Washington, DC  20549

 

FORM 10-Q

 

ý Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

 

For Quarterly Period Ended September 30, 2004

 

Commission File Number 0-23282

 

NMS Communications Corporation

(Exact name of registrant as specified in its charter)

 

Delaware		04-2814586
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification Number)
100 Crossing Boulevard, Framingham, Massachusetts		01702
(Address of principal executive offices)		(Zip Code)
(508) 271-1000
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES  ý    NO  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12-b-2 of the Securities Exchange Act of 1934).  YES  ý  NO  o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 47,384,605 shares of Common Stock, $0.01 par value, outstanding at October 31, 2004.

 

 

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION:
	Item 1. Financial Statements
		Unaudited Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003	3
		Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and 2003	4
		Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003	5
		Notes to Unaudited Condensed Consolidated Financial Statements	6
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		12
	Item 3. Quantitative and Qualitative Disclosures About Market Risk		20
	Item 4. Controls and Procedures		20
PART II - OTHER INFORMATION:
	Item 1. Legal Proceedings		21
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Purchases of Equity Securities		21
	Item 4. Submission of Matters to a Vote of Security Holders		21
	Item 5. Other Information		21
	Item 6. Exhibits		21
Signatures			22
Certifications			23

 

2

 

PART I – FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

NMS Communications Corporation

Condensed Consolidated Balance Sheets

(In thousands except share data)

(Unaudited)

 

		September 30, 2004			December 31, 2003
ASSETS
Current assets:
Cash and cash equivalents		$	31,770		$	59,917
Marketable securities		35,322			—
Accounts receivable, net of allowance for doubtful accounts of $910 and $995, respectively		12,153			9,254
Inventories		2,748			3,193
Prepaid expenses and other assets		6,280			4,598
Total current assets		88,273			76,962
Property and equipment, net of accumulated depreciation and amortization of $31,112 and $28,745, respectively		6,292			7,219
Long-term marketable securities		7,974			—
Other assets, net		1,615			2,147
Total assets		$	104,154		$	86,328
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable		$	4,219		$	4,692
Accrued expenses and other liabilties		13,933			13,656
Total current liabilities		18,152			18,348
Long-term debt		19,942			57,742
Common stock, $0.01 par value, 125,000,000 shares authorized at September 30, 2004 and December 31, 2003; 47,080,310 and 36,738,402 shares issued at September 30, 2004 and December 31, 2003, respectively, and 47,080,310 and 36,685,958 shares outstanding at September 30, 2004 and December 31, 2003, respectively		471			367
Additional paid-in capital		412,209			359,418
Accumulated deficit		(344,050		)	(346,834		)
Accumulated other comprehensive loss		(2,551		)	(2,326		)
Deferred compensation		(19		)	(102		)
Treasury stock, at cost, 0 and 52,444 shares at September 30, 2004 and December 31, 2003, respectively		—			(285		)
Stockholders’ equity		66,060			10,238
Total liabilities and stockholders’ equity		$	104,154		$	86,328

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

 

3

 

NMS Communications Corporation

Condensed Consolidated Statements of Operations

(In thousands except per share data)

(Unaudited)

 

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2004			2003			2004			2003
Revenues		$	25,693		$	21,796		$	75,334		$	63,687
Cost of revenues		9,477			9,751			28,021			37,569
Gross profit		16,216			12,045			47,313			26,118
Operating expenses:
Selling, general and administrative		8,727			8,376			24,798			29,428
Research and development		5,906			7,298			18,054			24,264
Restructuring and other related charges		—			3,014			—			6,948
Impairment charges		—			—			—			18,319
Total operating expenses		14,633			18,688			42,852			78,959
Operating income (loss)		1,583			(6,643		)	4,461			(52,841		)
Other income (expense):
Interest expense		(444		)	(942		)	(1,893		)	(2,854		)
Interest income		261			139			645			570
Gain (loss) on extinguishment of debt		(221		)	1,205			(369		)	1,893
Other		(49		)	275			6			(1,017		)
Other income (expense), net		(453		)	677			(1,611		)	(1,408		)
Income (loss) before income taxes		1,130			(5,966		)	2,850			(54,249		)
Income tax (benefit) expense		24			—			65			(36		)
Net income (loss)		$	1,106		$	(5,966	)	$	2,785		$	(54,213	)
Basic earnings (loss) per share		$	0.02		$	(0.16	)	$	0.06		$	(1.50	)
Weighted average basic shares outstanding		47,027			36,300			43,930			36,259
Diluted earnings (loss) per share		$	0.02		$	(0.16	)	$	0.06		$	(1.50	)
Weighted average diluted shares outstanding		49,135			36,300			46,414			36,259

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

 

4

 

NMS Communications Corporation

Condensed Consolidated Statements of Cash Flow

(In thousands)

(Unaudited)

 

		Nine Months Ended September 30,
		2004			2003
Cash flow from operating activities:
Net income (loss)		$	2,785		$	(54,213	)
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:
Depreciation and amortization		3,178			9,349
Write-off of debt issuance cost		320			135
Loss (gain) on extinguishment of debt		369			(1,893		)
Loss on impairment of goodwill and other intangibles		—			21,702
Loss on impairment and disposal of fixed assets		77			6,108
Foreign exchange translation gain on intercompany debt		(154		)	(710		)
Changes in assets and liabilities:
Accounts receivable		(2,900		)	(579		)
Inventories		445			4,524
Prepaid expenses and other assets		(1,691		)	1,474
Accounts payable		(471		)	(3,402		)
Accrued expenses and other liabilities		669			1,870
Net cash provided by (used in) operating activities		2,627			(15,635		)
Cash flow from investing activities:
Purchases of property and equipment		(1,792		)	(2,196		)
Purchases of marketable securities		(45,635		)	(23,844		)
Proceeds from the maturity and sale of marketable securities		2,000			41,070
Net cash provided by (used in) investing activities		(45,427		)	15,030
Cash flow from financing activities:
Repurchase of convertible notes		(38,541		)	(7,447		)
Proceeds from issuance of common stock, net of issuance costs		53,179			15
Net cash provided by (used in) financing activities		14,638			(7,432		)
Effect of exchange rate changes on cash		15			1,192
Net decrease in cash and cash equivalents		(28,147		)	(6,845		)
Cash and cash equivalents, beginning of period		59,917			56,768
Cash and cash equivalents, end of period		$	31,770		$	49,923

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

 

5

 

NMS Communications Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

 

A.                                    BASIS OF PRESENTATION

 

The condensed consolidated balance sheet as of September 30, 2004 and the condensed consolidated statements of operations for the three and nine month periods ending September 30, 2004 and 2003 and the statement of cash flows for the nine month periods ended September 30, 2004 and 2003 include the unaudited accounts of NMS Communications Corporation and its wholly owned subsidiaries (collectively, the “Company”).  The financial information included herein has been prepared without audit.  The consolidated balance sheet at December 31, 2003 has been derived from, but does not include all the disclosures contained in, the audited consolidated financial statements for the year ended December 31, 2003.

 

In the opinion of management, all adjustments, consisting of normal and recurring adjustments, which are necessary to present fairly the financial position, results of operations and cash flows for all interim periods presented have been made.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, management evaluates its estimates, including those related to revenue recognition, accounts receivable, inventories, investments, long-lived assets, income taxes, and restructuring and other related charges.  Management bases these estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates.  The operating results for the three and nine month periods ended September 30, 2004 are not necessarily indicative of the operating results to be expected for the full fiscal year.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to Securities and Exchange Commission rules and regulations.  The financial statements should be read in conjunction with the consolidated financial statements and notes therein of the Company contained in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2003.

 

B.                                    STOCK OPTION AND STOCK PURCHASE PLANS

 

The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its stock option and stock purchase plans. All options granted under the various plans administered by the Company have a vesting life not to exceed four years, and these options have an expiration date of up to ten years from the date of grant.

 

In accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“FAS”) No. 123, “Accounting for Stock-Based Compensation,” the fair value of each stock-based award granted by the Company has been estimated on the date of grant using the Black-Scholes option pricing model.

 

6

 

The following table illustrates the effect on net income (loss) and basic and diluted income (loss) per share as if the fair value method prescribed in FAS No. 123 had been applied to the Company’s stock option and stock purchase plan and recorded in the consolidated financial statements:

 

		Three months ended September 30,						Nine months ended September 30,
(In thousands, except per share data)		2004			2003			2004			2003
Net income (loss), as reported		$	1,106		$	(5,966	)	$	2,785		$	(54,213	)
Add: Stock-based employee compensation expense included in net income (loss)		28			108			83			675
Less: Total stock-based employee compensation expense determined under Black-Scholes option pricing model		(1,590		)	(1,539		)	(3,627		)	(4,659		)
Pro forma net loss		$	(456	)	$	(7,397	)	$	(759	)	$	(58,197	)
Income (loss) per share:
Basic net income (loss) per common share, as reported		$	0.02		$	(0.16	)	$	0.06		$	(1.50	)
Diluted net income (loss) per common share, as reported		$	0.02		$	(0.16	)	$	0.06		$	(1.50	)
Basic net loss per common share, pro forma		$	(0.01	)	$	(0.20	)	$	(0.02	)	$	(1.61	)
Diluted net loss per common share, pro forma		$	(0.01	)	$	(0.20	)	$	(0.02	)	$	(1.61	)

 

C.            BUSINESS AND CREDIT CONCENTRATION

 

At September 30, 2004, two customers, Lucent Technologies, Inc. (“Lucent”) and Avaya, Inc., represented 24.2% and 12.5%, respectively, of the Company’s outstanding net accounts receivable.  At December 31, 2003, no customer accounted for 10% or more of the Company’s net accounts receivable balance.

 

Lucent represented 16.0% and 13.0% of the Company’s revenues for the three and nine months ended September 30, 2004, respectively.

 

Lucent represented 18.4% of the Company’s revenues for the three months ended September 30, 2003. Lucent and a channel partner in the United States of America represented 16.3% and 14.4%, respectively, of the Company’s revenues for the nine months ended September 30, 2003.

 

D.            EARNINGS PER SHARE

 

The following table provides the basic and diluted income (loss) per share computations (amounts in thousands, except per share):

 

		Three months ended September 30,						Nine months ended September 30,
		2004			2003			2004			2003
Net income (loss)		$	1,106		$	(5,966	)	$	2,785		$	(54,213	)
Weighted average basic shares outstanding		47,027			36,300			43,930			36,259
Dilutive Effect of:
Options to purchase common shares		2,108			—			2,484			—
Weighted average diluted shares outstanding		49,135			36,300			46,414			36,259
Basic earnings (loss) per share		$	0.02		$	(0.16	)	$	0.06		$	(1.50	)
Diluted earnings (loss) per share		$	0.02		$	(0.16	)	$	0.06		$	(1.50	)

 

7

 

The weighted average basic and diluted shares outstanding calculation excludes those stock options for which the impact would have been antidilutive based on the exercise price of the options or the net loss position of the Company. The number of options that were antidilutive for the three months ended September 30, 2004 and 2003 were 3,142,550 and 9,395,491, respectively. The number of options that were antidilutive for the nine months ended September 30, 2004 and 2003 were 2,980,759 and 7,763,941, respectively.

 

E.              RESTRUCTURING AND OTHER RELATED CHARGES

 

In the third quarter of 2003, in an effort to reduce future operating expenses, the Company initiated restructuring efforts resulting in the recording of total restructuring and other related charges of $3.0 million. These charges consist of $2.5 million of involuntary severance related costs, $0.3 million accrual for an expected loss over the remaining term of a lease, and $0.2 million of other costs. The severance related costs were for approximately 65 employees across all areas of the company.

 

The Company’s restructuring efforts during the first nine months of 2003 resulted in the recording of total restructuring and other related charges of $6.9 million. These charges consist of $4.8 million of involuntary severance related costs, $0.5 million of lease termination costs, a $0.6 million write down of fixed assets, and a $1.0 million charge for a write down of an IML facility to fair market value (as the asset was being held for sale).

 

In the nine months ended September 30, 2003, involuntary severance related costs of $4.8 million resulted from the elimination of approximately 140 positions at the Company’s facilities in the United States, Canada, Europe and Asia based on terminations that were announced in January, April, July and October of 2003 and involved all areas of the Company. The following table sets forth activity relating to restructuring and other related charges during the first nine months of 2004:

 

In thousands		Employee Related			Facility Related			Other			Total
Restructuring accrual balance at December 31, 2003		$	1,515		$	1,692		$	121		$	3,328
Cash payments		(1,327		)	(341		)	(116		)	(1,784		)
Restructuring accrual balance at September 30, 2004		$	188		$	1,351		$	5		$	1,544

 

The remaining accrual balances for employee related and facility related charges are expected to be settled in cash over the next one and four years, respectively.

 

F.              INVESTMENTS

 

The Company classifies all of its investments in marketable securities as available-for-sale securities. These securities are stated at market value, with unrealized gains and losses reflected in other comprehensive loss in stockholders’ equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion are included in interest income. Realized gains and losses on marketable securities are included in earnings and are derived using the specific identification method for determining the cost of securities. The Company periodically evaluates the carrying value of its investments for other than temporary impairment.

 

8

 

Investments in marketable securities categorized as “available for sale” are carried at fair value and consist of the following:

 

(In thousands)		September 30, 2004			December 31, 2003
Money market mutual funds		$	10,042		$	5,064
Mortgage-backed securities		47,109			26,460
		57,151			31,524
Included in cash and cash equivalents		13,855			31,524
Marketable securities		$	43,296		$	—

 

At September 30, 2004 marketable securities of approximately $35.3 million are due to mature within one year and approximately $8.0 million are due to mature between one and two years. Net unrealized losses at September 30, 2004 were $0.1 million. There were no unrealized gains or losses at December 31, 2003.

 

For the three months and nine months ended September 30, 2004, proceeds from the maturity of marketable securities were $2.0 million. For the three months and nine months ended September 30, 2004, there were no gross realized gains or losses from the sale of securities.

 

For the three months ended September 30, 2003, there were no proceeds from the maturity of marketable securities. For the nine months ended September 30, 2003, there were  $41.1 million of proceeds from the sale of marketable securities. For the three months and nine months ended September 30, 2003, there were no gross realized gains or losses from the sale of securities.

 

G.            INVENTORIES

 

Inventories are stated at the lower of cost (first-in, first-out) or market. Inventories, as of September 30, 2004 and December 31, 2003, were comprised of the following:

 

(In thousands)		September 30, 2004			December 31, 2003
Raw materials		$	328		$	1,021
Work in process		103			196
Finished goods		2,317			1,976
		$	2,748		$	3,193

 

H.            SEGMENT AND GEOGRAPHIC INFORMATION

 

The Company’s business units are comprised of the Platform Solutions business unit, Voice Quality Systems (“VQS”) business unit, and the Network Infrastructure business unit. The PS business unit consists of products and services related to the Company’s systems building blocks that provide connectivity to communications networks, call processing, and real-time media processing as well as the NMS HearSay and MyCaller products. The VQS business unit consists of products and services related to the Company’s voice quality enhancement and echo cancellation systems. The NI business unit consists of the Company’s wireless access gateway product, AccessGate.

 

9

 

Management makes operating decisions and assesses the performance of individual business segments on a basis that excludes from consideration intangible assets, amortization of intangible assets, restructuring and other related costs and impairments of long-lived assets. Therefore, all goodwill, intangible assets, impairment and restructuring charges have been allocated to Corporate.

 

As of September 30, 2004 the Company had operations established in 12 countries outside the United States and its products are sold throughout the world. The Company is exposed to the risk of changes in social, political and economic conditions inherent in foreign operations and the Company’s results of operations and the value of its foreign assets are affected by fluctuations in foreign currency exchange rates.

 

The following table presents the Company’s revenues and operating income (loss), by business unit and by geographic segment. Revenues by geographic region are presented by attributing revenues from external customers on the basis of where products are sold. The Company has not recorded any significant revenues for the NI business unit as the systems and products related to this business unit are either in the development or trial phase.

 

		Three Months ended September 30,						Nine months ended September 30,
(In thousands)		2004			2003			2004			2003
Revenues by business unit
Platform Solutions		$	20,673		$	16,173		$	61,255		$	48,509
Voice Quality Systems		5,020			5,623			14,079			15,178
Network Infrastructure		—			—			—			—
Total revenues		$	25,693		$	21,796		$	75,334		$	63,687
Operating income (loss) by business unit
Platform Solutions		$	5,812		$	5		$	16,045		$	(3,033	)
Voice Quality Systems		1,102			472			2,715			(989		)
Network Infrastructure		(2,305		)	(1,327		)	(6,932		)	(3,560		)
Amortization of Intangibles and restructurings		—			(3,014		)	—			(35,608		)
Corporate		(3,026		)	(2,779		)	(7,367		)	(9,651		)
Total operating income (loss)		$	1,583		$	(6,643	)	$	4,461		$	(52,841	)
Revenues by geographic area
North America		$	12,366		$	10,984		$	36,763		$	34,461
Europe		5,342			4,100			16,693			11,799
Asia		7,612			6,554			20,972			16,585
Latin America		373			158			906			842
Total revenues		$	25,693		$	21,796		$	75,334		$	63,687
Operating income (loss) by geographic area
North America		$	(7,270	)	$	(12,781	)	$	(19,566	)	$	(56,596	)
Europe		2,670			1,947			8,065			(6,231		)
Asia		5,822			4,041			15,105			9,274
Latin America		361			150			857			712
Total operating income (loss)		$	1,583		$	(6,643	)	$	4,461		$	(52,841	)

 

10

 

I.                 COMPREHENSIVE INCOME (LOSS)

 

The following table represents the Company’s comprehensive income (loss) for the stated periods.

 

		Three Months ended September 30,						Nine Months ended September 30,
(In thousands)		2004			2003			2004			2003
Net income (loss)		$	1,106		$	(5,966	)	$	2,785		$	(54,213	)
Other comprehensive income (loss) items:
Foreign currency translation adjustment		(21		)	(402		)	(112		)	1,126
Change in market value of available for sale securities		49			—			(113		)	—
Comprehensive income (loss)		$	1,134		$	(6,368	)	$	2,560		$	(53,087	)

 

J.              LONG-TERM DEBT

 

Effective October 11, 2000, the Company issued $175.0 million of convertible subordinated notes (the “notes”). The notes are convertible into shares of our common stock at any time after 90 days following the last day of the original issuance of the notes and before the close of business on the business day immediately preceding the maturity date, at a conversion price of $63.125 per share, subject to specified adjustments. The notes bear interest at a rate of 5% per year which is payable semiannually on April 15 and October 15 of each year, commencing on April 15, 2001. The notes, which are unsecured obligations of the Company, will mature on October 15, 2005, unless previously redeemed or repurchased, and have no sinking fund requirement. Since the issuance of the notes, the Company has repurchased $155.1 million of the notes. At September 30, 2004, the Company had $19.9 million of remaining notes outstanding.

 

In the nine months ended September 30, 2004, the Company paid $38.5 million to extinguish $37.8 million face value of convertible debt and related accrued interest.  The Company recorded $0.3 million as “loss on extinguishment of debt.”

 

In the nine months ended September 30, 2003, the Company paid $7.4 million to extinguish $9.3 million face value of convertible debt and related accrued interest. The Company recorded $1.9 million as “gain on extinguishment of debt.”

 

K.            EQUITY

 

On March 17, 2004, the Company sold 9,200,000 shares of common stock at $5.75 per share.  The net proceeds of the offering were approximately $49.5 million.  In April of 2004, the Company invested a significant portion of the net proceeds of this offering in interest-bearing, investment-grade, mortgage backed securities.

 

In the three months and nine months ended September 30, 2004, employees, including certain executive officers, of the Company exercised 0.1 million and 1.1 million stock options, respectively. Cash proceeds provided by the issuance of common stock related to employee stock option exercises and employee stock purchases were $0.3 million and $3.7 million for the three months and nine months ended September 30, 2004, respectively.

 

11

 

L.             COMMITMENTS AND CONTINGENCIES

 

Litigation

 

The Company was the defendant in an action by Connectel, LLC initially filed in August 2000 in the U.S. District Court for the Eastern District of Virginia. This action was transferred by court order to the U.S. District Court for the District of Massachusetts. The plaintiff alleged that one or more of the Company’s products infringed upon two related United States patents owned by it and sought injunctive relief and damages in an unspecified amount. On September 2, 2004, Connectel filed a Motion to Withdraw its Infringement Claims. In a memorandum to the Court, Connectel agreed not to sue the Company on the patents at issue based on either the Company’s past or current products. The Company made no payments in connection with Connectel’s withdrawal or covenant not to sue the Company.

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

OVERVIEW

 

We are a leading provider of enabling technologies, platforms and systems to wireless and wireline telecommunications operators and network equipment and application providers. Our products, which include systems building blocks, a services delivery system, voice quality systems and a wireless access gateway, address a wide range of our customers’ needs as they seek to develop and deploy enhanced voice and data services and applications, and improve the quality and efficiency of communications networks. Telecommunications operators use our products to improve customer acquisition and retention, diversify revenue streams and reduce operating costs and capital expenditures. Network equipment and application providers use our products to help deploy leading technology solutions for their telecommunications and enterprise customers in a timely and cost-effective manner. We sell our products worldwide through our direct sales force as well as through channel partners. Our customers include leading telecommunications operators and network equipment and application providers such as Groupe Cegetel, Alcatel, Avaya, Ericsson, Lucent Technologies, Motorola, Siemens, SK Telecom, KDDI, Huawei Technologies, Comverse and Cisco Systems.

 

Our three business segments are comprised of the Platform Solutions (PS) business unit, the Voice Quality Systems (VQS) business unit and the Network Infrastructure (NI) business unit. The PS business unit consists of products and services, which we refer to as systems building blocks, that provide connectivity to communications networks, call processing, real-time media processing, APIs and other application development software tools. Also included in this business unit are a multi-application enhanced services delivery system and a wireless entertainment offering called MyCaller. The VQS business unit consists of our voice quality enhancement and echo cancellation products, systems and services. The NI business unit consists of our wireless access gateway product, AccessGate, that can lower carriers’ operating expenses in TDMA, GSM, universal mobile telecommunications system (UMTS) and EDGE networks by reducing the number of radio access network leased lines through advanced optimization techniques, without affecting voice and data quality.

 

The Company has been focused on several key initiatives during 2004: achieving revenue growth, launching two new products, MyCaller and AccessGate, and returning to profitability. Having taken several restructuring actions in 2003, the Company entered the year with the resource and cost model that management deemed appropriate for these initiatives.  We have had sequential and year-over-year revenue growth in the first three quarters of 2004, primarily driven from our PS business unit. We have

 

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obtained our first orders for MyCaller and AccessGate and expect to see our first revenues related to these recently introduced products in the fourth quarter of 2004. The cost reduction efforts taken in 2003 enabled the Company to return to profitability in the first quarter, and our headcount and cost structure have remained stable throughout the year resulting in profitability in all three quarters of 2004.

 

During the nine months ended September 30, 2004, we completed the sale of 9.2 million shares of common stock in an underwritten public offering resulting in net proceeds of $49.5 million. We invested the majority of the proceeds in both short term and long term marketable securities.  During that same period, we have retired $37.8 million of convertible debt leaving the remaining balance at $19.9 million at September 30, 2004.

 

RESULTS OF OPERATIONS

 

Revenues

Revenues consist primarily of product sales and, to a lesser extent, sales of services provided to our customers by our PS and VQS business units. The PS business unit revenues consist of sales of our systems building block products and services as well as NMS HearSay products. Future MyCaller revenues, if any, will be recorded as PS business unit sales. The VQS business unit revenues consist of sales of our voice quality enhancement and echo cancellation products, systems and services. The NI business unit revenues, which have been negligible to date, consist of our wireless access gateway product and services.

 

		For the three months ended September 30,												For the nine months ended September 30,
		2004					2003							2004					2003
($ In millions)		Amount			% of revenue		Amount			% of revenue		Change		Amount			% of revenue		Amount			% of revenue		Change
PS		$	20.7		80.5	%	$	16.2		74.2	%	27.8	%	$	61.3		81.3	%	$	48.5		76.2	%	26.3	%
VQS		5.0			19.5	%	5.6			25.8	%	(10.7	)%	14.0			18.7	%	15.2			23.8	%	(7.2	)%
Total revenues		$	25.7		100.0	%	$	21.8		100.0	%	17.9	%	$	75.3		100.0	%	$	63.7		100.0	%	18.3	%

 

Our revenue growth is attributable to an increase in revenues from the PS business unit offset by a slight decrease in revenues in the VQS business unit. The PS business unit revenue growth, reflected through volume increases in both channel partner and direct sales, resulted from improvement in capital spending by enterprise and telecommunications companies in our markets. We expect initial revenues derived from MyCaller sales in the fourth quarter of 2004.

 

The decrease in VQS business unit revenues is primarily due to a decrease in royalty fees. VQS business unit revenues from royalty fees were $0.4 million for the three months ended September 30, 2004, a $0.5 million decrease from $0.9 million for the three months ended September 30, 2003. VQS business unit revenues from royalty fees were $1.8 million for the nine months ended September 30, 2004, a $1.1 million decrease from $2.9 million for the nine months ended September 30, 2003. Without consideration of the royalty fees, VQS business unit quarterly revenues have remained relatively flat during 2003 and through the period ended September 30, 2004.

 

Revenues from Lucent, our primary VQS reseller to network operators and an emerging PS customer, represented 16.0% and 18.4% of total revenues for the three months ended September 30, 2004 and 2003, respectively. Lucent revenues represented 13.0% and 16.3% of total revenues for the nine months ended September 30, 2004 and 2003, respectively.

 

The NI business unit has had revenues that have been negligible to date. We expect initial revenues derived from AccessGate sales in the fourth quarter of 2004.

 

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		For the three months ended September 30,												For the nine months ended September 30,
		2004					2003							2004					2003
($ In millions)		Amount			% of revenue		Amount			% of revenue		Change		Amount			% of revenue		Amount			% of revenue		Change
North America		$	12.4		48.1	%	$	11.0		50.4	%	12.6	%	$	36.8		48.8	%	$	34.5		54.1	%	6.7	%
International		13.3			51.9	%	10.8			49.6	%	23.3	%	38.5			51.2	%	29.2			45.9	%	32.0	%
Total revenues		$	25.7		100.0	%	$	21.8		100.0	%	17.9	%	$	75.3		100.0	%	$	63.7		100.0	%	18.3	%

 

We have experienced growth in both our North American and International markets, specifically in our European and Asian markets. Our revenue growth, reflected through volume increases in both channel partner and direct sales, resulted from improvement in capital spending by enterprise and telecommunications companies in our markets. We expect initial revenues from MyCaller and AccessGate in our European market in the fourth quarter of 2004.

 

Gross Profit

Cost of revenues consists primarily of product cost; cost of services provided to our customers and overhead associated with testing and fulfillment operations.  The Company’s manufacturing process is outsourced to a contract manufacturer. In 2003, the Company also had amortization of acquired completed technology and impairment charges in “Cost of revenues”.  No similar charges were recorded in 2004.

 

		For the three months ended September 30,												For the nine months ended September 30,
		2004					2003							2004					2003
$ In millions		Amount			% of revenue		Amount			% of revenue		Change		Amount			% of revenue		Amount			% of revenue		Change
Revenues		$	25.7		100.0	%	$	21.8		100.0	%	17.9	%	$	75.3		100.0	%	$	63.7		100.0	%	18.3	%
Cost of revenues		9.5			36.9	%	9.8			44.7	%	(2.8	)%	28.0			37.2	%	37.6			59.0	%	(25.4	)%
Gross profit		$	16.2		63.1	%	$	12.0		55.3	%	34.6	%	$	47.3		62.8	%	$	26.1		41.0	%	81.1	%

 

The improvements in gross margin, from 2003 to 2004, were primarily driven by increased volume, product mix, cost reduction actions and efficiencies achieved with our contract manufacturer.

 

Our cost of revenues for the three months ended September 30, 2004 consisted primarily of product cost of $6.6 million, cost of services provided to our customers of $1.7 million and overhead associated with testing and fulfillment operations of $1.2 million.

 

Our cost of revenues for the three months ended September 30, 2003 consisted primarily of product cost of $6.5 million, cost of services provided to our customers of $1.7 million, overhead associated with testing and fulfillment operations of $1.6 million.

 

Our cost of revenues for the nine months ended September 30, 2003 included a $0.8 million of completed technology amortization related to past acquisitions and a $7.4 million impairment charge to reduce the carrying value of completed technology related to  past acquisitions which if excluded would result in a gross margin percentage of 53.9%.

 

Our cost of revenues for the nine months ended September 30, 2004 consisted primarily of product cost of $19.3 million, cost of services provided to our customers of $5.0 million and overhead associated with testing and fulfillment operations of $3.7 million.

 

Our cost of revenues for the nine months ended September 30, 2003 consisted primarily of product cost of $18.2 million, a $7.4 million impairment charge to reduce the carrying value of completed technology related to past acquisitions, cost of services provided to our customers of $5.8 million, overhead associated with testing and fulfillment operations of  $5.4 million and $0.8 million of completed technology amortization related to prior acquisitions.

 

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Selling, General and Administrative

Selling, general and administrative expenses consist primarily of salaries, commissions and related personnel expenses for those engaged in our sales, marketing, promotional, public relations, executive, accounting and administrative activities. In 2003, the amortization of intangible assets and non-cash compensation were included in selling, general and administrative costs.  There was no amortization in 2004.

 

		For the three months ended September 30,												For the nine months ended September 30,
		2004					2003							2004					2003
$ In millions		Amount			% of revenue		Amount			% of revenue		Change		Amount			% of revenue		Amount			% of revenue		Change
Selling, general and administrative expenses		$	8.7		34.0	%	$	8.4		38.4	%	4.2	%	$	24.8		32.9	%	$	29.4		46.2	%	(15.7	)%

 

Selling, general and administrative expense included a $0.6 million facilities related charge resulting from a sublease for the three months ended September 30, 2004. Excluding this charge from the results, selling, general and administrative expenses have been stable for all three quarters of the year at approximately $8 million a quarter. We expect this trend to remain consistent through the fourth quarter of 2004.

 

Selling, general and administrative expenses decreased during the nine-month period ended September 30, 2004 compared to the same period of 2003. The primary reason for the decrease in selling, general and administrative expense is the realization of cost savings from the reductions-in-force during 2003. Additionally included in selling, general and administrative expense for the nine months ended September 30, 2003 are $1.1 million of amortization of intangible assets and $0.8 million of non-cash compensation expense, both related to prior acquisitions. These expenses did not reoccur in the nine months ended September 30, 2004.

 

Research and Development

Research and development expenses consist primarily of salaries, personnel expenses and prototype fees related to the design, development, testing and enhancement of our products.

 

		For the three months ended September 30,												For the nine months ended September 30,
		2004					2003							2004					2003
$ In millions		Amount			% of revenue		Amount			% of revenue		Change		Amount			% of revenue		Amount			% of revenue		Change
Research and development expenses		$	5.9		23.0	%	$	7.3		33.5	%	(19.1	)%	$	18.1		24.0	%	$	24.3		38.1	%	(25.6	)%

 

The decreases in research and development expense were primarily due to cost savings from reductions-in-force in 2003. The Company is currently investing research and development expenditures in both MyCaller and AccessGate with the expectation that those products will begin to contribute to revenues in the fourth quarter of 2004, and more significantly in 2005.

 

Restructuring and Other Related Charges

Restructuring charges consist of involuntary severance related costs, facility closures or downsizing and disposal of excess or unused assets.

 

		For the three months ended September 30,						For the nine months ended September 30,
(In millions)		2004			2003			2004			2003
Involuntary severance related costs		$	—		$	2.5		$	—		$	4.8
Lease termination costs		—			0.3			—			0.5
Write down of fixed assets		—			—			—			0.6
Write down of IML facility and other		—			0.2			—			1.0
Restructuring and other related charges		$	—		$	3.0		$	—		$	6.9

 

In the third quarter of 2003, in an effort to reduce future operating expenses, the Company initiated restructuring efforts resulting in the recording of total restructuring and other related charges of $3.0 million. These charges consist of $2.5 million of involuntary severance related costs and $0.3 million of lease termination costs and $0.2 million of other costs.

 

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