The Company provides AESAs price protection and limited rights to
return unsold inventories of the Company's products in exchange for new
purchases.
Electronic Marketing. The Company has developed and maintains two Web sites,
--------------------
www.netopia.com and www.farallon.com, which provide customers product
information, a web store, technical support, bulletin board and File Transfer
Protocol ("ftp") service as well as Corporate information. These sites allow the
Company to email focused monthly electronic bulletins for customers and
partners, providing information on the Company's most recent upgrades and
promotions. The Company intends to expand its use of on-line electronic
advertising and commerce including the on-line sale of Internet/Intranet
collaboration software products. The Company currently supports secure on-line
commerce transactions using Netscape's Secure (SSL) Commerce Server and
CyberCash's Secure Internet Payment Service.
Other Marketing. The Company uses several marketing programs, such as trade
---------------
advertising, participation in trade shows, press briefings on strategy and new
products, and telemarketing, to support the sale and distribution of its
products. Through these marketing programs, Netopia seeks to build brand name
recognition, stimulate demand and inform channels about the capabilities and
benefits of the Company's products.
10
The Company relies primarily on distributors for the sale of its
Internet/Intranet and LAN products. Revenues from distributors accounted for 73%
of total revenues in fiscal 1995 and 60% of total revenues in each of fiscal
1996 and 1997. A substantial amount of the Company's revenues are generated from
a limited number of these distributors. The Company's three largest distributors
accounted for 43%, 35% and 34% of total revenues in fiscal 1995, 1996 and 1997,
respectively. During fiscal 1995, 1996, and 1997, revenue from Ingram accounted
for 22%, 18% and 19% of the Company's total revenues, respectively and revenue
from MicroWarehouse accounted for 13%, 11% and 10% of the Company's total
revenues, respectively. No other customers have accounted for 10% or more of the
Company's total revenues during fiscal 1995, 1996 or 1997. The distribution of
LAN products such as those offered by the Company has been characterized by
rapid change, including industry consolidations, financial difficulties of
distributors and the emergence of alternative distribution channels. There can
be no assurance that Ingram and MicroWarehouse will continue to serve as
distributors for the Company since the Company does not currently have a written
agreement regarding price or quantity commitments with these or other
distributors which operate on a purchase order basis. The Company's
-----
distributors generally offer products of several different companies, including
products that are competitive with the Company's products. There can be no
assurance that future sales by the Company's distributors will continue at
current levels, that the Company will be able to retain its current distributors
in the future on terms which are acceptable to the Company, that the Company's
current distributors will choose to or be able to market the Company's products
effectively, that economic conditions or industry demand will not adversely
affect these or other distributors, that these distributors will not devote
greater resources to marketing products of other companies or that internal
staffing changes or other changes at the Company's distributors will not disrupt
historical purchasing or payment patterns. Accordingly, the loss of, or a
significant reduction in revenue from, one of the Company's distributors, could
have a material adverse effect on the Company's business, operating results and
financial condition.
The Company grants to its distributors limited rights to return unsold
inventories of the Company's products in exchange for new purchases and provides
price protection to its distributors. Although the Company provides allowances
for projected returns and price decreases, any product returns or price
decreases in the future that exceed the Company's allowances will materially and
adversely affect the Company's business, operating results and financial
condition. The Company also provides end users with a lifetime warranty on
certain products and permits end users to return any product for its full
purchase price if the product does not perform as warranted. To date, the
Company has not encountered material warranty claims. Nevertheless, if future
warranty claims exceed the Company's reserves, the Company's business, operating
results and financial condition could be materially and adversely affected. In
addition, the Company attempts to further limit its liability to end users
through disclaimers of special, consequential and indirect damages and similar
provisions in its end user warranty. However, no assurance can be given that
such limitations of liability will be legally enforceable.
The Company's Internet/Intranet software products are often licensed to
customers on a volume license basis for use on private wide area network
(''WAN'') Intranets involving thousands of nodes. These licenses often involve
significant license and maintenance fees. As a result, the license of the
Company's Internet/Intranet software products often involves a significant
commitment of management attention and resources by prospective customers.
Accordingly, the Company's sales process for these products is often subject to
delays associated with long approval processes that typically accompany
significant capital expenditures. For these and other reasons, the sales cycle
associated with the license of the Internet/Intranet software products is often
lengthy and subject to a number of significant delays over which the Company has
little or no control. There can be no assurance that the Company will not
experience these and additional delays in the future on Internet/Intranet
software or other products.
The Company's Netopia Internet connectivity hardware products and Netopia
Virtual Office software are often distributed through partnerships with ISPs,
VARs and telecommunications carriers. These partnerships often involve lengthy
testing and certification studies as well as detailed agreements. As a result,
partnerships with ISPs, VARs and/or telecommunications carriers to distribute
Netopia products involve a significant commitment of management attention and
resources by prospective partners. Accordingly, the Company's business
development process for these distribution channels is often subject to delays
associated with long approval processes that typically accompany significant
partnership development and capital expenditures. For these and other reasons,
the business development process associated with the partnerships are often
lengthy and historically have been subject to a number of significant delays
over which the Company has little or no control. There can be no assurance that
the Company will not experience these and additional delays in the future on
partnership development.
11
Sales orders are typically shipped shortly after receipt and, consequently,
order backlog at the beginning of any quarter has in the past represented only a
small portion of that quarter's revenues. Accordingly, the Company's net
revenues in any quarter are substantially dependent on orders booked and shipped
during that quarter.
CUSTOMER SERVICE AND SUPPORT
The Company believes that it is recognized in the networking industry as
having an outstanding customer support organization. Netopia believes that
effective customer support is a key criterion used in selecting networking
solutions. Network managers and administrators, ISPs, VARs, distributors,
resellers, consultants and other experienced technical experts utilize the
Company's toll-free telephone support lines, fax and on-line services to access
Netopia's internal technical databases and support personnel. Additionally,
support personnel are trained to satisfy the needs of end users who are not
technical experts and do not have access to sophisticated technical support. The
Company believes that its support programs have been successful in creating
brand loyalty through its focused support of the specialized needs of these end
users, and through the easy-to-use, plug-and-play design of its products.
With Customer Care, Guaranteed! Service programs including Up and Running
Guaranteed!, Netopia will remotely configure the Netopia Internet Router and
assist users in setting up service with the user's telephone company and ISP.
The program is also available at a reduced price for users of the Netopia ISDN
Modem. Once unique in the industry, this concept has recently been adopted by a
number of the Company's competitors. However, the Company believes that its
program remains the most comprehensive in the market. The Company's expertise in
solving technical problems enables it to commit its resources to analyze any
problem an end user may have, even if it involves a product from another
company, thereby building customer loyalty to Netopia as the single source for
networking solutions.
TECHNOLOGY
The Netopia Internet Routers include several core communications technologies,
including a third-generation multi-protocol routing engine. The product's
operating software has been optimized for the special requirements of Internet
access over high-speed digital WAN links, and provides both packet header and
data-link compression. The routing engine operates in conjunction with companion
modules that provide connection/bandwidth management, authentication/security
and configuration/network management functions. The connection/ bandwidth
management module supports dial-on-demand routing, and tracks incoming and
outgoing data calls. Calls can be initiated based on time of day, type of data
traffic, and packet data thresholds. Additionally, switched circuit models
support a "dynamic bandwidth allocation" capability that transparently initiate
connections based on packet data thresholds. These technologies significantly
reduce telecommunications costs, particularly with ISDN which is typically
tariffed on the basis of usage. The authentication/security module provides PPP
authentication services between interconnected routers, dial-back security, and
packet filters that allow a LAN to maintain a degree of network security while
connecting to the Internet. Netopia Internet routers incorporate network address
translation, under the brand name, SmartIP. SmartIP allows for the development
of affordable LAN Internet accounts. The router supports a wide variety of local
and remote configuration/network management capabilities, including a utility
for assigning a LAN IP address to the router called SmartStart, which includes a
server for assigning IP addresses to desktop machines based on the DHCP, a
utility for automatically configuring router Frame Relay parameters called
SmartMatch, a menu-based console and virtual terminal (''TELNET'') interface,
Trivial File Transfer Protocol (''TFTP'') client for firmware upgrades, and the
Simple Network Management Protocol (''SNMP'').
The Internet/Intranet collaboration software includes patented cross platform
collaboration technology that provides remote control capabilities across
disparate operating systems. This collaboration system supports text and
graphical image display between homogeneous and heterogeneous computers
connected on a network, the Internet or via other transport media. The system
captures window system event messages during a recording process and then
translates these messages into procedure calls during the imaging process on the
destination platform. For example, this technology allows a Windows NT
workstation to view the screen of a Mac OS computer regardless of the
differences in screen size, resolution or color depth. This technology enables
the Company to better address the heterogeneous requirements of the Internet.
The Company has also developed proprietary compression technologies which are
used to minimize resources required for image transmissions over the Internet
and slow speed networks.
12
Windows GDI and Mac OS Quickdraw compression, Backing Store Cache compression,
and Font Negotiation technology enable the products to transmit the minimum
amount of data necessary to render an image.
Internet/Intranet collaboration software also includes multi-level security
technology that protects enterprise network computing resources and individual
users from unauthorized intrusion. Each product maintains its own database which
is used to verify the identity and define the privileges of any user attempting
to gain access to a machine. The Company has also developed unique
administration technology for security-conscious network administrators which
allows them to customize the functionality available to their organization. In
addition, the TCP/IP ports assigned to Netopia by the Internet Engineering Task
Force (''IETF'') allow network managers to safeguard their Intranet from
unauthorized access with widely available firewall technology. The Company
believes that the object-oriented modular architecture of its products allows
Netopia to exploit market opportunities quickly and address OEM customer
requirements. For instance, by leveraging the product's built-in Object Linking
and Embedding (''OLE'') automation, the Company was one of the first to market
real-time collaboration Netscape plug-ins and Internet applets. This
architecture allows new features, transports, and services to be quickly
incorporated to meet future market demands as well as provide easy integration
into other third-party applications.
The EtherWave family of products incorporates patented technology that permits
daisy-chained standard 10Base-T Ethernet segments with multiple nodes on each
segment. The Company's EtherWave products include internally developed
application-specific integrated circuits (''ASICs''), that combine large
functional logic blocks into a common silicon core. The Company believes it
possesses expertise in real-time, high-speed, embedded systems hardware design
using Complex Instruction Set Controller (''CISC'') and Reduced Instruction Set
Controller (''RISC'') processors, and Ethernet and Fast Ethernet technologies.
The Company believes it also possesses expertise in high-volume, low-cost
product design and domestic and international homologation requirements.
The personal computer industry is characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions,
short product life cycles and rapidly changing customer requirements. The
introduction of products embodying new technologies and the emergence of new
industry standards can render existing products obsolete and unmarketable. The
Company's future success will depend on its ability to enhance its existing
products and to introduce new products to meet changing customer requirements
and emerging technologies. For example, the Company's Netopia Internet
connectivity hardware products currently operate over ISDN, Fractional T1/T1
--
(domestically), Fractional E1/E1 (international) and Frame Relay
telecommunication services. As other communications technologies such as 56K
analog modems, Asynchronous Transfer Mode (''ATM''), Asymmetric Digital
Subscriber Line (''ADSL''), various other Digital Subscriber Line ("xDSL") and
communication over cable or wireless networks are developed or gain market
acceptance, the Company will be required to enhance its Internet connectivity
products to support such technologies, which will be costly, time consuming and
have uncertain market acceptance. If the Company is unable to modify its
products to support new Internet access technologies, or if ISDN, Fractional
T1/T1, Fractional E1/E1 or Frame Relay do not achieve widespread customer
acceptance as a result of the adoption of alternative technologies or as a
result of deemphasis of ISDN, Fractional T1/T1, Fractional E1/E1or Frame Relay
by telecommunications service providers, the Company's business, operating
results and financial condition would be materially and adversely affected. In
addition, the Company has historically derived a substantial majority of its
revenues from the sale of Ethernet connectivity products. In the event that
current Ethernet network technology is modified or replaced and the Company is
unable to modify its products to support new Ethernet technologies or
alternative technologies, the Company's business, operating results and
financial condition could be materially and adversely affected. The Company has
in the past and may in the future experience delays in new product development.
There can be no assurance that the Company will be successful in developing and
marketing product enhancements or new products that respond to technological
change, evolving industry standards and changing customer requirements, that the
Company will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these products or product
enhancements, or that its new products and product enhancements will adequately
meet the requirements of the marketplace and achieve any significant degree of
market acceptance. Failure of the Company, for technological or other reasons,
to develop and introduce new products and product enhancements in a timely and
cost-effective manner would have a material adverse effect on the Company's
business, operating results and financial condition. In addition, the future
introduction or even announcement of products by the Company or one or more of
its competitors embodying new technologies or changes in industry standards or
customer requirements could render the Company's then existing products obsolete
or unmarketable. There can be no assurance that the introduction or announcement
of new product offerings by the Company or one or more of its competitors will
not cause customers to defer purchases of existing
13
Company products. Any such deferral of purchases could have a material adverse
effect on the Company's business, operating results or financial condition.
Complex products such as those offered by the Company (such as the recently
introduced Internet connectivity hardware products, LAN products and new
software products/upgrades) may contain undetected or unresolved defects when
first introduced or as new versions are released. There can be no assurance
that, despite testing by the Company, defects will not be found in new products
or new versions of products following commercial release, resulting in loss of
market share, delay in or loss of market acceptance or product recall. Any such
occurrence could have a material adverse effect upon the Company's business,
operating results or financial condition.
PRODUCT DEVELOPMENT
The Company believes that its future business and operating results depend in
part on its ability to continue to enhance existing products, develop new
products and improve the price and performance of its products in a timely
manner. The Company continuously evaluates the emerging needs, developing
standards and emerging technologies of its target markets to identify new market
or product opportunities. Netopia is focusing its development efforts on
Internet connectivity through high-speed digital services, including ISDN, T-1,
Frame Relay, xDSL, ATM, analog and software enhancements including Netopia
Virtual Office, further internationalization of its products, PC card-based
products for laptop computers and cost-reducing design improvements. In
addition, the Company has relied and will continue to rely on external
development resources, such as OEM suppliers, for the development of certain of
its products and related components. The Company may in the future acquire
products or technologies to compliment current research and development efforts.
Research and development expenses were $8.4, $8.9 and $8.8 million for fiscal
years 1995, 1996, and 1997, respectively.
The personal computer industry is characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions,
short product life cycles and rapidly changing customer requirements. The
introduction of products embodying new technologies and the emergence of new
industry standards can render existing products obsolete and unmarketable. The
Company's Netopia Internet connectivity hardware products currently operate only
over ISDN, Fractional T1/T1, Fractional E1/E1 and Frame Relay telecommunication
service. As other communications technologies, such as 56K analog modems, ATM,
xDSL and communication over cable or wireless networks, are developed or gain
market acceptance, the Company will be required to enhance its Internet
connectivity products to support such technologies, which will be costly and
time consuming. If the Company is unable to modify its products to support new
Internet access technologies, or if technologies supported by current products
do not achieve widespread customer acceptance as a result of the adoption of
alternative technologies or as a result of deemphasis of these technologies by
communications service providers, the Company's business, operating results and
financial condition would be materially adversely affected. In addition, the
Company has historically derived a substantial majority of its revenues from the
sale of Ethernet connectivity products. In the event that current Ethernet
network technology is modified or replaced and the Company is unable to modify
its products to support new Ethernet technologies or alternative technologies,
the Company's business, operating results and financial condition could be
materially adversely affected. The Company has in the past and may in the future
experience delays in new product development. There can be no assurance that the
Company will be successful in developing and marketing product enhancements or
new products that respond to technological change, evolving industry standards
and changing customer requirements, that the Company will not experience
difficulties that could delay or prevent the successful development,
introduction and marketing of these products or product enhancements, or that
its new products and product enhancements will adequately meet the requirements
of the marketplace and achieve any significant degree of market acceptance.
Failure of the Company, for technological or other reasons, to develop and
introduce new products and product enhancements in a timely and cost-effective
manner would have a material adverse effect on the Company's business, operating
results and financial condition. In addition, the future introduction or even
announcement of products by the Company or one or more of its competitors
embodying new technologies or changes in industry standards or customer
requirements could render the Company's then existing products obsolete or
unmarketable. There can be no assurance that the introduction or announcement of
new product offerings by the Company or one or more of its competitors will not
cause customers to defer purchase of existing Company products. Such deferral of
purchases could have a material adverse effect on the Company's business,
operating results and financial condition.
14
Complex products such as those offered by the Company may contain undetected
or unresolved defects when first introduced or as new versions are released.
There can be no assurance that, despite testing by the Company, defects will not
be found in new products or new versions of products following commercial
release, resulting in loss of market share, delay in or loss of market
acceptance or product recall. Any such occurrence could have a material adverse
effect upon the Company's business, operating results and financial condition.
As of December 1, 1997, Netopia's research and development staff consisted of
62 employees. Of these employees 54 were focused primarily on Internet/Intranet
product development and 8 were focused primarily on LAN product development.
The Company believes that its future success will depend in large part upon its
ability to attract and retain highly-skilled engineering personnel. Competition
for such personnel is intense, and there can be no assurance that the Company
will be successful in attracting and retaining such personnel, the failure of
which could have a material adverse effect on the Company's business, operating
results and financial condition.
COMPETITION
The markets for the Company's products and services are intensely competitive,
highly fragmented and characterized by rapidly changing technology, evolving
industry standards, price competition and frequent new product introductions. A
number of companies offer products that compete with one or more of the
Company's products. The Company's current and prospective competitors include
OEM product manufacturers of Internet access and remote LAN access equipment,
manufacturers of remote control and screen sharing software and manufacturers of
LAN client access and network systems products. In the Internet access and
remote LAN access equipment market, the Company competes primarily with Ascend,
Cisco, 3Com/U.S. Robotics, Ramp Networks, Intel, and several other companies. In
the remote control and screen sharing software market, the Company competes
primarily with Symantec, Microsoft, Tivoli (IBM), Stac Electronics, Netscape,
Microcom (Compaq), Computer Associates, McAfee Associates, QuarterDeck, and
several other companies. In the LAN client access and network systems product
market, the Company competes primarily with Apple, Asante, Dayna (currently
being acquired by Intel), Global Village and several other companies. The
Company has experienced and expects to continue to experience increased
competition from current and potential competitors, many of whom have
substantially greater financial, technical, sales, marketing and other
resources, as well as greater name recognition and a larger customer base than
the Company. Accordingly, such competitors or future competitors may be able to
respond more quickly to new or emerging technologies and changes in customer
requirements or devote greater resources to the development, promotion and sales
of their products than the Company. In particular, established companies in the
personal computer industry may seek to expand their product offerings by
designing and selling products using competitive technology that could render
the Company's products obsolete or have a material adverse effect on the
Company's sales. For example, Microsoft has available for free, via download on
the Internet, communications and collaboration software compatible with the
Microsoft Internet Explorer and has publicly stated that they are committed to
integrating Internet technology into existing products at no additional cost to
customers. This software product, which enables real-time communication within a
workgroup, as well as similar future product offerings from Microsoft, could
undermine the Company's ability to market its Timbuktu Pro and/or Netopia
Virtual Office collaboration software. In addition, Netscape also offers
software that enables dispersed work groups to collaborate in the work
environment. Accordingly, there can be no assurance that the Company can
continue to market its collaboration software, which would have a material and
adverse effect on the Company's business, operating results and financial
condition. In addition, several of the Company's current competitors recently
have introduced free and/or paid guaranteed service and support programs that
appear to be similar to the Company's Up & Running, Guaranteed! program. As a
result, there can be no assurance that the Company can continue to charge a fee
for this support program, which could have a material and adverse effect upon
the Company's business, operating results and financial condition. The markets
in which the Company currently competes are subject to intense price competition
and the Company expects additional price and product competition as other
established and emerging companies enter these markets and new products and
technologies are introduced. Recently announced consolidations in the networking
environment continue to create companies with substantially greater financial,
technical, sales, marketing and other resources than the Company, as well as
greater name recognition and a significantly larger customer base. These
companies may be able to respond more quickly to new or emerging technologies
and changes in customer requirements or to devote greater resources to the
development, promotion and sales of its products. Increased competition may
result in the loss of market share, further price reductions and reduced gross
margins, any of which could materially and adversely affect the Company's
business, operating results and financial condition. There can be no assurance
that the Company will be able to compete successfully against current and future
competitors, or that
15
competitive factors faced by the Company will not have amaterial adverse effect
on the Company's business, operating results and financial condition.
Netopia believes that the principal competitive factors in its markets are:
(1) product feature, function and reliability, (2) customer service and support,
(3) price and performance, (4) ease of use, (5) brand name recognition (6)
strategic alliances, (7) size and scope of distribution channels, (8) timeliness
of new product introductions, (9) breadth of product line and (10) size of
installed customer base. While the Company believes, in general, that it
currently competes favorably with regard to these factors there can be no
assurance that the Company will be able to compete successfully in the future,
the failure of which would have a material adverse effect on the Company's
business, operating results and financial condition.
PROPRIETARY RIGHTS AND TECHNOLOGY
The Company's ability to compete is dependent in part on its proprietary
rights and technology. The Company relies primarily on a combination of patent,
copyright and trademark laws, trade secrets, confidentiality procedures and
contractual provisions to protect its proprietary rights. The Company generally
enters into confidentiality or license agreements with its employees, resellers,
distributors, customers and potential customers and limits access to the
distribution of its software, hardware designs, documentation and other
proprietary information, however in some instances the Company may find it
necessary to release its source code to certain parties, for example the Company
recently entered into a product development agreement pursuant to which it
released certain source code to a third party in Asia the People's Republic of
China. There can be no assurance that the steps taken by the Company in this
regard will be adequate to prevent misappropriation of its technology. The
Company currently has ten issued United States patents. There can be no
assurance that the Company's patents will not be invalidated, circumvented or
challenged, that the rights granted thereunder will provide competitive
advantages to the Company or that any of the Company's pending or future patent
applications, whether or not being currently challenged by applicable
governmental patent examiners, will be issued with the scope of the claims
sought by the Company, if at all. Furthermore, there can be no assurance that
others will not develop technologies that are similar or superior to the
Company's technology or design around the patents owned by the Company. Despite
the Company's efforts to protect its proprietary rights, unauthorized parties
may attempt to copy aspects of the Company's products or to obtain and use
information that the Company regards as proprietary. Policing unauthorized use
of the Company's products is difficult, and while the Company is unable to
determine the extent to which piracy of its software products exists, software
piracy is expected to be a persistent problem. In selling its software products,
the Company relies primarily on ''shrink wrap'' licenses that are not signed by
licensees and, therefore, it is possible that such licenses may be unenforceable
under the laws of certain jurisdictions. In addition, the laws of some foreign
countries where the Company's products are or may be manufactured or sold,
particularly developing countries including various countries in Asia, such as
the People's Republic of China, do not protect the Company's proprietary rights
as fully as do the laws of the United States. There can be no assurance that the
Company's means of protecting its proprietary rights in the United States or
abroad will be adequate or that competing companies will not independently
develop similar technology.
The Company relies upon certain software, firmware and hardware designs that
it licenses from third parties, including firmware that is integrated with the
Company's internally developed firmware and used in the Company's products to
perform key functions. There can be no assurance that these third-party licenses
will continue to be available to the Company on commercially reasonable terms.
The loss of, or inability to maintain, such licenses could result in shipment
delays or reductions until equivalent firmware could be developed, identified,
licensed and integrated which would materially and adversely affect the
Company's business, operating results and financial condition.
The Company has conducted a comprehensive review of its computer systems to
identify the systems that could be affected by the "Year 2000" issue and has
developed and implemented a plan to resolve the issue. The Year 2000 issue is
the result of computer programs being written using two digits rather than four
to define the application year. Any of the Company's programs that have time-
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in a major system failure or miscalculations.
The Company presently believes that with modifications to existing software and
converting to new software, the Year 2000 issue should not pose significant
operational problems for the Company's computer systems as so modified and
converted. However,
16
if such modifications and conversion are not sufficient, the Year 2000 issue may
have a material impact on the operations of the Company.
EMPLOYEES
As of December 1, 1997 the Company employed 244 persons, including 63 in sales
and marketing, 62 in research and development, 38 in customer service and
support, 47 in manufacturing operations, and 34 in general and administrative
functions. The Company also contracts with consultants who provide short and
long-term services to the Company in various areas. Netopia believes that its
relations with its employees are good. None of Netopia's employees is
represented by a labor union and the Company has not experienced a work
stoppage. The Company believes its business depends to a significant extent on
the contributions of its senior management and other key personnel and on
Netopia's ability to attract and retain highly qualified personnel. Competition
to hire such personnel in Netopia's industry and location is intense.
The Company's business and prospects depend to a significant degree upon the
continuing contributions of its key management, sales, marketing, product
development and administrative personnel. The Company does not have employment
contracts with its key personnel and does not maintain any key person life
insurance policies. The loss of key management or technical personnel could
materially adversely affect the Company's business, operating results and
financial condition. The Company believes that its prospects depend in large
part upon its ability to attract and retain highly-skilled engineering,
managerial, sales and marketing, and administrative personnel. Competition for
such personnel is intense, and there can be no assurance that the Company will
be successful in attracting and retaining such personnel. Failure to attract and
retain key personnel could have a material adverse effect on the Company's
business, operating results and financial condition.
ITEM 2. PROPERTIES
The Company leases approximately 49,000 square feet of office space for its
headquarters in Alameda, California. The site is used for research and
development, administration, customer service, and sales and marketing
activities. The facility is currently leased for a five year term, expiring
December 31, 1997. A First Amendment to this lease has been executed, which
extends the term of the lease for five years, commencing on January 1, 1998, and
expiring on December 31, 2002. In addition, the Company leases approximately
29,000 square feet of warehouse space in San Leandro, California to accommodate
the Company's distribution center, which maintains inventory and provides
shipping and handling. The lease is for a five year term, expiring December 31,
1997. The Company has exercised the first of two five-year renewal options on
this space. The renewal period will commence on January 1, 1998, and expire on
December 31, 2002. The Company leases approximately 2,100 square feet of office
space in Dallas, Texas which is used to house it's software telemarketing sales
group. The lease term is for five years commencing on August 1, 1997, and
expiring on July 31, 2002. The Company leases approximately 11,000 square feet
of research and development office space in Lawrence, Kansas and 1,450 square
feet in San Jose, California, the leases on which expire on July 30, 1998 and
September 30, 2002, respectively. The company leases a full-service office suite
consisting of approximately 300 square feet, in Norcross, Georgia. This facility
is used as a regional sales office. The lease is for one year, commencing April
9, 1997, and expiring April 8, 1998. The Company also leases approximately 1,200
square feet of sales office space in France. The lease term is for nine years
ending February 28, 2005. The Company believes that its existing facilities are
adequate for its current needs and that additional space sufficient to meet the
Company's needs for the foreseeable future is available on reasonable terms.
CALIFORNIA HEADQUARTERS. The Company's corporate headquarters and a large
portion of its research and development facilities as well as other critical
business operations are located in California, near major earthquake faults.
The Company's business, financial condition and operating results could be
materially adversely affected in the event of a major earthquake.
ITEM 3. LEGAL PROCEEDINGS
As of December 1, 1997 the Company was not involved in any pending legal
proceedings which the Company believes could have a material adverse effect on
the Company.
17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted to a vote of security holders of the Company during
the fourth quarter ended September 30, 1997.
PART II.
ITEM 5. MARKET FOR NETOPIA'S COMMON STOCK AND RELATED STOCK-
HOLDER MATTERS
The Company's Common Stock trades on The Nasdaq Stock Market under the symbol
"NTPA." The table below sets forth the high and low sales prices per share as
reported on The Nasdaq Stock Market since the Company's initial public offering
on June 13, 1996. The Company's initial public offering price was $16.00 per
share. The Company's name changed from Farallon Communication, Inc. to Netopia,
Inc. and the Nasdaq Stock Market stock ticker changed from "FRLN" to "NTPA" on
November 17, 1997.
Fiscal Year Ended September 30, 1997 High Low
- ------------------------------------ ---- ---
First quarter ended December 31, 1996......... $14.500 $6.375
Second quarter ended March 31, 1997........... 6.313 4.250
Third quarter ended June 30, 1997............. 5.375 3.938
Fourth quarter ended September 30, 1997....... 7.125 4.375
Fiscal Year Ended September 30, 1996 High Low
- ------------------------------------ ---- ---
Third quarter ended June 30, 1996(1).......... $19.000 $14.750
Fourth quarter ended September 30, 1996....... 15.000 7.500
(1) Trading of the Company's Common Stock commenced on June 13, 1996,
accordingly the high and low price information represents 12 trading days.
The Company believes several factors including but not limited to quarter-to-
quarter variances in financial results, announcements of new products and new
orders by the Company or its competitors could cause the market price of the
Company's Common Stock to fluctuate substantially. In addition, the stock
prices for many high technology companies typically experience extreme price
fluctuations, which are often not related to changes in the operating
performance of the specific companies. Broad market fluctuations as well as
general economic conditions such as a recessionary period or high interest rates
may affect the market price of the Company's Common Stock. As of December 1,
1997 the Company had approximately 176 registered shareholders of record. The
Company has not paid cash dividends on its Common Stock. The Company currently
anticipates that it will retain all future earnings, if any, for use in its
business and does not anticipate paying any cash dividends on its Common Stock
in the foreseeable future.
18
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data has been derived from the audited
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 included elsewhere in this Form 10-K.
YEARS ENDED SEPTEMBER 30,
----------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- ------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
Internet/Intranet products................. $ -- $ 5,310 $ 6,569 $ 16,718 $ 20,170
LAN products............................... 48,425 51,691 50,620 44,886 32,023
-------- -------- -------- -------- --------
Total revenues........................... 48,425 57,001 57,189 61,604 52,193
Cost of revenues:
Internet/Intranet products................. -- 447 674 3,811 6,396
LAN products............................... 24,302 30,368 28,842 28,439 20,810
-------- -------- -------- -------- --------
Total cost of revenues................... 24,302 30,815 29,516 32,250 27,206
-------- -------- -------- -------- --------
Gross profit............................. 24,123 26,186 27,673 29,354 24,987
Operating expenses:
Research and development................... 7,434 6,671 8,429 8,919 8,839
Selling and marketing...................... 14,087 13,983 13,691 15,778 15,540
General and administrative................. 3,216 3,228 2,888 3,429 3,291
Restructuring costs (1).................... 1,048 -- -- -- --
-------- -------- -------- -------- --------
Total operating expenses................. 25,785 23,882 25,008 28,126 27,670
-------- -------- -------- -------- --------
Operating income (loss).................. (1,662) 2,304 2,665 1,228 (2,683)
Other income, net........................... 249 291 815 1,040 1,869
-------- -------- -------- -------- --------
Income (loss) before income taxes........ (1,413) 2,595 3,480 2,268 (814)
Income tax expense (benefit) (2)............ 1 408 974 (1,433) (285)
-------- -------- -------- -------- --------
Net income (loss).......................... $ (1,414) $ 2,187 $ 2,506 $ 3,701 $ (529)
======== ======== ======== ======== ========
Net income (loss) per share................. $ 0.25 $ 0.33 $ (0.05)
======== ======== ========
Shares used in per share computations (3)... 9,891 11,071 11,335
======== ======== ========
SEPTEMBER 30,
----------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
CONSOLIDATED BALANCE SHEET DATA:............ (IN THOUSANDS)
Working capital............................. $ 16,866 $ 19,569 $ 21,755 $ 49,469 $ 49,979
Total assets................................ 29,075 29,289 33,872 61,618 61,001
Long-term liabilities, net of current
portion.................................... 1,262 689 218 46 361
Total stockholders' equity.................. 19,176 21,644 24,279 53,143 53,977
(1) In fiscal 1993, the Company reduced its number of employees and identified
certain impaired assets as part of a restructuring.
(2) See Note 4 of Notes to Consolidated Financial Statements.
(3) See Note 1 of Notes to Consolidated Financial Statements.
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The discussion in this Report contains forward-looking statements that
involve risks and uncertainties. The statements contained in this Report that
are not purely historical are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, including statements regarding the
Company's expectations, beliefs, intentions or strategies regarding the future.
All forward-looking statements included in this document are based on
information available to the Company on the date hereof, and the Company assumes
no obligation to update any such forward-looking statement. The Company's actual
results could differ materially from those discussed herein. Factors that could
cause or contribute to such differences include, but are not limited to, those
discussed in "Other Factors That May Affect Future Results" as well as those
discussed in this section and elsewhere in this Report, and the risks discussed
in the Company's other Securities and Exchange Commission Filings.
OVERVIEW
Netopia develops, markets and supports complete, easy-to-use, plug-and-play
Internet connectivity and networking solutions and real-time collaboration
software to increase the productivity and efficiency of Internet, Intranet and
LAN users. The Company was founded in 1985 and initially focused on the
development of networking products for AppleTalk LANs, including the PhoneNET
network system. Historically, the Company has derived a substantial majority of
its revenues from its LAN products. In 1993, the Company revised its business
strategy to concentrate on the Internet and Intranet markets through the
utilization of its TCP/IP and routing expertise. In the first quarter of fiscal
1994, the Company released its Timbuktu Pro Internet/Intranet collaboration
software product (TCP/IP enabled), and in the first quarter of fiscal 1996, the
Company introduced its Netopia family of Internet connectivity products and
services. Although the Company has experienced growth in Internet/Intranet
product revenues over the last four years, the Company does not believe prior
growth rates are sustainable or indicative of future Internet/Intranet operating
results. There can be no assurance that the Company will be profitable on a
--
quarterly or annual basis. The Company's limited Internet/Intranet operating
history and the dynamic market environment in which the Company competes makes
the prediction of future Internet/Intranet operating results difficult, if not
impossible.
The Company's total revenues are derived from the sale of Internet/Intranet
connectivity and software products and Farallon division of LAN connectivity
products. Internet/Intranet product revenues include license revenues for its
Timbuktu Pro and Netopia Virtual Office software, sales of the Netopia family of
Internet connectivity products, and fees for related services as well as revenue
from licensing the Company's patent covering cross-platform screen-sharing
technology. LAN products revenue is derived primarily from the sale of Ethernet,
EtherWave, Fast Ethernet and LocalTalk compatible products which include the
PhoneNET system network connectivity products and, historically, remote access
and LAN software. Revenue relating to the sale and licensing of hardware and
software products is recognized upon shipment of the products by the Company,
patent revenue is recognized upon the licensing of the rights to the patent and
service revenues are recognized ratably over the term of the contract. Certain
of the Company's sales are made to customers under agreements permitting limited
rights of return for stock balancing or with protection for future price
decreases. Revenue is recorded net of an estimated allowance for returns. Any
product returns or price decreases in the future that exceed the Company's
allowances may materially adversely affect the Company's business, operating
results and financial condition.
As the Company continues to focus on increasing its Internet/Intranet
business, and as a result of variable average selling prices of the Company's
LAN products, declining sales of Mac OS computers and competitive factors, the
Company expects that LAN products revenue may decline and may account for a
decreasing percentage of total revenues in future periods to the extent that
Internet/Intranet product revenues increase. As a result, the Company's future
operating results are dependent upon continued market acceptance of its
Internet/Intranet products and enhancements thereto. Historically, the Company
has been dependent upon sales of its LAN products, and to the extent that
continuing declines in revenues from LAN products is not offset by increases in
revenue from other sources, such as sales of the Company's Internet/Intranet
products, then the Company's business, operating results and financial condition
will be materially adversely affected.
20
The Company's gross margin has varied significantly in the past and will
likely vary significantly in the future depending primarily on the mix of
products sold by the Company and external market factors including but not
limited to price competition. The Company's Timbuktu Pro and Netopia Virtual
Office collaboration software products have a higher average gross margin than
the balance of the Company's products. Accordingly, to the extent the product
mix for any particular quarter includes a substantial proportion of lower margin
products, there will be a material adverse effect on the Company's business,
operating results and financial condition.
Netopia sells its Internet/Intranet and LAN products and related maintenance,
support and other services primarily through distributors, while certain
products are also sold directly through select ISPs and VARs or directly by the
Company to corporate accounts and higher education institutions. Revenues from
distributors accounted for 73%, of the Company's total revenues for fiscal 1995,
and 60% of the Company's total revenue for each of fiscal 1996 and 1997. The
Company's three largest distributors accounted for 43%, 35% and 34% of the
Company's total revenues for fiscal 1995, 1996 and 1997, respectively. The
Company intends to continue to use its existing ISPs and VARs to sell the
Company's Internet/Intranet products, and to recruit additional ISPs and VARs
and pursue other marketing channels in the future. There can be no assurance
that the Company's current distributors will choose to or be able to market the
Company's products effectively, that economic conditions or industry demand will
not adversely affect these or other distributors, or that these distributors
will not devote greater resources to marketing products of other companies. The
loss of, or a significant reduction in revenue from, one of the Company's
distributors could have a material adverse effect on the Company's business,
operating results and financial condition.
International revenues accounted for 29% of the Company's total revenues for
each of fiscal 1995, 1996 and 1997, and are derived primarily from Europe and
Japan. The Company's international revenues are currently denominated in United
States dollars, and revenues generated by the Company's distributors currently
are paid to the Company in United States dollars. The results of the Company's
international operations may fluctuate from period to period based on global
economic factors including, but not limited to, the current economic situation
in Asia and Japan and movements in currency exchange rates. Historically,
movements in exchange rates have not materially affected the Company's total
revenues. However, there can be no assurance that movements in currency exchange
rates will not have a material adverse effect on the Company's revenues in the
future.
The Company expects that international revenues will continue to represent a
significant portion of its total revenues. Any significant decline in
international demand for the Company's products would have a material adverse
effect on the Company's business, operating results and financial condition. The
Company believes that in order to increase sales opportunities and profitability
it will be required to expand its international operations. The Company has
committed and continues to commit significant management attention and financial
resources to developing international sales and support channels. There can be
no assurance that the Company will be able to maintain or increase international
market demand for its products. In addition, sales of the Company's LAN products
are dependent upon the international demand for Apple products. To the extent
that the Company is unable to maintain or increase international demand for its
products, or that international demand for Apple products does not meet the
Company's expectations, the Company's international sales will be limited, and
the Company's business, operating results and financial condition would be
materially and adversely affected.
The Company's international business is subject to inherent risks, including
but not limited to the impact of possible and existing recessionary environments
in economies outside the United States, costs of localizing products for foreign
countries, longer receivable collection periods and greater difficulty in
accounts receivable collection, unexpected changes in regulatory requirements,
difficulties and costs of staffing and managing foreign operations, potentially
adverse tax consequences and political and economic instability. In addition,
the laws of certain foreign countries in which the Company's products are or may
be manufactured or sold, including various countries in Asia including the
People's Republic of China, may not protect the Company's products or
intellectual property rights to the same extent as do the laws of the United
States and thus make the possibility of piracy of the Company's technology and
products more likely. There can be no assurance that the Company will be able to
sustain or increase international revenues, or that the foregoing factors will
not have a material adverse effect on the Company's future international
revenues and its business, operating results and financial condition. The
Company has a substantial portion of its products and components manufactured by
foreign suppliers. The Company's operating results are subject to the risks
inherent in international purchases, including, but not limited to, various
regulatory requirements, political and economic changes and disruptions,
transportation delays, export/import controls, tariff regulations,
21
higher freight rates and potentially adverse tax consequences. Duty, tariff and
freight costs can materially increase the cost of crucial components for the
Company's products.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of operations
data of the Company expressed as a percentage of total revenues for the periods
indicated:
YEARS ENDED SEPTEMBER 30,
-------------------------
1995 1996 1997
-------------------------
Revenues:
Internet/Intranet products............. 11.5% 27.1% 38.6%
LAN products........................... 88.5 72.9 61.4
-------------------------
Total revenues........................ 100.0 100.0 100.0
-------------------------
Cost of revenues:
Internet/Intranet products............. 1.2 6.2 12.2
LAN products........................... 50.4 46.2 39.9
-------------------------
Total cost of revenues................ 51.6 52.4 52.1
-------------------------
Gross profit.................... 48.4 47.6 47.9
Operating expenses:
Research and development............... 14.7 14.5 16.9
Selling and marketing.................. 23.9 25.6 29.8
General and administrative............. 5.1 5.6 6.3
-------------------------
Total operating expenses.............. 43.7 45.7 53.0
-------------------------
Operating income (loss)......... 4.7 2.0 (5.1)
Other income, net....................... 1.4 1.7 3.6
-------------------------
Income (loss) before income taxes... 6.1 3.7 (1.5)
Income tax expense (benefit)............ 1.7 (2.3) (0.5)
-------------------------
Net income (loss)................... 4.4% 6.0% (1.0)%
=========================
YEARS ENDED SEPTEMBER 30, 1995, 1996 AND 1997
Revenues. The Company's total revenues increased 7.7% from $57.2 million for
fiscal 1995 to $61.6 million for fiscal 1996, and decreased 15.3% to $52.2
million for fiscal 1997. Internet/Intranet products revenue increased 154.5%
from $6.6 million for fiscal 1995 to $16.7 million for fiscal 1996, and
increased 20.6% to $20.2 million for fiscal 1997. The increase in
Internet/Intranet revenues for fiscal 1996 was due to the introduction and
initial market acceptance of ISDN versions of the Company's Netopia family of
Internet connectivity products and services, increased sales of the Windows
versions of Timbuktu Pro collaboration software (particularly volume licenses in
corporate Intranets), upgrade cycles and increased volume licenses related to
the Macintosh version of Timbuktu Pro as well as the licensing of the Company's
patent covering cross-platform screen-sharing technology. Exclusive of the
patent license, revenues from Timbuktu Pro decreased slightly late in fiscal
1996 reflecting a decrease in sales of the Macintosh version of Timbuktu Pro,
partially offset by a slight growth in sales of the Windows version of Timbuktu
Pro. The increase in Internet/Intranet revenues for fiscal 1997 was primarily
due to increased sales of international versions of ISDN routers which were
introduced in the fourth quarter of fiscal 1996, the fiscal 1997 first quarter
introduction of the "So-Smart" ISDN routers domestically, a greater number of
regional ISPs selling the Netopia family of Internet connectivity products and
increased sales of the Windows versions of Timbuktu Pro. These increases were
partially offset by decreased sales of the Macintosh version of Timbuktu Pro,
decreased revenue from patent licenses and price competition related to ISDN
routers. The Company believes the decline in Timbuktu Pro Mac products reflects
declining sales of Macintosh computers and Apple's loss of market share. LAN
products revenue decreased 11.3% from $50.6 million for fiscal 1995 to $44.9
million for fiscal 1996, and decreased 28.7% to $32.0 million for fiscal 1997.
The decrease in LAN revenues for fiscal 1996 was due to declining sales and
average selling prices of EtherWave and LocalTalk products, partially offset by
the introduction of new Ethernet, Fast Ethernet and OEM Ethernet products. The
decrease in LAN revenues for fiscal 1997 was primarily due to decreased sales
and average selling prices of EtherWave and LocalTalk products and declining
average selling prices of the Company's Ethernet products, partially offset by
new Fast Ethernet and Ethernet product introductions.
22
Although Fast Ethernet and Ethernet product revenue benefited in fiscal years
1996 and 1997 from new product introductions, the increase was partially offset
by declining demand for certain Ethernet products, price competition and vendor
incorporation of built-in Ethernet connectivity into certain new computers. The
Company also believes declining EtherWave sales are primarily a result of price
competition from standard 10Base-T hubs, cards and transceivers as well as
vendor incorporation of built-in Ethernet connectivity into certain new
computers. Overall, the Company believes its LAN products continue to be
adversely affected by declining sales of Macintosh computers and Apple's loss of
market share. To the extent that the Company continues to experience weakened
demand for its products such as Timbuktu Pro Mac, EtherWave, LocalTalk and
Ethernet products, the Company's business, operating results and financial
condition will be materially adversely affected. Internet/Intranet products
revenue accounted for 11.5%, 27.1% and 38.6% of the Company's total revenues for
fiscal 1995, 1996 and 1997, respectively, while LAN products revenue accounted
for 88.5%, 72.9% and 61.4% of the Company's total revenues for fiscal 1995, 1996
and 1997, respectively.
Revenues from distributors accounted for 73% of the Company's total revenues
for fiscal 1995 and 60% of the Company's total revenue for each of fiscal 1996
and 1997. The decrease in the percentage of revenues from distributors was
primarily due to declining sales of the Company's LAN products which are sold
primarily through the distribution channel. Revenues from Ingram accounted for
22%, 18% and 19% of the Company's total revenues for fiscal 1995, 1996 and 1997,
respectively, and revenues from MicroWarehouse accounted for 13%, 11% and 10% of
the Company's total revenues for fiscal 1995, 1996 and 1997, respectively. No
other customers have accounted for 10% or more of the Company's total revenues
during fiscal 1995, 1996 and 1997.
International revenues accounted for 29% of total revenues for each of fiscal
1995, 1996 and 1997. Although international revenues remained flat as a
percentage of total revenue from fiscal 1995 to fiscal 1996, they increased 8.2%
from $16.6 million for fiscal 1995 to $18.0 million for fiscal 1996 primarily
due to increased sales in the Pacific Rim which the Company believes were
partially offset late in the fiscal 1996 by delays, technical difficulties and
interrupted supply of Apple PowerBooks and decreased international sales of
other Apple products. Although international revenues remained flat as a
percentage of total revenue from fiscal 1996 to fiscal 1997, they decreased
16.8% from $18.0 million for fiscal 1996 to $15.0 million for fiscal 1997
primarily due to decreased sales in the Pacific Rim. Revenues from the Pacific
Rim region decreased 39.5% from $6.3 million for fiscal 1996 to $3.8 million for
fiscal 1997. The Company believes the decline in international revenue is
primarily due to recessionary economic conditions in Japan as well as eroding
Apple market share worldwide. To the extent that the Company continues to
experience weakened international demand for its products, the Company's
business, operating results and financial condition would be materially
adversely affected.
Gross Margin. The Company's gross margin for Internet/Intranet and LAN
products is affected by many factors, including but not limited to pricing
strategies, royalties paid to third parties, new versions of existing products
and product mix. The Company's total gross margin decreased from 48.4% for
fiscal 1995 to 47.6% for fiscal 1996, and increased to 47.9% for fiscal 1997.
Internet/Intranet products gross margin decreased from 89.7% for fiscal 1995 to
77.2% for fiscal 1996, and decreased to 68.3% for fiscal 1997. The decrease in
Internet/Intranet products gross margin for fiscal 1996 was primarily due to the
introduction of Netopia Internet connectivity products which have lower gross
margins than the Company's Internet/Intranet software products, partially offset
by the licensing of the Company's patent covering cross-platform screen-sharing
technology. The decrease in Internet/Intranet products gross margin for fiscal
1997 was primarily due to the increased sales of Netopia Internet connectivity
products which have lower gross margins than the Company's Internet/Intranet
software products and decreased revenue from patent licenses. The Company's
gross margin for LAN products decreased from 43.0% for fiscal 1995 to 36.6% for
fiscal 1996 and decreased to 35.0% for fiscal 1997. The decrease in LAN products
gross margins for fiscal 1996 were primarily due to declining sales and average
selling prices on the Company's higher margin EtherWave and LocalTalk products
and increased sales of lower margin Ethernet and Fast Ethernet products.
Additionally, LAN products gross margins were adversely affected in fiscal 1996,
by a non-recurring charge to cost of sales resulting from standard cost
reductions on inventory as well as additional inventory reserves the Company
recorded in the fourth quarter. These reserves were primarily related to Fast
Ethernet products which had experienced market acceptance below the Company's
expectations. The decrease for fiscal 1997 was primarily related to declining
sales of higher margin EtherWave and LocalTalk products and average selling
price reductions as a result of price competition. This decrease was partially
offset by increased sales of certain higher margin Ethernet products for
Macintosh clones and retrofit upgrades as well as cost reductions as a result of
transferring certain production offshore and continued product re-engineering.
23
Research and Development. Research and development expenses increased from
$8.4 million for fiscal 1995 to $8.9 million for fiscal 1996, and decreased to
$8.8 million for fiscal 1997. The increase for fiscal 1996 was primarily a
result of additional headcount and other employee related expenses related to
the development of the Company's Internet/Intranet products. The decrease for
fiscal 1997 was primarily due to decreased development related expenses as well
as decreased incentives, recruiting, travel and contractor expenses partially
offset by increased salaries and international localization of the Company's
Internet/Intranet products. Such expenses represented 14.7%, 14.5% and 16.9% of
the Company's total revenues for fiscal 1995, 1996 and 1997, respectively. The
Company believes that it will continue to devote substantial resources to
product and technological development and that research and development costs
will increase in absolute dollars in fiscal 1998. Historically, the Company has
believed its process for developing software is essentially completed
concurrently with the establishment of technological feasibility and no internal
software costs have been capitalized to date. During fiscal 1997, $350,000 of
product development costs incurred subsequent to the delivery of a working
model, under a development agreement with a third party, have been capitalized.
No software development costs were capitalized during fiscal 1995 or 1996. The
Company may enter into further development agreements in which the Company may
be required to capitalize certain costs of software development.
Selling and Marketing. Selling and marketing expenses increased from $13.7
million for fiscal 1995 to $15.8 million for fiscal 1996, and decreased to $15.5
million for fiscal 1997. The increase for fiscal 1996 was primarily due to
increased headcount with the addition of direct software and Netopia Internet
connectivity sales forces and associated expenses as well as increased
advertising and promotional spending relating to the introduction of the
Company's new Netopia Internet connectivity products and Internet Applets. The
decrease for fiscal 1997 was primarily due to decreased print advertising and
other marketing related expenses, as the Company continues to focus on
electronic marketing efforts, partially offset by increased headcount and
related expenses as well as increased telecommunications expenses. Such
expenses represented 23.9%, 25.6% and 29.8% of the Company's total revenues for
fiscal 1995, 1996 and 1997, respectively. The Company believes selling and
marketing expenses will increase in absolute dollars in fiscal 1998 primarily
due to increased personnel related expenses and increased advertising and
promotional activities.
General and Administrative. General and administrative expenses increased
from $2.9 million for fiscal 1995 to $3.4 million for fiscal 1996, and decreased
to $3.3 million for fiscal 1997. The increase for fiscal 1996 was primarily due
to consulting fees related to the acquisition of the Netopia trademark and
increased personnel related expenses. The decrease for fiscal 1997 was primarily
due to reduced consulting fees and employee related expenses partially offset by
increased accounting services, legal services and insurance expense related to
being a public company. Such expenses represented 5.1%, 5.6% and 6.3% of the
Company's total revenues for fiscal 1995, 1996 and 1997, respectively. The
Company believes that general and administrative costs will increase in absolute
dollars for fiscal 1998 as the Company continues to incur additional costs of
being a public company, such as expenses related to Directors and Officers
insurance, investor relations and increased professional fees.
Other Income, Net. Other income, net, represents interest earned by the
Company on its cash, cash equivalents and short-term investments offset by
interest expense.
Provision for Income Taxes. The effective tax rate for fiscal 1995 was 28%.
The effective tax rate for fiscal 1996, excluding the effect of an adjustment to
the valuation allowance against deferred tax assets, was 38%. The effective tax
rate for fiscal 1997, including the effect of an adjustment to the valuation
allowance, was 35%. Excluding the impact of changes in the valuation allowance
against deferred tax assets, these rates differ from the statutory rate
primarily due to research tax credits and tax exempt interest income. See Note 4
of Notes to Consolidated Financial Statements.
In fiscal 1996, the Company reversed a full valuation allowance that it had
previously provided against its deferred tax assets, resulting in a non-
recurring income tax benefit of approximately $2.3 million. Prior to the
reversal, the Company believed that, based upon available objective evidence,
there was sufficient uncertainty regarding the realizability of its deferred tax
assets to warrant a full valuation allowance. The factors considered included
prior losses, inconsistent profits, lack of carryback potential to realize
deferred tax assets, dependence on LAN products and associated declining market
and gross margins for LAN products, dependence upon Apple and uncertain market
acceptance of its Internet/Intranet products. During fiscal 1996, the Company
believed that due to
24
the demonstrated market acceptance of its new Internet/Intranet products, the
uncertainty regarding the realizability of its deferred tax assets had
diminished to the point where it was more likely than not that the deferred tax
assets would be realized.
In fiscal 1997, the Company believed that, based upon available objective
evidence, there was sufficient uncertainty regarding the realizability of
certain of its deferred tax assets to warrant a partial valuation allowance,
primarily related to the expected realizability of its research credit
carryforwards. The factors considered included the relatively shorter product
life cycles in the high technology industry and the uncertainty of longer-term
taxable income estimates related thereto, and limits on the carryback potential
for realizing certain deferred tax assets. Management believes that it is more
likely than not that the Company will realize the approximately $2.9 million in
net deferred tax assets as of September 30, 1997, but no assurances can be
provided in that regard. To the extent that the Company cannot achieve
consistent profitability in the near future or as a result of acquisition or
divestiture activity, the Company may be required to record a full valuation
allowance against its remaining net deferred tax assets. In the event the
Company records a full valuation allowance against its deferred tax assets, the
Company's operating results would be materially and adversely affected.
OTHER FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company operates in a rapidly changing environment that involves a number
of risks, many of which are beyond the Company's control. The following
discussion highlights some of these risks. The Company's actual results could
differ materially from those discussed herein. Factors that could cause or
contribute to such differences include, but are not limited to, those discussed
in this section and elsewhere in this Report, and the risks discussed in the
Company's other United States Securities and Exchange Commission Filings.
FLUCTUATIONS IN QUARTERLY RESULTS; FUTURE OPERATING RESULTS UNCERTAIN. The
Company's quarterly operating results have varied significantly in the past and
are likely to vary significantly in the future. For example, the Company has
recently experienced quarterly losses and experienced a loss for fiscal 1997.
The Company's results depend on factors such as changes in networking and
communications technologies, price and product competition, usage of the
Internet and developments and changes in the Internet market, the demand for the
Company's products, demand for Apple's products, changes in pricing policies by
the Company or its competitors, including the grant of price protection terms
and discounts by the Company, changes in the mix of products sold by the Company
and the resulting change in total gross margin, changes in the mix of channels
through which the Company's products are offered, product enhancements and new
product announcements by the Company and its competitors, market acceptance of
new products of the Company or its competitors, raw material costs, write-offs
of obsolete inventory, the size and timing of distributor and end user orders
and purchasing cycles, customer order deferrals in anticipation of enhancements
to the Company's or competitors' products, customer order deferrals in
anticipation of new MacOS product offerings and the elimination of a number of
Macintosh cloning licenses issued by Apple, customer order deferrals for
budgetary or other reasons including but not limited to government programs such
as E-Rate, manufacturing delays, disruptions in sources of supply, product life
cycles, product quality problems, personnel changes, changes in the Company's
strategy, changes in the level of operating expenses, the timing of research and
development expenditures, the level of the Company's international revenues,
fluctuations in foreign currency exchange rates, general economic conditions,
both in the United States and abroad, and economic conditions specific to the
industries in which the Company competes, among others. The Company's limited
Internet/Intranet operating history and the dynamic market environment in which
the Company competes makes the prediction of future Internet/Intranet operating
results difficult, if not impossible. Sales orders are typically shipped shortly
after receipt and, consequently, order backlog at the beginning of any quarter
has in the past represented only a small portion of that quarter's revenues.
Accordingly, the Company's net revenues in any quarter are substantially
dependent on orders booked and shipped during that quarter. Historically, the
Company has often shipped and recognized a significant portion of its revenues
in the last weeks, or even days, of a quarter. As a result, the magnitude of
quarterly fluctuations may not become evident until late in, or after the close
of a particular quarter. The Company typically experiences significant volumes
of shipments at the end of the quarter which may be exposed to delays caused by
shipping halts or other factors beyond the Company's control. In addition, the
Company recognizes revenue on products sold through distributors upon shipment
to the distributor. Although the Company maintains reserves for projected
returns and price decreases, there can be no assurance that such reserves will
be adequate. The Company's business also has experienced seasonality in the
past, largely due to customer buying patterns such as budgeting cycles of
educational institutions that purchase the Company's products and the summer
slow down in most European
25
markets. There can be no assurance that the Company's operating results will not
be affected by seasonality in the future or that such seasonality will occur in
a manner consistent with prior periods.
The Company's expense levels are based in large part on expectations as to
future revenues and as a result are relatively fixed in the short term. If
revenues are below expectations in any given quarter, net income or loss is
likely to be disproportionately affected. Due to all of the foregoing factors,
and other factors discussed herein, revenues and net income or loss for any
future period are not predictable with any significant degree of certainty.
Accordingly, the Company believes that period-to-period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. There can be no assurance that the
Company's business strategies will be successful or that the Company will be
able to return to or sustain profitability on a quarterly or annual basis in the
future. It is likely that in some future quarter the Company's operating results
will be below the expectations of public market analysts and investors. In such
event, the price of the Company's Common Stock would likely be materially and
adversely affected.
MANAGEMENT OF CHANGING BUSINESS. The Company has shifted its business strategy
from providing only LAN products to reducing its reliance on LAN products and
focusing development and management efforts on its Internet/Intranet business.
This transition represents a significant challenge for the Company and its
administrative, operational and financial resources and places increased demands
on its systems and controls. The Company's ability to manage the continuing
development of its Internet/Intranet business will require the Company to
continue to change, expand and improve its operational, management and financial
systems and controls and to expand its manufacturing capabilities. This
transition has resulted in a continuing increase in the level of responsibility
for both existing and new management personnel. The Company anticipates that any
growth in its Internet/Intranet business will require it to recruit and hire a
substantial number of new engineering, sales and marketing, customer service,
administrative and managerial personnel. There can be no assurance that the
Company will be successful in hiring or retaining these personnel, if needed. In
addition, certain aspects of the Company's Internet/Intranet business require
volume sales to achieve profitability. If the Company is unable to achieve such
volumes or to manage the transition effectively, the Company's business,
operating results and financial condition will be materially and adversely
affected.
LITIGATION. From time to time, the Company has received claims of infringement
of other parties' proprietary rights. Although the Company believes that all
such claims received to date are without merit or are immaterial, there can be
no assurance that third parties will not assert infringement or other claims in
the future with respect to the Company's current or future products or
activities. The Company expects that it will increasingly be subject to
infringement claims as the number of products and competitors in the Company's
industry segments grow and the functionality of products in different industry
segments overlap. Any such claims, with or without merit, could be time
consuming to defend, result in costly litigation, divert management's attention
and resources, cause product shipment delays or require the Company to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company, if at all. In
the event of a successful claim of product infringement against the Company and
failure or inability of the Company to license the infringed or similar
technology, the Company's business, operating results and financial condition
would be materially and adversely affected.
From time to time, the Company may be involved in litigation or administrative
claims arising out of its operations in the normal course of business. In the
event of a successful claim against the Company, the Company's business,
operating results and financial condition would be materially and adversely
affected.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS OR DIVESTITURES. The Company
may acquire or invest in companies, technologies or products that complement the
Company's business or its product offerings. In addition, the Company continues
to evaluate performance of all its products and product lines and may sell or
discontinue current technologies, products or products lines. Any acquisitions
or divestiture may result in potentially dilutive issuance of equity securities,
the write-off of software development costs or other assets, the amortization of
expenses related to goodwill and other intangible assets and/or the incurrence
of debt, any of which could have a material adverse effect on the Company's
business, financial condition and results of operations. Acquisitions or
divestiture would involve numerous additional risks including difficulties in
the assimilation or separation of operations, services, products and personnel,
the diversion of management's attention from other business concerns, the
disruption of the Company's business, the entry into markets in which the
Company has little or no direct prior
26
experience and the potential loss of key employees. There can be no assurance
that the Company would be successful in overcoming these or any other
significant risks encountered.
TARIFF AND REGULATORY MATTERS. The Company is not currently subject to
direct regulation by any government agency, other than regulations applicable to
businesses generally. However, rates for telecommunications services are
governed by tariffs of licensed carriers that are subject to regulatory
approval. Future changes in these tariffs could have a material adverse effect
on the Company's business, operating results and financial condition. For
example, if tariffs for public switched digital services increase in the future
relative to tariffs for private leased services, then the cost-effectiveness of
the Company's products would be reduced and its business, operating results and
financial condition would be materially and adversely affected. In addition, the
Company's telecommunications products must meet standards and receive
certification for connection to public telecommunications networks prior to
their sale. In the United States, such products must comply with Part 15(a)
(industrial equipment), Part 15(b) (residential equipment) and Part 68 (analog
and ISDN lines) of the Federal Communications Commission regulations. The
Company's telecommunications products also must be certified by certain domestic
telecommunications carriers. In foreign countries, such products are subject to
a wide variety of governmental review and certification requirements. While
certain foreign countries and the European Economic Community regulate the
importation and certification of the Company's products, most foreign customers
typically require that the Company's products receive certification from their
country's primary telecommunication carriers. Any future inability to obtain on
a timely basis or retain domestic regulatory approvals and certification or
foreign regulatory approvals, including safety and telecommunications, could
have a material adverse effect on the Company's business, operating results and
financial condition.
VOLATILITY OF STOCK PRICE. The market price of the shares of the Company's
Common Stock is highly volatile and may be significantly affected by factors
such as actual or anticipated fluctuations in the Company's results of
operations, announcements of technological innovations, introduction of new
products by the Company or its competitors, developments with respect to
patents, copyrights or proprietary rights, conditions and trends in the
networking and other technology industries, changes in or failure by the Company
to meet securities analysts' expectations, general market conditions and other
factors. In addition, the stock market has from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the common stocks of technology companies. These broad market
fluctuations may adversely affect the market price of the Company's Common
Stock. In the past, following periods of volatility in the market price of a
particular company's securities, securities class action litigation has often
been brought against that company. There can be no assurance that such
litigation will not occur in the future with respect to the Company. Such
litigation could result in substantial costs and a diversion of management's
attention and resources, which could have a material adverse effect upon the
Company's business, operating results and financial condition.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash flow from
operations, the private sale of equity securities and the Initial Public
Offering ("IPO") of the Company's Common Stock. Since inception, the Company has
raised $19.4 million from the private sale of equity securities and
approximately $24.8 million, net of offering expenses, from the Company's IPO
completed in June, 1996. As of September 30, 1997, the Company had cash, cash
equivalents and short-term investments representing 68% of total assets.
The Company generated cash from operating activities of $5.0 million in fiscal
1995, used $3.3 million in fiscal 1996 and generated $4.3 million in fiscal
1997. The cash used in operations in fiscal 1996 was primarily due to increases
in accounts receivable related to volume license sales of the Company's software
products, that occurred in the last weeks of the fourth quarter ended September
30, 1996, increases in operating expenses related to the introduction of Netopia
Internet connectivity hardware products, reduction in accounts payable and
increases in inventory related to the Company's new Netopia hardware and Fast
Ethernet products. The cash generated by operations in fiscal 1997 was primarily
due to collection of accounts receivable and decreased inventory, partially
offset by reductions of accounts payable and other accrued liabilities. Netopia
Internet connectivity products represented 12% and 23% of total gross inventory
at September 30, 1996 and 1997, respectively, and Fast Ethernet products
represented 23% and 16% of total gross inventory at September 30, 1996 and 1997,
respectively.
27
The Company's investing activities in fiscal 1995, 1996 and 1997, have related
primarily to the purchases of capital equipment and short-term investment
activity. Expenditures for capital equipment totaled $1.3 million, $2.2 million
and $1.1 million for fiscal 1995, 1996 and 1997, respectively, primarily
representing acquisitions of tooling and test fixtures for new products as well
as computer equipment used predominantly in product development. The Company
expects that its capital expenditures may increase in future periods to support
new product development and production. The Company's financing activities in
fiscal 1995, 1996 and 1997, represent activity on loans, exercise of stock
options, the IPO and activities related to the Company's Employee Stock Purchase
Plan. The Company's principal commitments consist primarily of leases on its
headquarters facilities and operating equipment. See Note 6 of Notes to
Consolidated Financial Statements.
The Company believes that its existing cash, cash equivalents and short-term
investments will be adequate to meet its cash needs for working capital and
capital expenditures for at least the next 12 months. Thereafter, if cash
generated from operations is insufficient to satisfy the Company's liquidity
requirements, the Company may seek to sell additional equity or convertible debt
securities or obtain additional credit facilities. The sale of additional equity
or convertible debt securities could result in additional dilution to the
Company's stockholders. A portion of the Company's cash may be used to acquire
or invest in complementary businesses or products or to obtain the right to use
complementary technologies. From time to time, in the ordinary course of
business, the Company evaluates potential acquisitions of such businesses,
products or technologies. The Company has no agreements or commitments and is
not currently engaged in any negotiations with respect to any such transaction.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14(a) for an index to the consolidated financial statements and
supplementary financial information which are attached hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference to the
information contained in the section captioned "Proposal 1 Election of
Directors" in the Proxy Statement to be filed with the Commission within 120
days after the end of the fiscal year ended September 30, 1997.
ITEM 11. EXECUTIVE COMPENSATION
Pursuant to General Instruction G(3) to Form 10-K, the information required by
this item is incorporated by reference to the information contained in the
section captioned "Executive Compensation and Other Matters" in the Proxy
Statement to be filed with the Commission within 120 days after the end of the
fiscal year ended September 30, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICAIL OWNERS AND
MANAGEMENT
The information required by this item is incorporated by reference to the
information contained in the section captioned "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement to be filed with the
Commission within 120 days after the end of the fiscal year ended September 30,
1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information contained in the section captioned "Compensation Committee and
Insider Participation" in the Proxy Statement to be filed with the Commission
within 120 days after the end of the fiscal year ended September 30, 1997.
28
PART IV.
ITEM 14. EXHIBITS, FINANCIAL SCHEDULES, AND REPORTS ON FORM 8-K
(a) FINANCIAL SCHEDULES
The following financial statements of Netopia, Inc. are filed as part of this
report on Form 10-K:
INDEX TO FINANCIAL STATEMENTS PAGE
Independent Auditors' Report............................................... 32
Consolidated Balance Sheets at September 30, 1996 and 1997................. 33
Consolidated Statements of Operations for the Years Ended September 30,
1995, 1996 and 1997........................................................ 35
Consolidated Statements of Stockholders' Equity for the Years Ended
September 30, 1995, 1996 and 1997.......................................... 35
Consolidated Statements of Cash Flows for the Years Ended September 30,
1995, 1996 and 1997........................................................ 36
Notes to Consolidated Financial Statements................................. 37
(b) EXHIBITS
Exhibits have been filed separately with the Securities and Exchange
Commission in connection with the Annual Report on Form 10-K or have been
incorporated into the report by reference. Copies of such exhibits may be
obtained from the Company upon request. The Company did not file any Form 8-K's
for fiscal 1997.
EXHIBIT
NO. DESCRIPTION
- ------- -----------------------------------------------------
*3.1 Restates and Amended Certificate of Incorporation
*3.2 Restated and Amended Bylaws of the Registrant
3.3 Certificate of Ownership and Merger (Corporate Name Change).
*4.1 Specimen Certificate Representing the Common Stock
*4.2 Amended and Restated Investor Rights Agreement, dated March 27, 1992,
among the Registrant and the investors and founders named therein, as
amended.
*10.1 Form of Indemnification Agreement entered into between the Registrant
and its directors and officers.
*10.2 1996 Stock Option Plan and forms of agreements thereunder.
*10.3 Employee Stock Purchase Plan.
10.4 Office Lease Agreement between the Company and WHLW Real Estate
Limited Partnership, dated May 1, 1997.
10.5 Real Property Lease Extension Agreement between the Company and
Bobwhite Meadow, L.P., dated March 1,1996.
11.1 Statement of computation of per share earnings.
23.1 Report on Schedule and Consent of Independent Auditors'
*21.1 Subsidiary of the Registrant.
27.1 Financial Data Schedule.
* Incorporated herein by reference to the Company's Registration
Statement on From S-1 (No. 333-3868).
29
(c) FINANCIAL STATEMENT SCHEDULE
Schedule--Valuation and Qualifying Accounts
NETOPIA, INC.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Charged
(Credited)
Balance at to Costs Balance at
beginning and End of
Description of Period Expenses Deductions Period
----------- ---------- ----------- ---------- -----------
Allowance for Doubtful Accounts
Year ended September 30, 1995 $ 532 $ 121 $136 $ 517
Year ended September 30, 1996 $ 517 $ 179 $ 37 $ 659
Year ended September 30, 1997 $ 659 $ 21 $114 $ 566
Allowance for Returns
Year ended September 30, 1995 $ 388 $ 434 $ 85 $ 737
Year ended September 30, 1996 $ 737 $ 300 $368 $ 669
Year ended September 30, 1997 $ 669 $ 200 $308 $ 561
Valuation Allowance for Deferred Tax Assets
Year ended September 30, 1995 $2,108 $ 187 --- $2,295
Year ended September 30, 1996 $2,295 $(2,295) --- ---
Year ended September 30, 1997 --- $ 512 --- $ 512
(d) Reports on Form 8-K.
No reports on Form 8-K were filed during the last quarter of fiscal 1997.
30
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on behalf
by the undersigned, thereunto duly authorized, in the City of Alameda, State of
California on this 17/th/ day of December, 1997.
NETOPIA, INC.
BY: /s/ Alan B. Lefkof
---------------------------------------
Alan B. Lefkof
President and Chief Executive Officer
Dated December 17, 1997
Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on behalf
by the undersigned, thereunto duly authorized.
SIGNATURE TITLE DATE
- --------------------------------------------------------------------------------
/s/ Alan B. Lefkof President, Chief Executive December 17, 1997
- --------------------------- Officer and Director (Principal
Alan B. Lefkof Executive Officer)
/s/ James A. Clark Vice President and Chief December 17, 1997
- --------------------------- Financial Officer (Principal
James A. Clark Financial and Accounting
Officer)
/s/ Reese M. Jones December 17, 1997
- --------------------------- Chairman of the Board of
Reese M. Jones Directors
/s/ Bandel L. Carano December 17, 1997
- --------------------------- Director
Bandel L. Carano
/s/ David F. Marqurdt December 17, 1997
- --------------------------- Director
David F. Marquardt
/s/ James R. Swartz December 17, 1997
- --------------------------- Director
James R. Swartz
31
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Netopia, Inc. and subsidiary:
We have audited the accompanying consolidated balance sheets of Netopia, Inc.
(formerly Farallon Communications, Inc.) and subsidiary as of September 30, 1996
and 1997 and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the years in the three-year period ended
September 30, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Netopia,
Inc. and subsidiary as of September 30, 1996 and 1997 and the results of their
operations and their cash flows for each of the years in the three-year period
ended September 30, 1997 in conformity with generally accepted accounting
principles.
KPMG PEAT MARWICK LLP
San Francisco, California
November 4, 1997
32
NETOPIA, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
SEPTEMBER 30,
-------------------
1996 1997
-------------------
ASSETS
Current assets:
Cash and cash equivalents.............. $19,910 $14,444
Short-term investments............... 17,235 27,192
Trade accounts receivable, less
allowance for doubtful accounts
and returns of $1,328 and $1,127,
respectively........................ 11,172 8,332
Inventories, net....................... 6,295 4,421
Deferred tax asset..................... 1,829 1,463
Prepaid expenses and other current 1,457 790
assets................................
------- -------
Total current assets................. 57,898 56,642
Furniture, fixtures, and equipment, net. 2,935 2,321
Deferred taxes and other assets......... 785 2,038
------- -------
$61,618 $61,001
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................... $ 4,979 $ 4,302
Accrued compensation................. 2,023 1,237
Accrued liabilities.................. 470 195
Deferred revenue..................... 787 874
Other short-term liabilities......... 170 55
------- -------
Total current liabilities........... 8,429 6,663
------- -------
Long-term liabilities................... 46 361
------- -------
Total liabilities....................... 8,475 7,024
------- -------
Commitments and contingencies
Stockholders' equity:
Preferred stock:
$0.001 par value, 5,000,000 shares -- --
authorized, none issued or
outstanding........................
Common stock:
$0.001 par value, 25,000,000 shares
authorized; 11,119,961 and 11,492,732
shares issued and outstanding at
September 30, 1996 and September 30,
1997, respectively.................... 12 12
Additional paid-in capital............. 49,232 50,568
Deferred compensation.................. (81) (54)
Retained earnings...................... 3,980 3,451
------- -------
Total stockholders' equity........... 53,143 53,977
------- -------
$61,618 $61,001
======= =======
See accompanying notes to consolidated financial statements.
33
NETOPIA, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED SEPTEMBER 30,
----------------------------
1995 1996 1997
------- ------- -------
Revenues:
Internet/Intranet products.......... $ 6,569 $16,718 $20,170
LAN products........................ 50,620 44,886 32,023
------- ------- -------
Total revenues.................... 57,189 61,604 52,193
------- ------- -------
Cost of revenues:
Internet/Intranet products.......... 674 3,811 6,396
LAN products........................ 28,842 28,439 20,810
------- ------- -------
Total cost of revenues............ 29,516 32,250 27,206
------- ------- -------
Gross profit...................... 27,673 29,354 24,987
------- ------- -------
Operating expenses:
Research and development............ 8,429 8,919 8,839
Selling and marketing............... 13,691 15,778 15,540
General and administrative.......... 2,888 3,429 3,291
------- ------- -------
Total operating expenses.......... 25,008 28,126 27,670
------- ------- -------
Operating income (loss)........... 2,665 1,228 (2,683)
Other income, net...................... 815 1,040 1,869
------- ------- -------
Income (loss) before income taxes... 3,480 2,268 (814)
Income tax provision (benefit)......... 974 (1,433) (285)
------- ------- -------
Net income (loss)................... $ 2,506 $ 3,701 $ (529)
======= ======= =======
Net income (loss) per share............ $ 0.25 $ 0.33 $ (0.05)
======= ======= =======
Shares used in per share calculation... 9,891 11,071 11,335
======= ======= =======
See accompanying notes to consolidated financial statements.
34
NETOPIA, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
FOREIGN TOTAL
PREFERRED STOCK COMMON STOCK ADDITIONAL DEFERRED RETAINED CURRENCY STOCK-
-------------------- ----------------- PAID-IN COMPEN- EARNINGS TRANSLATION HOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL SATION (DEFICIT) ADJUSTMENT EQUITY
----------- ------- ---------- ------ ---------- --------- --------- ----------- -----------
Balances, September 30, 1994........ 5,550,899 $ 6 3,470,495 $ 3 $23,862 $-- $(2,227) $-- $21,644
Exercise of stock options........... 40,308 -- 153,486 1 128 -- -- -- 129
Issuance of common stock bonus...... -- -- 250 -- -- -- -- -- --
Net income.......................... -- -- -- -- -- -- 2,506 -- 2,506
---------- ------ ---------- ------ ------- -------- -------- ---------- -------
Balances, September 30, 1995........ 5,591,207 6 3,624,231 4 23,990 -- 279 -- 24,279
---------- ------ ---------- ------ ------- -------- -------- ---------- -------
Exercise of stock options........... -- -- 135,238 -- 148 -- -- -- 148
Issuance of common stock net of
issuance costs of $1,222.......... -- -- 1,750,000 2 24,812 -- -- -- 24,814
Conversion of preferred stock
to common stock.................... (5,591,207) (6) 5,591,207 6 -- -- -- -- --
Issuance of common stock for
consulting services................ -- -- 5,000 -- 30 -- -- -- 30
Issuance of common stock for
rights and services................ -- -- 14,285 -- 162 -- -- -- 162
Deferred compensation related
to grant of stock options.......... -- -- -- -- 90 (90) -- -- --
Amortization of deferred
compensation....................... -- -- -- -- -- 9 -- -- 9
Net income.......................... -- -- -- -- -- -- 3,701 -- 3,701
---------- ------ ---------- ------ ------- -------- -------- ---------- -------
Balances, September 30, 1996........ -- -- 11,119,961 12 49,232 (81) 3,980 -- 53,143
---------- ------ ---------- ------ ------- -------- -------- ---------- -------
Exercise of stock options -- -- 194,535 -- 443 -- -- -- 443
Issuance of common stock under
Employee Stock Purchase Plan....... -- -- 178,236 -- 833 -- -- -- 833
Issuance of Stock Warrants.......... -- -- -- -- 60 -- -- -- 60
Amortization of deferred
compensation....................... -- -- -- -- -- 27 -- -- 27
Net loss............................ -- -- -- -- -- -- (529) -- (529)
---------- ------ ---------- ------ ------- -------- -------- ----------- -------
Balance, September 30, 1997 -- $ -- 11,492,732 $ 12 $50,568 $ (54) $ 3,451 $ -- $53,977
========== ====== ========== ====== ======= ======== ======== =========== =======
See accompanying notes to consolidated financial statements.
35
NETOPIA, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED SEPTEMBER 30,
---------------------------------
1995 1996 1997
---------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................. $ 2,506 $ 3,701 $ (529)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization.................... 1,466 1,757 1,812
Deferred income taxes............................ -- (2,197) (673)
Amortization of deferred compensation............ -- 9 27
Noncash compensation for services................ -- 192 60
Change in doubtful accounts and returns
on accounts receivable......................... 334 74 (201)
Changes in operating assets and liabilities:
Trade accounts receivable...................... (838) (3,522) 3,041
Inventories.................................... (363) (1,537) 1,874
Prepaid expenses and other current assets...... (593) (453) 667
Deposits and other assets...................... (109) (186) 49
Accounts payable and accrued liabilities....... 2,968 (1,563) (1,508)
Deferred revenue............................... (125) 619 87
Other liabilities.............................. (257) (173) 185
------- ------- -------
Net cash provided by (used in)
operating activities...................... 4,989 (3,279) 4,891
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture, fixtures, and equipment... (1,335) (2,182) (1,111)
Capitalization of software development costs..... -- -- (350)
Purchase of short-term investments............... (7,273) (124,337) (35,900)
Proceeds from the sale of short-term investments. 15,325 110,783 25,943
------- -------- --------
Net cash provided by (used in)
investing activities...................... 6,717 (15,736) (11,418)
------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net...... 129 24,962 1,061
Net repayments on loans and line of
credit.......................................... (639) -- --
------- -------- --------
Net cash provided by (used in) financing
activities........................... (510) 24,962 1,061
------- -------- --------
Net increase (decrease) in cash and cash equivalents 11,196 5,947 (5,466)
Cash and cash equivalents, beginning of year....... 2,767 13,963 19,910
------- -------- --------
Cash and cash equivalents, end of year............. $13,963 $ 19,910 $ 14,444
======= ========= ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid.................................... $ 57 $ 3 $ 1
======= ========= ========
Income taxes paid................................ $ 1,014 $ 1,050 $ 289
======= ========= ========
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING
ACTIVITIES:
Accrual of stock option deferred compensation.... -- $ 90 --
======= ========= ========
Issuance of warrants for consulting services..... -- -- $ 60
======= ========= ========
Issuance of common stock for consulting services. -- $ 30 --
======= ========= ========
Issuance of common stock and redeemable common
stock for rights and services.................. $ 162 --
======= ========= ========
Tax benefit of stock options exercised........... -- -- $ 215
======== ========= ========
See accompanying notes to consolidated financial statements
36
NETOPIA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Netopia, Inc. formerly Farallon Communications, Inc. (the "Company"),
develops, markets, and supports complete, easy-to-use Internet/Intranet
connectivity and networking solutions and real-time Internet/Intranet
collaboration software. Historically, revenues attributable to the Company's
Internet/Intranet products have primarily resulted from the licensing of
software and sale of hardware, and revenues attributable to the Company's LAN
products have primarily resulted from the sale of hardware.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiary located in France. All significant
intercompany balances and transactions have been eliminated in consolidation. In
fiscal 1994, the Company changed the functional currency for its French
subsidiary to the U.S. dollar.
Cash Equivalents and Short-Term Investments
Cash equivalents consist of instruments with purchased maturities of 90 days
or less. Certain cash equivalents and all of the Company's investments are
classified as available-for-sale under the provisions of Statement of Financial
Accounting Standards ("FAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The securities are carried at fair value which
approximates cost.
The amortized cost of available-for-sale debt securities are adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization is included in other income, net. Realized gains and losses, and
declines in value judged to be other than temporary on available-for-sale
securities are included in other income, net. The cost of securities sold is
based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in other income, net.
Cash equivalents and short-term investments classified as available-for-sale
as of September 30, 1996 and 1997 consisted of the following (in thousands):
SEPTEMBER 30,
--------------------
1996 1997
--------------------
Municipal securities....................................................... $15,207 $ -
U.S. Treasury Securities and obligations of U.S. Government agencies....... 2,028 8,193
Corporate debt............................................................. - 22,526
Commercial paper........................................................... 12,985 7,102
------- -------
$30,220 $37,821
======= =======
Available-for-sale securities as of September 30, 1997 consisted of the
following, by contractual maturity (in thousands):
1997
-------
Due in one year or less...... $37,821
Expected maturities may differ from contractual maturities because issuers of
the securities may have the right to prepay obligations without penalties.
37
NETOPIA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued
Revenue Recognition
The Company recognizes revenues from licenses of computer software provided
that a firm purchase order has been received, the software and related
documentation have been shipped, collection of the resulting receivable is
deemed probable, and no other significant vendor obligations exist. Patent
revenue is recognized upon the licensing of the rights to the patent.
Maintenance and service revenues are recognized over the period in which
services are provided. Hardware revenues are recognized upon shipment. Certain
of the Company's sales are made to customers under agreements permitting right
of return for stock balancing and price protection. Revenue is recorded net of
an estimated allowance for returns.
Concentrations of Credit Risk
Financial instruments that potentially expose the Company to concentrations of
credit risk principally consist of cash, cash equivalents, short-term
investments, and accounts receivable.
The Company limits the amounts invested in any one type of investment. The
Company maintains its cash investments with two financial institutions.
Management believes the financial risks associated with such deposits are
minimal.
The Company sells its products primarily through distributors and other large
scale resellers. Sales are generally not collateralized, credit evaluations are
performed as appropriate, and allowances are provided for estimated credit
losses. Historically, the Company has not experienced significant losses on
trade receivables from any particular customer, industry, or geographic region.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined by
the first-in, first-out (FIFO) method.
Furniture, Fixtures, and Equipment
Furniture, fixtures, and equipment are stated at cost. Depreciation is
calculated using the straight-line method over the shorter of estimated useful
lives or related lease terms ranging from one to seven years.
Impairment of Long-Lived Assets
The Company adopted the provisions of Statement of Financial Accounting
Standards ("FAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of ," in fiscal 1997. FAS No. 121
requires that long-lived assets and certain identifiable intangibles be reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by comparison of the carrying amount of an asset to
future net cash flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceed the fair value of the
assets. Assets to be disposed of are reported at the lower of the carrying
value amount or the fair value less costs to sell. The adoption of FAS No. 121
did not have a material impact on the Company's financial position, results of
operations, or liquidity.
Software Development Costs
Research and development costs include costs related to software products that
are expensed as incurred until the technological feasibility of the product has
been established. The Company has defined technological feasibility as
completion of a working model. After technological feasibility is established,
any additional software development costs are capitalized in accordance with
Statement of Financial Accounting Standards ("FAS") No. 86, "Accounting for the
Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed." Product
development costs capitalized are amoritized over a future period. Amoritization
of capitalized product development costs is computed on a straight-line basis
over the estimated economic life of the product, which is generally 1-2 years.
38
NETOPIA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
All other research and development expenditures are charged to research and
development expense in the period incurred. During fiscal 1997, $350,000 of
product development cost incurred subsequent delivery of a working model, under
a development agreement with a third party, have been capitalized. No amounts
were capitalized in fiscal 1995 and 1996.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years that those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Stock-Based Compensation
The Company has elected to continue to use the intrinsic value-based method as
allowed under APB Opinion No. 25, "Accounting for Stock Issued to Employees," to
account for all of its stock-based employee compensation plans. Pursuant to
Statement of Financial Accounting Standards ("FAS") No. 123, "Accounting for
Stock-Based Compensation," the Company is required to disclose the pro forma
effects on operating results as if the Company had elected to use the fair value
approach to account for all its stock-based employee compensation plans.
Use of Estimates
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the consolidated
financial statements and the recorded amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Stock Split
On April 16, 1996, the Company's Board of Directors authorized a one-for-two
reverse stock split on outstanding shares and options. Accordingly, all share
and per share amounts have been adjusted to reflect the stock split.
Per Share Calculations
Net income (loss) per share is based on the weighted average number of shares
of common stock, common equivalent shares from the convertible preferred stock
using the ''as-converted'' method and dilutive common equivalent shares from
options outstanding during the period using the treasury stock method.
Pursuant to certain SEC Staff Accounting Bulletins, common stock issued for
consideration below the assumed IPO price and stock options granted with
exercise prices below the assumed IPO price during the 12-month period prior to
the date of the initial filing of the registration statement, even when
antidilutive, have been included in the calculation of net income per share,
using the treasury stock method based on the IPO filing price, as if they were
outstanding for all periods presented prior to their issuance or grant.
The Financial Accounting Standard Board recently issued Statement of Financial
Accounting Standards ("FAS") No. 128, "Earnings Per Share." FAS No. 128
requires the presentation of basic earnings per share ("EPS"), and for companies
with complex capital structures, diluted EPS. FAS No. 128 is effective for
annual and interim periods ending after December 15, 1997. The Company expects
that for profitable periods basic EPS will be higher than EPS as presented in
the accompanying financial statements and diluted EPS will not differ materially
from EPS as presented in the accompanying financial statements. Computations
for loss periods should not change significantly.
39
NETOPIA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. INVENTORIES
Inventories consisted of the following (in thousands):
SEPTEMBER 30,
------------------
1996 1997
------------------
Raw materials and work in process... $2,477 $1,966
Finished goods...................... 3,818 2,455
------------------
$6,295 $4,421
==================
3. FURNITURE, FIXTURES, AND EQUIPMENT
Furniture, fixtures, and equipment consisted of the following (in thousands):
SEPTEMBER 30,
--------------------
1996 1997
--------------------
Office equipment........................ $ 2,989 $ 3,263
Furniture and fixtures.................. 1,255 1,367
Computers............................... 7,231 7,954
Leasehold improvements.................. 518 521
--------------------
11,993 13,105
Accumulated depreciation and
amortization........................... (9,058) (10,784)
--------------------
$ 2,935 $ 2,321
====================
4. INCOME TAXES
Income tax expense (benefit) consisted of the following (in thousands):
YEARS ENDED SEPTEMBER 30,
-------------------------
1995 1996 1997
-------------------------
Current:................................
Federal................................ $ 922 $ 472 $ 179
State.................................. 16 244 (6)
Foreign................................ 36 48 --
-------------------------
974 764 173
-------------------------
Deferred:...............................
Federal................................ -- (1,814) (378)
State.................................. -- (383) (295)
-------------------------
-- (2,197) (673)
-------------------------
Charge in lieu of taxes attributable to
employer stock option plans -- -- 215
-------------------------
Total tax expense (benefit) $ 974 $(1,433) $(285)
=========================
40
NETOPIA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Income tax expense (benefit) differs from the amounts computed by applying the
statutory income tax rate of 34% to pretax income as a result of the following
(in thousands):
YEARS ENDED SEPTEMBER 30,
-----------------------------
1995 1996 1997
-----------------------------
Computed "expected" tax expense $1,183 $ 771 $(277)
(benefit) of 34%.......................
Change in valuation allowance for 187 (2,295) 512
deferred tax assets....................
Tax exempt interest income.............. -- -- (163)
Research credits........................ (433) (72) (172)
State tax and other, net................ 37 163 (185)
-----------------------------
$ 974 $(1,433) $(285)
=============================
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets are presented below (in thousands):
SEPTEMBER 30,
----------------
1996 1997
----------------
Deferred tax asset:
Reserves and accruals not currently. $1,421 $1,541
deductible.........................
Deferred rent....................... 79 16
Research credit..................... 197 1,012
Alternative minimum tax credit
carryforward....................... 92 183
Tangible and intangible assets...... 325 462
State tax and other, net............ 83 168
----------------
Total gross deferred assets....... 2,197 3,382
Less valuation allowance.......... -- (512)
----------------
Net deferred tax assets........... $2,197 $2,870
================
The net change in the total valuation allowance for the years ended September
30, 1996 and 1997 was a decrease of $2,295,000 and an increase of $512,000,
respectively.
At September 30, 1996, the Company believed that due to the demonstrated
market acceptance of Internet/Intranet products over the previous year, the
uncertainty regarding the realizability of its deferred tax assets had
diminished to the point where it was now more likely than not that the deferred
tax asset would be realized.
At September 30, 1997, the Company believed that based upon available
objective evidence, there was sufficient uncertainty regarding the realizability
of certain of its tax assets to warrant a partial valuation allowance, primarily
related to the expected realizability of its research credit carryforwards. The
factors considered included the relative shorter product life cycles in the high
technology industry and the uncertainty of longer-term taxable income estimates
related thereto and limits on the carryback potential for realizing deferred tax
assets. Management believes that it is more likely than not that the Company
will realize the approximately $2.9 million in net deferred tax assets as of
September 30, 1997, but no assurances can be provided in that regard.
As of September 30, 1997, the Company had research credit carryforwards of
approximately $1,012,000 for federal tax purposes and $222,000 research credit
carryforwards for state tax purposes. If not utilized, the federal credit
carryforwards will expire in years 2009 through 2012. Also, the Company had
alternative minimum tax credit carryforwards of approximately $183,000.
41
NETOPIA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
5. STOCKHOLDERS' EQUITY AND STOCK OPTION PLAN
On April 23, 1996 the Company was reincorporated in the State of Delaware.
The Company's authorized capital consists of 25,000,000 shares of $0.001 par
value Common Stock and 5,000,000 shares of $0.001 par value Preferred Stock.
Common Stock
In June 1996, the Company completed the sale of 1,750,000 shares of Common
Stock, which generated net proceeds of approximately $24.8 million.
The holders of Common Stock are entitled to one vote per share on all matters
to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding Preferred Stock, the holders of Common Stock are
entitled to receive ratably such dividends, if any, as may be declared from time
to time by the Board of Directors out of funds legally available therefore. In
the event of the liquidation, dissolution or winding up of the Company, the
holders of Common Stock are entitled to share ratably in all assets remaining
after payment of liabilities, subject to prior distribution rights of Preferred
Stock, if any, then outstanding. The Common Stock has no preemptive or
conversion rights or other subscription rights.
Preferred Stock
Upon the Company's initial public offering of its Common Stock on June 13,
1996, all shares of issued and outstanding Preferred Stock were converted to
5,591,207 shares of Common Stock. Following the conversion, the Company had no
Preferred Stock outstanding.
Common Stock Warrants
Warrants to purchase 60,000 shares of common stock were issued in fiscal 1997
for consulting services provided. The warrants will expire on April 22, 2002.
The exercise price of the warrants was $4.00. The Company recognized an expense
of $60,000 for the issuance of these warrants.
Stock Option Plan
On April 16, 1996, the Board adopted the 1996 Stock Option Plan (the ''1996
Plan'') providing for the issuance of incentive or non-statutory options to
directors, employees, and non-employee consultants. Options are granted at the
discretion of the Board of Directors.
The 1996 Plan succeeds the previous equity incentive program and 3,166,995
shares of the Company's Common Stock have been authorized under the 1996 Plan.
This share reserve is comprised of (i) 294,945 shares available for issuance
under the predecessor plan and 1,372,050 shares subject to outstanding options
thereunder at March 31, 1996 and (ii) an additional increase of 1,500,000
shares. As of September 30, 1997 the 1996 Plan share reserve of 2,909,584 shares
is comprised of (i) 2,867,200 shares subject to outstanding options and (ii)
42,384 shares available for grant.
Incentive stock may be granted at not less than 100% of the fair market value
per share and non-statutory stock options may be granted at not less than 85% of
the fair market value per share at the date of grant as determined by the Board
of Directors or committee thereof, except for options granted to a person owning
greater than 10% of the total combined voting power of all classes of stock of
the Company, for which the exercise price of the options must be not less than
110% of the fair market value.
Included in the 1996 Plan is a provision for the automatic grant of non-
statutory options to non-employee Board of Director members of 25,000 shares on
the effective date of the Company's proposed IPO at the initial offering price.
These shares have been granted to three non-employee Board of Director members.
Thereafter, each new director will be granted an option to purchase 25,000
shares of Common Stock on the date they become a Board member of the Company at
the then current fair market value. Options issued to Directors are exercisable
42
NETOPIA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
immediately subject to the Company's right of repurchase. The Company's right to
repurchase will lapse ratably over five years or upon the Director's departure
from the Board.
The Board of Directors, on July 24, 1996, unanimously amended the Notice of
Grant to provide for a four year vesting schedule commencing on the date of the
grant. Grants prior to that date normally vest over five years commencing on
the date of the grant.
The Company has the right of first refusal to acquire shares obtained by the
exercise of options at a price equal to or greater than the price being offered
for such shares by a third party. For options granted prior to February 22,
1991, the Company has a right to repurchase shares obtained by the exercise of
options in the event of termination of employment of the optionee stockholder at
a price equal to fair market value on the date of termination of employment.
The Company has recorded deferred compensation of $90,000 for the difference
between the grant price and the deemed fair value of the Common Stock underlying
options granted in October and December of 1995. This amount is being amortized
over the vesting period of the individual options, generally five years.
Amortization of deferred compensation is being charged to operating expense.
In 1990, the Company effected a recapitalization whereby each share of the
Company's Common Stock outstanding or reserved for issuance upon exercise of
options was converted into a unit for one share of Common Stock and one share of
Series A Preferred Stock. The options relating to these units are included in
the table below. In January 1997, the Company repriced 180,840 outstanding
options to $5.63, no directors or officers of the Company received repriced
options. The options relating to this action are reflected in the table below.
The following table summarizes activity under the 1996 Plan (and its
predecessor):
INCENTIVE STOCK OPTIONS
-------------------------------------------------
UNITS OF 1 SHARE
-----------------------
EACH COMMON STOCK AND
SERIES A PREFERRED
COMMON STOCK STOCK
-------------------------------------------------
NUMBER OF PRICE NUMBER OF PRICE
OPTIONS RANGE OPTIONS RANGE
-------------------------------------------------
Outstanding as of September 30, 1994... 1,056,387 1.00-1.20 40,308 $3.68
Options granted........................ 517,975 1.20-1.60 --
Options exercised...................... (113,177) 1.00-1.20 (40,308) $3.68
Options canceled....................... (110,646) 1.00-1.60 --
--------------------------------------
Outstanding as of September 30, 1995... 1,350,539 1.00-1.60 --
Options granted........................ 518,975 1.60-16.00 --
Options exercised...................... (135,238) 1.00 - 1.60 --
Options canceled....................... (132,971) 1.00-12.50 --
--------------------------------------
Outstanding as of September 30, 1996.. 1,601,305 $ 1.00-16.00 --
Options granted........................ 1,787,365 $ 4.00-13.25 --
Options exercised...................... (194,535) $ 1.00-11.25 --
Options canceled....................... (326,935) $ 1.00-15.00 --
--------------------------------------
Outstanding as of September 30, 1997.. 2,867,200 $ 1.00-16.00 --
======================================
Exercisable............................ 882,280 --
========== ===========
43
NETOPIA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes information about stock options outstanding at
September 30, 1997:
Options Outstanding Options Exercisable
---------------------------------------------------------------------------------------
Number of Weighted
Outstanding Average Number
shares as of Remaining Weighted Exercisable as Weighted
Range of September 30, Contractual Average of September Average
Exercise Prices 1997 Life Exercise Price 30, 1997 Exercise Price
- ---------------- ---------------------------------------------------------------------------------------
$ 1.00 287,752 3.89 $ 1.00 287,752 $ 1.00
$ 1.20 432,285 6.45 1.20 274,355 1.20
$ 1.60-4.00 407,237 8.43 2.71 130,645 2.14
$ 4.13-4.50 298,251 9.51 4.39 33,384 4.37
$ 4.63-5.13 68,250 9.83 4.64 - -
$ 5.25 518,500 9.92 5.25 - -
$ 5.32-6.34 269,525 9.24 5.60 43,021 5.60
$ 6.38 464,750 9.25 6.38 86,598 6.38
$9.50-11.25 45,650 8.77 9.95 11,525 9.97
$ 16.00 75,000 8.70 16.00 15,000 16.00
---------------------------------------------------------------------------------
$1.00-16.00 2,867,200 8.31 $ 4.32 882,280 $ 2.49
=================================================================================
1996 Employee Stock Purchase Plan
On April 16, 1996, the Board adopted the 1996 Employee Stock Purchase Plan
(the ''Purchase Plan'') and reserved 300,000 shares of Common Stock for issuance
under the Purchase Plan. To date an additional 200,000 shares have been approved
for issuance under the Purchase Plan. As of September 30, 1997, 178,236 shares
have been issued under the Purchase Plan.
Pro Forma Disclosure - Compensatory Stock Arrangements
Stock options are granted at not less than the fair market value of the Common
Stock on the date of grant. All options expire no later than ten years from the
date of grant. The Company has adopted the Statement of Financial Accounting
Standards ("FAS") No. 123, "Accounting for Stock Based Compensation" which was
issued in October 1995. In accordance with the provisions of FAS 123, the
Company applies APB Opinion 25 and related interpretations in accounting for its
stock option plans and accordingly, does not recognize compensation cost. If the
Company had elected to recognize compensation cost based on the fair value of
the options granted at grant date and the far value of shares purchased under
the plan as prescribed by FAS 123, net income (loss) and per share results would
have been the pro forma amounts indicated in the table below (in thousands
except per share amounts):
Year Ended September
30,
------------------------
1996 1997
---------- -----------
Net income (loss) - as reported $3,701 $ (529)
Net income (loss) - pro forma $3,492 $(1,109)
Net income (loss) per share- as reported $ 0.33 $ (0.05)
Net income (loss) - per share pro forma $ 0.32 $ (0.10)
The effect on net income (loss) and net income (loss) per share is not expected
to be indicative of the effects on results in future years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable while the Company's employee stock options have
characteristics significantly different from those of traded options. In
addition, option valuation models require the
44
NETOPIA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
input of highly subjective assumptions including the expected stock price
volatility. The fair value of each option grant and share purchased under the
Purchase Plan are estimated on the date of grant or share purchase using the
Black-Scholes option-pricing model with the following assumptions:
Year Ended September 30,
-------------------------
1996 1997
----------- -----------
Expected volatility 70% 70%
Risk-free interest rate 5.6% 5.6%
Expected dividend yield -- --
The expected lives of options under the Employee Stock Option and Employee
Stock Purchase Plans are estimated at four years and six months, respectively.
The effect of applying FAS No. 123 for disclosing compensation costs may not
be representative of the effects on reported net income (loss) for the future
years because pro forma net income (loss) reflects compensation costs only for
stock options granted in fiscal 1996 and 1997, and does not consider
compensation costs for stock option granted prior to October 1, 1995.
6. COMMITMENTS AND CONTINGENCIES
Leases
The Company conducts its operations in leased facilities and with equipment
under operating lease agreements expiring at various dates through 2002.
The following is a schedule of future minimum rental payments required under
these leases that have initial or remaining noncancelable lease terms in excess
of one year (in thousands):
YEARS ENDING SEPTEMBER 30,
- --------------------------
1998............................... $ 432
1999............................... 55
2000............................... 36
2001............................... 37
2002............................... 33
Total minimum lease payments.. $ 593
======
Total rental expense for all operating leases amounted to approximately
$1,169,000, $1,117,000 and $1,156,844 for the years ended September 30, 1995,
1996 and 1997, respectively.
Litigation
The Company is involved in various legal matters that have arisen in the
normal course of business. Management believes, after consultation with counsel,
any liability that may result from the disposition of such legal matters will
not have a material adverse effect on the Company's operating results and
financial condition.
Plan for Savings and Investments
The Company maintains a plan for savings and investments under which eligible
employees may contribute up to 15% of their annual compensation. In addition,
the Company may make discretionary retirement contributions to the plan. No
discretionary retirement contributions were made in any period presented.
45
NETOPIA, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. SIGNIFICANT CUSTOMERS AND REVENUE BY GEOGRAPHIC REGION
During the years ended September 30, 1995, 1996 and 1997, one customer
accounted for approximately 22%, 18% and 19%, respectively, and a second
customer accounted for approximately 13%, 11% and 10%, respectively, of total
net revenues. No other customers have accounted for 10% or more of the
Company's total revenue for the last three fiscal years.
Revenue by geographic region are as follows (in thousands):
YEARS ENDED SEPTEMBER 30,
----------------------------
1995 1996 1997
----------------------------
United States........... $40,552 $43,609 $37,237
Europe.................. 8,833 9,274 9,058
Asia/Pacific............ 5,355 6,322 3,824
Canada.................. 1,443 1,263 1,204
Latin America........... 1,006 1,136 870
------------------------------
Total revenues..... $57,189 $61,604 $52,193
==============================
The Company has no material operating assets outside the United States.
46