UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 000-21783
8X8, INC.
(Exact name of Registrant as Specified in its Charter)
2445 Mission College Blvd.
Santa Clara, CA 95054
(Address of Principal Executive Offices including Zip Code)
(408) 727-1885
(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 reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 121(b)2 of the Securities Exchange Act of 1934). YES [ ] NO [ X ]
The number of shares of the Registrant's Common Stock outstanding as of July 21, 2003 was 28,475,370.
8X8, INC.
FORM 10-Q
TABLE OF CONTENTS
| PART I. FINANCIAL INFORMATION | Page No. |
| Item 1. Financial Statements: | |
| Condensed Consolidated Balance Sheets at June 30, 2003 and March 31, 2003 | |
| Condensed Consolidated Statements of Operations for the three months ended June 30, 2003 and 2002 | |
| Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2003 and 2002 | |
| Notes to Unaudited Condensed Consolidated Financial Statements | |
| Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | |
| Item 3. Quantitative and Qualitative Disclosures About Market Risk | |
| Item 4. Controls and Procedures | |
| PART II. OTHER INFORMATION | |
| Item 6. Exhibits and Reports on Form 8-K | |
| Signature |
Part I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
8X8, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
June 30, March 31,
2003 2003
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ....................... $ 1,903 $ 3,371
Short-term investments........................... 879 208
Accounts receivable, net ........................ 419 1,290
Inventory ....................................... 380 352
Other current assets ............................ 719 595
------------ ------------
Total current assets .......................... 4,300 5,816
Property and equipment, net ....................... 524 841
Intangibles and other assets ...................... 31 48
------------ ------------
$ 4,855 $ 6,705
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................ $ 833 $ 652
Accrued compensation ............................ 656 847
Accrued warranty ................................ 476 477
Deferred revenue ................................ 292 545
Other accrued liabilities ....................... 1,049 1,125
Income taxes payable ............................ 214 226
------------ ------------
Total current liabilities ..................... 3,520 3,872
------------ ------------
Commitments and contingencies (Notes 5 and 9)
Contingently redeemable common stock............... 488 669
Stockholders' equity:
Common stock .................................... 28 28
Additional paid-in capital ...................... 151,008 150,827
Deferred compensation ........................... (10) (12)
Accumulated deficit ............................. (150,179) (148,679)
------------ ------------
Total stockholders' equity .................... 847 2,164
------------ ------------
$ 4,855 $ 6,705
============ ============
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
8X8, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended
June 30,
--------------------
2003 2002
--------- ---------
Product revenues ........................... $ 861 $ 1,374
License and other revenues ................. 762 1,894
--------- ---------
Total revenues .......................... 1,623 3,268
--------- ---------
Cost of product revenues ................... 363 605
Cost of license and other revenues ......... 391 256
--------- ---------
Total cost of revenues .................. 754 861
--------- ---------
Gross profit ............................... 869 2,407
--------- ---------
Operating expenses:
Research and development ................. 1,044 2,392
Selling, general and administrative ...... 1,266 2,183
--------- ---------
Total operating expenses ................ 2,310 4,575
--------- ---------
Loss from operations ....................... (1,441) (2,168)
Other income (expense), net ................ (59) 43
--------- ---------
Net loss ................................... $ (1,500) $ (2,125)
========= =========
Net loss per basic and diluted share........ $ (0.05) $ (0.08)
========= =========
Basic and diluted shares outstanding........ 28,475 28,246
========= =========
The accompanying notes are an integral part of these unaudited con consolidated financial statements.
8X8, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
Three Months Ended
June 30,
----------------------
2003 2002
---------- ----------
Cash flows from operating activities:
Net loss ...................................................... $ (1,500) $ (2,125)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization .......................... 314 480
Other .................................................. 115 9
Changes in assets and liabilities.............................. 273 (88)
---------- ----------
Net cash used in operating activities ................... (798) (1,724)
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment ........................ -- (43)
Proceeds from sale of equipment ............................ 1 11
Short term investments -- trading activity, net............. (671) (191)
---------- ----------
Net cash used in investing activities ................... (670) (223)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock ..................... -- 19
---------- ----------
Net cash provided by financing activities .............. -- 19
---------- ----------
Net decrease in cash and cash equivalents ..................... (1,468) (1,928)
Cash and cash equivalents at the beginning of the period ...... 3,371 12,422
---------- ----------
Cash and cash equivalents at the end of the period ............ $ 1,903 $ 10,494
========== ==========
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
8X8, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
1. DESCRIPTION OF THE BUSINESS
THE COMPANY
8x8, Inc., or 8x8, and its subsidiaries (collectively, the Company) develop and market communication technology for internet protocol or, IP, telephony and video applications. The Company was incorporated in California in February 1987, and in December 1996 was reincorporated in Delaware. In August 2000, the Company changed its name from 8x8, Inc. to Netergy Networks, Inc. The Company changed its name back to 8x8, Inc. in July 2001. During the fiscal year ended March 31, 2001, 8x8 formed two subsidiaries, Netergy Microelectronics, Inc. (Netergy) and Centile, Inc. (Centile) and reorganized its operations more clearly along its three product lines.
- Within the parent company, 8x8 offers the Packet8 service that enables broadband internet users to add digital telephone service to their high-speed internet connection. In addition, 8x8 offers videophones for use on both traditional telephony networks and in conjunction with the Packet8 service;
- Netergy provides voice and video semiconductors and related communication software to original equipment manufacturers (OEMs) of telephones, terminal adapters, and other edge devices and to other semiconductor companies. Netergy's technologies are used to make IP telephones and to voice- enable cable and digital subscriber line modems, wireless devices, and other broadband technologies; and
- Centile develops and markets hosted iPBX solutions that allow service providers to offer to small and medium-sized businesses over broadband networks the features and functions that a user commonly expects to find in a typical business phone system. A hosted iPBX solution is a software application that implements the functionality of a business phone system over the same data connection that a business uses for connection to the internet. The phone system software runs on servers that are located at a central data center so that the only phone system equipment that is required at the customer site are telephones. The phone system can also be accessed and controlled from any web browser on the internet.
LIQUIDITY
The possibility that the Company will not be able to meet its obligations as and when they become due over the next twelve months raises substantial doubt about the Company's ability to continue as a going concern. Accordingly, the Company has been pursuing, and will continue to pursue, among other things, the implementation of certain cost reduction strategies and the licensing or sale of its technologies or projects. Additionally, the Company plans to seek additional financing and evaluate financing alternatives during the next twelve months in order to meet its cash requirements for the remainder of fiscal 2004. The Company has sustained net losses and negative cash flows from operations since fiscal 1999 that have been funded primarily through the issuance of equity securities and borrowings. Management expects to experience negative cash flows for the foreseeable future and such losses may be substantial. There is no assurance that the Company will be able to obtain financing on terms favorable to the Company, or at all. If the Company issues additional equity or convertible debt securities to raise funds, the ownership percentage of the Company's existing stockholders would be reduced and they may experience significant dilution. Failure to increase revenues, to manage net operating expenses and to raise additional financing through public or private equity financing or other sources of financing may result in the Company not achieving its longer term business objectives. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
In connection with efforts to improve its liquidity, in June 2003 Netergy entered into an agreement whereby it would sell certain assets and license/sell certain technology related to its next-generation video compression semiconductor product for cash. The closing of this transaction is subject to certain conditions beyond the Company's control and there can be no assurance that the transaction will close. Even if the transaction closes, additional cash resources may be necessary for the Company to sustain its operations. The Company does not expect to incur a loss on this transaction.
In July 2003, the Company announced that Netergy had licensed its voice over IP Audacity-T2 and T2U semiconductor products and Veracity software. The customer obtained rights to sell T2 and T2U based semiconductor products bundled with the Veracity software, and, in return, will pay Netergy a license fee and royalties for each T2 and T2U semiconductor it sells.
2. BASIS OF PRESENTATION
The accompanying interim condensed consolidated financial statements are unaudited and have been prepared on substantially the same basis as our annual financial statements for the fiscal year ended March 31, 2003. In the opinion of management, these financial statements reflect all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation of our financial position, results of operations and cash flows for the periods presented. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates.
These financial statements should be read in conjunction with the Company's audited consolidated financial statements for the year ended March 31, 2003 and notes thereto included in the Company's fiscal 2003 Annual Report on Form 10-K. Certain prior period balances have been reclassified to conform to the current period presentation.
The results of operations and cash flows for the interim periods included in these financial statements are not necessarily indicative of the results to be expected for any future period or the entire fiscal year.
Accounting for Stock-Based Compensation
The Company accounts for employee stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB Opinion No. 25) and related interpretations thereof. As required under Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), the Company provides pro forma disclosure of net loss and loss per share. If the Company had elected to recognize compensation costs based on the fair value at the date of grant of the awards, consistent with the provisions of SFAS No. 123, net loss and loss per share amounts would have been as follows (in thousands, except per share amounts):
Quarter Ended June 30,
--------------------
2003 2002
--------- ---------
Net loss: $ (1,500) $ (2,125)
Add: Stock-based compensation expense
included in reported net income........ 2 3
Deduct: Total stock-based compensation
determined pursuant to SFAS No.123.. (726) (1,111)
--------- ---------
Pro forma net loss (basic and diluted) $ (2,224) $ (3,233)
========= =========
As reported net loss per share.............. $ (0.05) $ (0.08)
Pro forma net loss per share................ $ (0.08) $ (0.11)
3. SHORT-TERM INVESTMENTS
The Company's short-term investments primarily comprise publicly traded corporate equity securities. All short-term investments are held in the Company's name and are custodied with major financial institutions. The specific identification method is used to compute the gains and losses on equity securities. At June 30, 2003, all of the Company's short-term investments were classified as trading securities. Unrealized gains and losses on these investments are included in Other Income, net, in the condensed consolidated statements of operations.
In March 2002, 8x8's board of directors (the Board) authorized the Company to open securities trading accounts and make investments of up to $1.0 million, as directed by the Company's Chairman, Joe Parkinson, the Chief Executive Officer, or the Chief Financial Officer. Mr. Parkinson has agreed to personally reimburse 8x8 on a quarterly basis for any losses resulting from his trading activities in order to maintain a minimum investment account balance of $1.0 million. The Board has been assured of Mr. Parkinson's ability to cover any such losses; however, should he be unable to do so, it could have a material impact on the Company's cash flows and results of operations. As part of the arrangement, the Board has expressed its intent, but not obligation, to pay Mr. Parkinson a quarterly bonus in an amount equal to 25% of the profits attributable to investments made on the Company's behalf by Mr. Parkinson to the extent such a bonus exceeds his salary for the corresponding period. The Company or Mr. Parkinson can terminate this arrangement at any time. Under the arrangement, the Company is required to return to Mr. Parkinson the amount representing the increase in value of the investment account over $1.0 million to the extent required to restore replenishment payments made by Mr. Parkinson in prior quarters. Through March 31, 2003, Mr. Parkinson had made cumulative replenishment payments of approximately $137,000 to offset losses incurred. As of June 30, 2003, the investment account balance approximated $1,126,000. Accordingly, the Company had a payable of approximately $126,000 to Mr. Parkinson at June 30, 2003, which was paid in July 2003. As of June 30, 2003, $879,000 of the $1.0 million allocated for such investment activities was invested in marketable equity securities and mutual funds, and the remainder was invested in money market funds.
4. BALANCE SHEET DETAIL
June 30, March 31,
2003 2003
------------ ------------
Inventory (in thousands):
Raw materials and work-in-process .. $ 172 $ 147
Finished goods ..................... 208 205
------------ ------------
$ 380 $ 352
============ ============
5. CONVERTIBLE SUBORDINATED DEBENTURES
Issuance of the Debentures
In December 1999, the Company issued $7.5 million of 4% Series A and Series B convertible subordinated debentures (the Debentures) due in December 2002. In conjunction with the issuance of the Debentures, the lenders received warrants to purchase 531,915 8x8 common shares at $7.05 per share and 105,634 shares at $35.50 per share (the Lender Warrants). The Company also issued warrants to the placement agent to purchase 53,191 8x8 common shares at $7.05 per share and 10,563 shares at $35.50 per share. All of the warrants expired in December 2002.
Redemption of the Debentures and the Issuance of Contingently Redeemable Common Stock
In December 2001, the Company redeemed the Debentures for $4.5 million in cash and 1,000,000 shares of common stock. Additionally, the Company agreed to reduce the exercise price of the Lender Warrants to $0.898 per share. This transaction resulted in an extraordinary gain of $779,000, net of the incremental fair value of the repriced warrants, the write-off of unamortized debt discount and debt issue costs, and other costs associated with the early extinguishment of the Debentures.
Under the terms of a registration rights agreement that the Company and the lenders entered into in connection with the issuance of the 1,000,000 shares of common stock, the Company agreed to register the shares for resale and maintain the effectiveness of the registration statement for specified periods of time until the shares are resold or can be resold without the registration statement (the Maintenance Requirements). The Company further agreed that if it does not comply with the Maintenance Requirements through December 2003, it may be required to pay cash penalties and redeem all or a portion of the shares held by the lenders at the higher of $0.898 per share or the market price of the Company's stock at the time of the redemption. The shares held by the lenders at June 30, 2003 were recorded at their potential redemption value at June 30, 2003 of $488,000 and classified as contingently redeemable common stock due to the redemption rights described above. The Company will not mark the contingently redeemable common stock to the higher of $0.898 per share or market unless it becomes probable that the Company will not be able to comply with the Maintenance Requirements.
6. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing net income (loss) available to common stockholders (numerator) by the weighted average number of vested, unrestricted common shares outstanding during the period (denominator). Due to net losses incurred for the three month periods ended June 30, 2003 and 2002, basic and diluted shares outstanding for each of the respective periods are the same. The following equity instruments were not included in the computations of net income (loss) per share because the effect on the calculations would be anti-dilutive (in thousands):
Three Months Ended
June 30,
--------------------
2003 2002
--------- ---------
Common stock options ................... 6,950 9,610
Warrants................................ -- 701
--------- ---------
6,950 10,311
========= =========
7. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss), as defined, includes all changes in equity (net assets) during a period from non-owner sources. The difference between net income (loss) and comprehensive income (loss) is due primarily to unrealized gains and losses on short-term investments classified as available-for-sale and foreign currency translation adjustments. Comprehensive income (losses) for the three month periods ended June 30, 2003 and 2002, were as follows (in thousands):
Three Months Ended
June 30,
--------------------
2003 2002
--------- ---------
Net loss, as reported................... $ (1,500) $ (2,125)
Cumulative translation adjustment....... -- 7
--------- ---------
Comprehensive loss...................... $ (1,500) $ (2,118)
========= =========
8. SEGMENT REPORTING
The Company has three reportable segments: Netergy, Centile, and Corporate and Other. Inter-segment revenues between the reportable segments were not significant during the periods presented. Shared support service functions such as human resources, facilities management, and other infrastructure support and overhead costs are allocated between the segments. Accounting policies are applied consistently to the segments, where applicable. The Company's reportable segments have been determined based on the nature of the operations and products offered to customers:
- The Netergy segment primarily reflects the activity associated with the sale and development of semiconductors, related software, and product reference designs focused on the IP telephony and videoconferencing markets. In addition, the Netergy segment includes revenue derived from the license of video monitoring technology to GE Interlogix, Inc. (formerly Interlogix, Inc.).
- The Centile segment reflects activity associated with the development and sale of its hosted iPBX solution, as well as media hub systems.
- The Corporate and Other segment represents the business activities of the parent entity, 8x8, Inc. The results for the Corporate and Other segment principally reflect activities related to the Packet8 IP telephone service, sale of videophones, unallocated corporate overhead expenses, and revenues and certain costs associated with discontinued product lines.
The following table illustrates results by segment (in thousands):
Three Months Ended
June 30,
--------------------
2003 2002
--------- ---------
Revenues
Netergy................................. $ 1,407 $ 3,054
Centile ................................ 158 151
Corporate and Other .................... 58 63
--------- ---------
Total revenues ...................... $ 1,623 $ 3,268
========= =========
Gross profit (loss)
Netergy................................. $ 806 $ 2,284
Centile ................................ 128 84
Corporate and Other .................... (65) 39
--------- ---------
Total gross profit .................. $ 869 $ 2,407
========= =========
Operating income (loss)
Netergy................................. $ 171 $ (535)
Centile ................................ (537) (768)
Corporate and Other .................... (1,075) (865)
--------- ---------
Total operating loss ................. $ (1,441) $ (2,168)
========= =========
Net income (loss)
Netergy................................. $ 179 $ (450)
Centile ................................ (598) (833)
Corporate and Other .................... (1,081) (842)
--------- ---------
Total net loss ....................... $ (1,500) $ (2,125)
========= =========
There were no significant reconciling items between the segments for the revenue, gross profit, operating loss, and net loss amounts.
9. COMMITMENTS AND CONTINGENCIES
Guaranties and Product Warranties
In the normal course of business, the Company indemnifies other parties, including customers, lessors and parties to other transactions with the Company, with respect to certain matters. The Company has agreed to hold the other party harmless against losses arising from: i) a breach of representations or covenants or ii) out of intellectual property infringement or other claims made against certain parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, the Company has entered into indemnification agreements with its officers and directors.
It is not possible to determine the maximum potential amount of the Company's exposure under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material impact on the Company's operating results or financial position.
The Company accrues for the estimated costs that may be incurred under its product warranties upon revenue recognition. Changes in the Company's product warranty liability during the quarter ended June 30, 2003 were not material.
Leases
At June 30, 2003, future minimum annual lease payments under noncancelable operating leases, net of sublease income, were as follows (in thousands):
Year ending March 31:
Remaining 2004...................... $ 289
2005................................ 282
2006................................ 39
------------
Total minimum payments................. $ 610
============
Legal Proceedings
The Company is involved in various legal claims and litigation that have arisen in the normal course of its operations. While the results of such claims and litigation cannot be predicted with certainty, the Company currently believes that the final outcome of such matters will not have a materially significant adverse effect on the Company's financial position or results of operations. However, should the Company not prevail in any such litigation, it could have a materially adverse impact on the Company's operating results, cash flows and financial position.
10. SALE OF CENTILE EUROPE S.A.
On June 20, 2003, Centile, Inc. executed an agreement with Sunleigh Investments Ltd. (Sunleigh) for Sunleigh to acquire Centile Europe S.A. (Centile Europe) for 1,100,000 Euros on July 1, 2003. Sunleigh acquired substantially all the assets and liabilities of the business, and the Company is obligated to pay certain liabilities incurred by Centile Europe prior to the closing date. In addition, Sunleigh received a non-exclusive license to Centile's IPBX technology, and also received exclusivity for the European market for one year subsequent to the closing date. Correspondingly, Centile Europe granted exclusivity for the North American market to Centile, Inc. for the same period. Under the acquisition agreement, Sunleigh is obligated to pay the purchase price, net of amounts withheld for pre-closing obligations, in installments through December 31, 2003. The purchase price is subject to adjustment based on the closing balance sheet of Centile Europe as of July 1, 2003. The Company does not expect to record a loss on this transaction. Revenues and operating losses attributable to the operations of Centile Europe approximated $20,000 and $400,000 for the quarter ended June 30, 2003 and $70,000 and $360,000 for the quarter ended June 30, 2002, respectively. The Company continues to operate the Centile business in the United States.
11. RECENT ACCOUNTING PRONOUNCEMENTS
On October 3, 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30. SFAS No. 144 develops one accounting model for long-lived assets that are to be disposed of by sale and requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (i) can be distinguished from the rest of the entity, and (ii) will be eliminated from the ongoing operations of the entity in a disposal transaction. The Company adopted SFAS No. 144 in the first quarter of fiscal 2003, and its adoption did not have a material impact on the Company's results of operations and financial condition.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," which expands previously issued accounting guidance and disclosure requirements for certain guarantees. FIN 45 requires an entity to recognize an initial liability for the fair value of an obligation assumed by issuing a guarantee. The provision for initial recognition and measurement of the liability will be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The Company does not expect this interpretation to have a material impact on its consolidated results of operations or financial position. The Company has included additional disclosures in accordance with FIN 45 in the footnotes to these consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The additional disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. 8x8 will continue to account for stock- based compensation in accordance with Accounting Principles Board Opinion No. 25. The Company has included additional disclosures in accordance with SFAS No. 148 in the footnotes to these consolidated financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including our statements regarding factors that could impact our gross margins; the collection of amounts receivable related to the sale of Centile Europe S.A, a subsidiary of the Company; our expectation that we will not incur a loss on the sale of Centile Europe S.A.; the outcome of our appeal of the delisting determination received from the Nasdaq staff; our cost estimates under contracts accounted for using the percentage of completion method; efforts to raise additional financing; commitment of resources, and reduction in operating costs including the possible sale or cessation of certain business segments and the possible further reduction of personnel and suspension of salary increases and capital expenditures. You should not place undue reliance on these forward-looking statements. Actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including our good faith assumptions being incorrect, our business expenses being greater than anticipated due to competitive factors or unanticipated development or sales costs; revenues not resulting in the manner anticipated due to a continued slow down in technology spending, particularly in the telecommunications market; our failure to generate investor interest or to sell certain of our assets or business segments. The forward-looking statements may also be impacted by the additional risks faced by us as described in this Report, including those set forth under the section entitled "Factors that May Affect Future Results." All forward-looking statements included in this Report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements.
OVERVIEW
8x8, Inc., or 8x8, and its subsidiaries (collectively, the Company or we) develop and market telecommunication technology for IP telephony and video applications. We have three product lines: i) internet protocol telephone devices, videophones, and internet communication services; ii) voice and video semiconductors and related software; and iii) software that implements the functionality of a private branch exchange, or PBX, over data networks.
Our first product line includes consumer telephones, videophones, and communication software and services that work over broadband networks. 8x8 sells internet protocol telephony software and services that enable customers to provision and use IP dial-tone services with IP telephones and videophones. The service is marketed under the brand name Packet8. 8x8 also sells videophones that work over normal phone lines.
We have two primary subsidiaries, Netergy Microelectronics, Inc. (Netergy) and Centile, Inc. (Centile). Netergy provides voice and video semiconductors and related communication software to original equipment manufacturers, or OEMs, of telephones, terminal adapters, and other endpoint communication devices and to other semiconductor companies. Netergy's technologies are used to make IP telephones and to voice-enable cable and digital subscriber line, or DSL, modems, wireless devices, and other broadband technologies. Centile develops and markets hosted iPBX solutions that allow service providers to offer to small and medium-sized businesses over broadband networks the features and functions that are commonly found in a typical business phone system. A hosted iPBX solution is a software application that implements the functionality of a business phone system over the same data connection that a business uses for connection to the internet. The phone system software runs on servers that are located at a central data center so that the only phone system equipment that is required at the customer site are telephones. The phone system can also be accessed and controlled from any web browser on the internet.
RECENT DEVELOPMENTS
On June 20, 2003, Centile, Inc. executed an agreement with Sunleigh Investments Ltd. (Sunleigh) for Sunleigh to acquire Centile Europe S.A. (Centile Europe) for 1,100,000 Euros on July 1, 2003. Sunleigh acquired substantially all the assets and liabilities of the business, and we are obligated to pay certain liabilities incurred by Centile Europe prior to the closing date. In addition, Sunleigh received a non-exclusive license to Centile's IPBX technology, and also received exclusivity for the European market for one year subsequent to the closing date. Correspondingly, Centile Europe granted exclusivity for the North American market to Centile, Inc. for the same period. Under the acquisition agreement, Sunleigh is obligated to pay the purchase price, net of amounts withheld for pre-closing obligations, in installments through December 31, 2003. The purchase price is subject to adjustment based on the closing balance sheet of Centile Europe as of July 1, 2003. We do not expect to record a loss on this transaction. Revenues and operating losses attributable to the operations of Centile Europe approximated $20,000 and $400,000 for the quarter ended June 30, 2003 and $70,000 and $360,000 for the quarter ended June 30, 2002, respectively. We continue to operate the Centile business in the United States.
In July 2003, we announced that Netergy had licensed its voice over IP Audacity-T2 and T2U semiconductor products and Veracity software. The customer obtained rights to sell T2 and T2U based semiconductor products bundled with the Veracity software, and, in return, will pay Netergy a license fee and royalties for each T2 and T2U semiconductor it sells.
On July 11, 2003, we received a Nasdaq Staff Determination notification that we had not, by July 7, 2003, regained compliance with the minimum $1.00 closing bid price per share requirement, as set forth in Marketplace Rule 4310(c)(4), and that, accordingly, our securities would be subject to delisting from The Nasdaq SmallCap Market at the opening of business on July 22, 2003. Furthermore, we were notified by the Nasdaq Staff that we were not in compliance with Marketplace Rule 4310(c)(2)(B), which requires us to have a minimum of $2,500,000 in stockholders' equity or $35,000,000 market value of listed securities or $500,000 of net income from continuing operations for the most recently completed fiscal year (or two of the three most recently completed fiscal years). As we are entitled pursuant to the procedures set forth in the Nasdaq Marketplace Rule 4800 Series, the Company appealed the Nasdaq Staff's determination to a Nasdaq Listing Qualifications Panel. There can be no assurance that the Company's appeal will be successful.
RESULTS OF OPERATIONS
The following table sets forth condensed consolidated statements of operations data for the three month periods ended June 30, 2003 and 2002, respectively, expressed as a percentage of our total revenues represented by each item. Cost of product revenues is presented as a percentage of product revenues and cost of license and other revenues is presented as a percentage of license and other revenues.
Three Months Ended
June 30,
---------------------------
2003 2002
------------ ------------
Product revenues ....................... 53% 42%
License and other revenues ............. 47% 58%
------------ ------------
Total revenues ...................... 100% 100%
------------ ------------
Cost of product revenues ............... 42% 44%
Cost of license and other revenues ..... 51% 14%
------------ ------------
Total cost of revenues .............. 46% 26%
------------ ------------
Gross profit ........................... 54% 74%
------------ ------------
Operating expenses:
Research and development ............. 64% 73%
Selling, general and administrative .. 78% 67%
------------ ------------
Total operating expenses ............ 142% 140%
------------ ------------
Loss from operations ................... -88% -66%
Other income (expense), net ............ -4% 1%
------------ ------------
Net loss ............................... -92% -65%
============ ============
The following discussion should be read in conjunction with our condensed consolidated financial statements and the notes thereto:
Revenues
Product revenues were $861,000 in the first quarter of fiscal 2004, a decrease of approximately $513,000 from the $1,374,000 reported in the first quarter of fiscal 2003. The decrease in the quarter ended June 30, 2003 as compared to the corresponding period in the prior year was due primarily to a decrease in unit shipments of videoconferencing and IP telephony semiconductor products as well as decreases in average selling prices (ASPs) of our IP telephony semiconductors. As a result, for the three months ended June 30, 2003 as compared to the same period in the prior year, we realized overall decreases in videoconferencing and IP telephony semiconductor revenues of $138,000 and $296,000, respectively.
Due to reduced demand and difficulties in ensuring supply, in July 2002, we announced the end of life of our existing videoconferencing semiconductor products, including VCP, VCPex, and LVP, that have historically generated substantially all of our videoconferencing semiconductor product revenues. We received last time buy orders from customers for the aforementioned products, and product shipments are substantially complete. Total videoconferencing semiconductor product revenues approximated $520,000 and $657,000 for the three month periods ended June 30, 2003 and 2002, respectively. As a result of the end of life of our existing videoconferencing semiconductor products, we will become more dependent on the growth of revenues from sales of our IP telephony semiconductor products and new video semiconductor products currently in development.
License and other revenues were $762,000 in the first quarter of fiscal 2004, as compared to $1,894,000 in the first quarter of fiscal 2003. License and other revenues, the majority of which are considered to be non-recurring in nature, consist primarily of technology licenses and related maintenance revenues, as well as royalties earned under such licenses, and revenue derived under contracts to perform development services. The decrease of approximately $1,132,000 quarter over quarter was due to the following:
- A decrease of approximately $750,000 in royalties earned by Netergy from a single customer under a license agreement for our MPEG technology due to the expiration of the royalty period;
- A $143,000 decrease in license revenues associated with the sale of our video monitoring business in June 2000; all revenues associated with that transaction were recognized as of May 31, 2003;
- A decrease of approximately $230,000 in revenues recognized by Netergy under a contract to develop our next-generation video compression semiconductor product that is accounted for using the percentage of completion method. No revenues were recognized under this contract during the first quarter of fiscal 2004. Profit estimates on this contract are revised periodically based on changes in facts; any loss would be recognized immediately. We have recognized $140,000 of cumulative losses to date, and changes in our cost estimates could require us to recognize additional losses in future periods as the revenues under this contract are fixed; and
- A decrease of approximately $60,000 in revenues from Netergy's IP telephony technology.
These decreases were partially offset by a $100,000 increase in license and maintenance revenues associated with Centile's hosted iPBX product. In addition, our Packet8 business began signing up subscribers in the third quarter of fiscal 2003 and continued growing in the first quarter of fiscal 2004.
Three customers represented more than 10% of our total revenues for the quarter ended June 30, 2003. These customers represented 26%, 18% and 14% of our total revenues, respectively. During the same period in the prior year we also had three customers represent greater than 10% of our total revenues. Those percentages were 23%, 13%, and 10%, respectively. Our revenue distribution by geographic region (based upon the destination of shipments) was as follows:
Three Months Ended
June 30,
--------------------
2003 2002
--------- ---------
United States............................ 39% 48%
Europe................................... 25% 35%
Asia Pacific............................. 36% 17%
--------- ---------
100% 100%
========= =========
Cost of Revenues and Gross Profit
The cost of product revenues consists of costs associated with components, semiconductor wafer fabrication, system and semiconductor assembly and testing performed by third-party vendors and direct and indirect costs associated with purchasing, scheduling and quality assurance. Gross profit from product revenues decreased to approximately $500,000 for the first quarter of fiscal 2004 from approximately $770,000 for the quarter ended June 30, 2002, and product gross margins increased from 56% in the first quarter of fiscal 2003 to 58% in the first quarter of fiscal 2004. The decrease in product gross profit is primarily due to a decrease in units shipped offset by an increase in average selling prices. The increase in gross margin is due primarily to lower standard costs for our IP telephony semiconductors resulting from a change in suppliers, combined with increases in the average selling prices of our videoconferencing and IP telephony semiconductors, offset by reductions in units shipped.
Our product gross margin is affected by a number of factors including product mix, product pricing, the percentage of direct sales and sales to resellers, and manufacturing and component costs. The markets for our products are characterized by falling average selling prices. Average selling prices realized to date for our IP telephony semiconductors have been lower than those historically attained for our videoconferencing semiconductor products, resulting in lower gross margins. In the likely event that we encounter significant price competition in the markets for our products, we could be at a significant disadvantage compared to our competitors, many of whom have substantially greater resources, and therefore may be better able to withstand an extended period of downward pricing pressure. To respond to competitive pricing pressures, we may be required to introduce differentiated products and continue to reduce costs as a means of maintaining or improving our margins. We may not be successful in our development efforts or product cost reduction measures and may face continued erosion of margins.
Gross profit from license and other revenues, which were largely nonrecurring, was approximately $370,000 and $1.6 million in the first quarters of fiscal 2004 and 2003, respectively. Associated gross margins were 49% and 87% in the first quarters of fiscal 2004 and fiscal 2003, respectively. The decrease in gross margin from fiscal 2003 to fiscal 2004 was due primarily to costs incurred to perform development services under revenue generating contracts that were included in the Cost of License and Other Revenues line item in the condensed consolidated statements of operations. Gross margins associated with license and other revenues may be adversely impacted in the future if revenues derived from our existing contract to perform non-recurring engineering services associated with the development of our next-generation video compression semiconductor product increase as a percentage of total license and other revenues or if a change in our cost estimates requires us to recognize additional losses on this contract, as the revenues under this contract are fixed. We recognized cumulative losses on this contract through June 30, 2003 of approximately $140,000.
Research and Development Expenses
Research and development expenses consist primarily of personnel, system prototype design and fabrication, mask, prototype wafer and equipment costs necessary for us to conduct our development efforts. Research and development costs, including software development costs, are expensed as incurred. Research and development expenses decreased by approximately $1,348,000 in the first quarter of fiscal 2004 as compared to the first quarter of fiscal 2003. The significant decrease in research and development expenses for the three month period ended June 30, 2003 as compared to the comparable period in the prior year was due to the following:
- The shift in engineering resources from research and development functions to revenue generating contracts; these costs approximated $350,000 and $232,000 for the quarters ended June 30, 2003 and June 30, 2002, respectively, and were included in cost of license and other revenue;
- Lower compensation costs due to a reduction in research and development personnel as compared to the comparable prior year periods;
- The closure of Netergy's office in the United Kingdom in the fourth quarter of fiscal 2003;
- Lower depreciation expense due to the retirement of assets; and
- Our overall efforts to reduce discretionary operating costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of personnel and related overhead costs for sales, marketing, finance, human resources and general management. Such costs also include sales commissions, trade show, advertising and other marketing and promotional expenses. Selling, general and administrative expenses decreased by $917,000 in the first quarter of fiscal 2004 as compared to the same period in the prior year. The decrease in selling, general and administrative expenses for the first quarter of fiscal 2004 was primarily attributable to:
- Lower compensation costs due to a reduction in sales and administrative personnel; and
- Lower financial reporting, legal, public relations, consulting, and recruiting expenditures resulting from our efforts to reduce discretionary operating costs, slightly offset by an increase in various sales and marketing expenses associated with our new Packet8 IP telephone service.
Other Income, Net
In the first quarters of fiscal 2004 and 2003, other income (expense), net, was ($54,000) and $43,000, respectively. The significant increase in other expense was due to a decrease in interest income and foreign exchange losses related to our international subsidiaries.
Provision for Income Taxes
There were no tax provisions recorded during the three month periods ended June 30, 2003 and 2002, due to net losses incurred.
Related Party Transactions
During the fourth quarter of fiscal 2000, the Company sold 3.7 million shares of its common stock to STMicroelectronics NV at a purchase price of $7.50 per share and received net proceeds of $27.7 million. In June 2002, STMicroelectronics NV and subsidiaries (STM), an affiliate of the Company, acquired Alcatel Microelectronics NV (AME). AME, now a wholly owned subsidiary of STM, was a customer of Netergy and supplier of semiconductors. The Company now purchases semiconductors from STM. During the first quarter of fiscal 2004, we purchased semiconductors from a subsidiary of STM, and such purchases approximated $171,000. In addition, during fiscal 2003 we contracted with a subsidiary of STM for non-recurring engineering services related to the development of our new semiconductor product. As of March 31, 2003, we had recorded liabilities to STM of approximately $88,000 for semiconductor purchase commitments.
In March 2002 the Board authorized us to open securities trading accounts and make investments of up to $1.0 million on behalf of 8x8, Inc. as directed by our Chairman, Joe Parkinson, Chief Executive Officer, or Chief Financial Officer. Mr. Parkinson has agreed to personally reimburse 8x8 on a quarterly basis for any losses resulting from his trading activities in order to maintain a minimum investment account balance of $1.0 million. The Board has been assured of Mr. Parkinson's ability to cover any such losses; however, should he be unable to do so it could have a material impact on our cash flows and results of operations. As part of the arrangement, our Board has expressed its intent, but not obligation, to pay Mr. Parkinson a quarterly bonus in an amount equal to 25% of the profits attributable to investments made on our behalf by Mr. Parkinson to the extent such a bonus exceeds his salary for the corresponding period. The Company or Mr. Parkinson can terminate this arrangement at any time, subject to the terms of an agreement between 8x8 and Mr. Parkinson. Under the arrangement, we are required to return to Mr. Parkinson the amount representing the increase in value of the investment account over $1.0 million to the extent required to restore replenishment payments made by Mr. Parkinson in prior quarters. Through March 31, 2003, Mr. Parkinson had made cumulative replenishment payments of approximately $137,000 to offset losses incurred. As of June 30, 2003, the investment account balance approximated $1,126,000. Accordingly, we had a payable of approximately $126,000 to Mr. Parkinson at March 31, 2003, which was paid in July 2003. As of June 30, 2003, $879,000 of the $1.0 million allocated for such investment activities was invested in marketable equity securities and mutual funds. The remaining balance was invested in money market funds.
Recent Accounting Pronouncements
On October 3, 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30. SFAS No. 144 develops one accounting model for long-lived assets that are to be disposed of by sale and requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (i) can be distinguished from the rest of the entity, and (ii) will be eliminated from the ongoing operations of the entity in a disposal transaction. We adopted SFAS No. 144 in the first quarter of fiscal 2003, and its adoption did not have a material impact on our results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The additional disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. We believe that the adoption of this standard will have no material impact on our financial statements.
Liquidity and Capital Resources
As of June 30, 2003, we had cash and cash equivalents and short-term investments approximating $2.8 million, representing a decrease of approximately $800,000 from March 31, 2003. We currently have no bank borrowing arrangements.
Cash used in operations of approximately $800,000 for the first three months of fiscal 2004 was primarily attributable to the net loss of $1.5 million, adjusted for $314,000 of depreciation and amortization and net cash generated from changes in operating assets and liabilities of $273,000. Cash used in operations of approximately $1.7 million for the first three months of fiscal 2002 was primarily attributable to the net loss of $2.1 million, adjusted for $480,000 of depreciation and amortization and net cash used in changes in operating assets and liabilities of $88,000. Our negative operating cash flows primarily reflect our net losses resulting from the same factors affecting our revenues and expenses as described above.
Cash used in investing activities in the three months ended June 30, 2003 was primarily attributable to net purchases of marketable equity securities and mutual funds of $671,000. Cash used in investing activities for the three months ended June 30, 2002 was attributable to net purchases of marketable equity securities of $191,000 and capital expenditures of $43,000, partially offset by proceeds from the sale of equipment of $11,000.
Cash provided by financing activities during the first three months of fiscal 2003 consisted primarily of proceeds resulting from the sale of common stock to employees through our employee stock option plans and stock purchase plans. As of June 30, 2003, our principal commitments consisted of obligations outstanding under noncancelable operating leases. At June 30, 2003, future minimum annual lease payments under noncancelable operating leases, net of sublease income, were as follows (in thousands):
Year ending March 31:
Remaining 2004...................... $ 289
2005................................ 282
2006................................ 39
------------
Total minimum payments................. $ 610
============
As noted previously, we redeemed our convertible subordinated debentures in December 2001. The consideration included the issuance of 1,000,000 shares of our common stock to the lenders. We have committed to maintaining the effectiveness of the registration statement filed with the Securities and Exchange Commission covering the resale of these shares. Should we fail to maintain the effectiveness of the registration statement, we may be required to pay cash penalties and redeem all or a portion of the shares at the higher of $0.898 or the market price of our common stock at the time of the redemption which could have a material adverse effect on our cash flows and results of operations. The value of the shares still held by the lenders of $488,000 at June 30, 2003, based upon the $0.898 per share minimum potential redemption price, is reflected as contingently redeemable common stock in the condensed consolidated balance sheet.
Based upon our current expectations, we believe that our current cash and cash equivalents and short-term investments, together with cash generated from operations, are not sufficient to satisfy our expected working capital and capital expenditure requirements for the remainder of fiscal 2004. The possibility that we will not be able to meet our obligations as and when they become due over the next twelve months raises substantial doubt about our ability to continue as a going concern. Accordingly, we have been pursuing, and will continue to pursue, the implementation of certain cost reduction strategies. Additionally, we plan to seek additional financing and evaluate financing alternatives during the next twelve months in order to meet our cash requirements for fiscal 2004. We may also seek to explore business opportunities, including acquiring or investing in complementary businesses or products that will require additional capital from equity or debt sources. Additionally, the development and marketing of new products could require a significant commitment of resources, which could in turn require us to obtain additional financing earlier than otherwise expected. We may not be able to obtain additional financing as needed on acceptable terms, or at all, which may require us to reduce our operating costs and other expenditures, including reductions of personnel and suspension of salary increases and capital expenditures. Alternatively, or in addition to such potential measures, we may elect to implement other cost reduction actions as we may determine are necessary and in our best interests, including the possible sale or cessation of certain of our business segments. Any such actions undertaken might limit our opportunities to realize plans for revenue growth and we might not be able to reduce our costs in amounts sufficient to achieve break-even or profitable operations. If we issue additional equity or convertible debt securities to raise funds, the ownership percentage of our existing stockholders would be reduced and they may experience significant dilution. New investors may demand rights, preferences or privileges senior to those of existing holders of our common stock. If we are not successful in these actions, we may be forced to cease operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial market risk consists primarily of risks associated with international operations and related foreign currencies. We derive a significant portion of our revenues from customers in Europe and Asia. In order to reduce the risk from fluctuation in foreign exchange rates, the vast majority of our sales are denominated in U.S. dollars. In addition, all of our arrangements with our semiconductor foundry and assembly vendors are denominated in U.S. dollars. We have foreign subsidiaries and are exposed to market risk from changes in exchange rates. We have not entered into any currency hedging activities. To date, our exposure to exchange rate volatility has not been significant; however, there can be no assurance that there will not be a material impact in the future.
We invest the majority of our surplus cash and cash equivalents in money market funds that bear variable interest rates, and, accordingly, fluctuations in interest rates do not have an impact on the fair values of such investments. However, given the currently low yields on such money market funds and other low-risk governmental and corporate debt securities, in March 2002 our Board of Directors authorized us to open securities trading accounts and make investments in other classes of securities that may generate higher returns. The amount allocated for such investments was $1.0 million to be invested on behalf of 8x8, Inc. at the direction of the Company's Chairman, Joe Parkinson, the Chief Executive Officer, or the Chief Financial Officer. Mr. Parkinson has agreed to personally reimburse 8x8 on a quarterly basis for any losses resulting from his trading activities in order to maintain a minimum investment account balance of $1.0 million. The Board has been assured of Mr. Parkinson's ability to cover any such losses; however, should he be unable to do so, it could have a material impact on our cash flows and results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
We will need to raise additional capital to support our operations, and failure to do so in a timely manner may cause us to implement additional cost reduction strategies
As of June 30, 2003, we had approximately $2.8 million in cash and cash equivalents and short-term investments. The possibility that we will not be able to meet our obligations as and when they become due over the next twelve months raises substantial doubt about our ability to continue as a going concern. Accordingly, we have been pursuing, and will continue to pursue, the implementation of certain cost reduction strategies. Additionally, we are seeking additional financing and evaluating financing alternatives in order to meet our cash requirements for fiscal 2004. We may not be able to obtain additional financing as needed on acceptable terms, or at all, which may require us to further reduce our operating costs and other expenditures, including additional reductions of personnel and capital expenditures. Alternatively, or in addition to such potential measures, we may elect to implement other cost reduction actions as we may determine are necessary and in our best interests, including the possible sale or cessation of certain of our business segments. Any such actions undertaken might limit our opportunities to realize plans for revenue growth and we might not be able to reduce our costs in amounts sufficient to achieve break-even or profitable operations. If we issue additional equity or convertible debt securities to raise funds, the ownership percentage of our existing stockholders would be reduced and they may experience significant dilution. New investors may demand rights, preferences or privileges senior to those of existing holders of our common stock. If we are not successful in these actions, we may be forced to cease operations.
We have a history of losses and we are uncertain as to our future profitability
We recorded an operating loss of approximately $1.5 million in the quarter ended June 30, 2003 and we ended the period with an accumulated deficit of $150 million. In addition, we recorded operating losses of $12 million, $10 million and $74.5 million for the fiscal years ended March 31, 2003, 2002 and 2001, respectively. We expect that we will continue to incur operating losses for the foreseeable future, and such losses may be substantial. We will need to generate significant revenue growth to achieve an operating profit. Given our history of fluctuating revenues and operating losses, we cannot be certain that we will be able to achieve profitability on either a quarterly or annual basis in the future.
We may not be able to maintain our listing on the Nasdaq SmallCap Market
In April 2002, we were notified by the Nasdaq staff that the bid price for our common stock must close at $1.00 per share or more for a minimum of ten consecutive trading days during the ninety calendar day period ending July 9, 2002 or we might be delisted. As we were not in compliance under the Nasdaq National Market minimum bid price listing standard by July 9, 2002, we transferred to and began trading on the Nasdaq SmallCap Market on July 26, 2002. As a result of our transfer to the Nasdaq SmallCap Market, our delisting determination was extended an additional ninety days until October 7, 2002. Although our common stock did not achieve a closing bid price of $1.00 for at least ten consecutive trading days before October 7, 2002, we met the initial listing criteria for the Nasdaq SmallCap Market as of October 7, 2002. As a result, we remained eligible to be quoted on the Nasdaq SmallCap Market for an additional 180-calendar day grace period, which expired on April 7, 2003, subject to our compliance with the continued listing requirements during the extended grace period. On April 8, 2003, the Nasdaq staff notified us that we had been granted an additional ninety days, or until July 7, 2003 to regain compliance with the minimum bid price listing standard. On July 11, 2003, the Nasdaq staff notified us that we had not, by July 7, 2003, regained compliance with the minimum $1.00 closing bid price per share requirement, as set forth in Marketplace Rule 4310(c)(4), and that, accordingly, our securities would be subject to delisting from The Nasdaq SmallCap Market at the opening of business on July 22, 2003. Furthermore, we have been notified by the Nasdaq Staff that we are not in compliance with Marketplace Rule 4310(c)(2)(B), which requires that we have a minimum of $2,500,000 in stockholders' equity or $35,000,000 market value of listed securities or $500,000 of net income from continuing operations for the most recently completed fiscal year (or two of the three most recently completed fiscal years). As we are entitled pursuant to the procedures set forth in the Nasdaq Marketplace Rule 4800 Series, on July 18, 2003 we filed an appeal of the Nasdaq Staff's determination to a Nasdaq Listing Qualifications Panel. There can be no assurance that our appeal will be successful and that we will be able to remain listed on the Nasdaq SmallCap Market.
Delisting could reduce the ability of our shareholders to purchase or sell shares as quickly and as inexpensively as they have done historically. For instance, failure to obtain listing on another market or exchange may make it more difficult for traders to sell our securities. Broker-dealers may be less willing or able to sell or make a market in our common stock. Not maintaining a listing on a major stock market may:
- result in a decrease in the trading price of our common stock;
- lessen interest by institutions and individuals in investing in our common stock;
- make it more difficult to obtain analyst coverage; and
- make it more difficult for us to raise capital in the future.
Our stock price has been highly volatile
The market price of the shares of our common stock has been and is likely to be highly volatile. It may be significantly affected by factors such as:
- actual or anticipated fluctuations in our operating results;
- announcements of technical innovations;
- loss of key personnel;
- new products or new contracts by us, our competitors or their customers;
- developments with respect to patents or proprietary rights, general market conditions, changes in financial estimates by securities analysts, and other factors which could be unrelated to, or outside our control; and
- the potential delisting of our common stock.
The stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the common stocks of technology companies and that have often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been initiated against the issuing company. If our stock price is volatile, we may also be subject to such litigation. Such litigation could result in substantial costs and a diversion of management's attention and resources, which would disrupt business and could cause a decline in our operating results. Any settlement or adverse determination in such litigation would also subject us to significant liability.
If we fail to maintain effectiveness of a registration statement for the resale of shares of our common stock issued in connection with the redemption of our previously outstanding convertible debt, we may be forced to pay a cash penalty or redeem all or a portion of the shares, causing our business to suffer
Under the terms of a registration rights agreement we entered into in connection with the redemption of our outstanding convertible debt, we agreed to register the 1,000,000 shares of our common stock issued to the former note holders for resale. If we fail to maintain the effectiveness of the registration statement through December 2003, we may be required to pay cash penalties and may be required to redeem all or a portion of the shares of common stock held by the former note holders. Under the agreement, the redemption price would be the higher of $0.898 or the market price of our common stock at the time of the redemption. If we are required to pay a cash penalty or to redeem any of the shares, this will deplete our cash reserves, which may cause significant harm to our business, results of operations and financial condition.
The growth of our business and future profitability depends on future IP telephony revenue
We believe that our business and future profitability will be largely dependent on widespread market acceptance of our IP telephony technology and products. Our videoconferencing semiconductor business has not provided sufficient revenues to profitably operate our business, and we have announced the end of life of these products and have substantially completed end of life shipments. To date, we have not generated significant revenue from the sale of our IP telephony products and services. If we are not able to generate significant revenues selling into the IP telephony market, our business and operating results would be seriously harmed.
Success of our IP telephony strategy assumes that there will be future demand for IP telephony systems and services. In order for the IP telephony market to continue to grow, several things need to occur. Telephone service providers must continue to invest in the deployment of high speed broadband networks to residential and commercial customers. IP networks must improve quality of service for real-time communications, managing effects such as packet jitter, packet loss, and unreliable bandwidth, so that toll-quality service can be provided. IP telephony equipment must achieve the 99.999% reliability that users of the public switched telephone network have come to expect from their telephone service. IP telephony service providers must offer cost and feature benefits to their customers that are sufficient to cause the customers to switch away from traditional telephony service providers. If any or all of these factors fail to occur, our business may not grow.
Our business has been adversely affected by the downturn in the telecommunications industry and these developments will continue to impact our revenues and operating results
Through the end of 2000, the telecommunications market was experiencing rapid growth spurred by a number of factors including deregulation in the industry, entry of a large number of new emerging service providers, growth in data traffic and the availability of significant capital from the financial markets. In 2001, the telecommunications industry began a reversal of some of these trends, marked by a dramatic reduction in current and projected future capital expenditures by service providers, financial difficulties and, in some cases, bankruptcies experienced by emerging service providers, as well as a sharp contraction in the availability of capital. These conditions caused a substantial reduction in demand for telecommunications equipment and related software, which has had a resulting impact on demand for Netergy's IP telephony semiconductor and software products and for Centile's hosted iPBX solution. If our current or potential customers are forced to defer or further curtail their capital spending programs, sales of our hosted iPBX product and Packet8 IP telephone service to telecommunication service providers and sales of our IP telephony semiconductors to manufacturers of telecommunication equipment may continue to be adversely affected, which would negatively impact our business, financial condition, and results of operations. In addition, many of the industries in which telecommunication service providers operate have experienced consolidation. The loss of one or more of our current or potential telecommunication service provider or telecommunication equipment OEM customers, through industry consolidation or otherwise, could reduce or eliminate our sales to such a customer and consequently harm our business, financial condition, and results of operations.
We expect the developments described above to continue to affect our business for at least the next several quarters in the following manner:
- our ability to accurately forecast revenue will be diminished;
- our revenues could be reduced; and
- our losses may increase because operating expenses are largely based on anticipated revenue trends and a high percentage of our expenses are and will continue to be fixed in the short-term.
Our business, operating results and financial condition could be materially and adversely impacted by any one or a combination of the above.
Our future operating results may not follow past or expected trends due to many factors and any of these could cause our stock price to fall
Our historical operating results have fluctuated significantly and will likely continue to fluctuate in the future, and a decline in our operating results could cause our stock price to fall. On an annual and a quarterly basis, there are a number of factors that may affect our operating results, many of which are outside our control. These include, but are not limited to:
- changes in market demand;
- the timing of customer orders;
- competitive market conditions;
- lengthy sales cycles and/or regulatory approval cycles;
- new product introductions by us or our competitors;
- market acceptance of new or existing products;
- the cost and availability of components;
- the mix of our customer base and sales channels;
- the mix of products sold;
- the management of inventory;
- the level of international sales;
- continued compliance with industry standards; and
- general economic conditions.
Our gross margin is affected by a number of factors including product mix, the recognition of license and other revenues for which there may be little or no corresponding cost of revenues, product pricing, the allocation between international and domestic sales, the percentages of direct sales and sales to resellers, and manufacturing and component costs. The markets for our products are characterized by falling average selling prices. We expect that, as a result of competitive pressures, our product end of life announcement, and other factors, gross profit as a percentage of revenue for our videoconferencing semiconductor products will continue to decrease. Average selling prices realized to date for our IP telephony semiconductors have been lower than those historically attained for our videoconferencing semiconductor products, resulting in lower gross margins. In the likely event that we encounter significant price competition in the markets for our products, we could be at a significant disadvantage compared to our competitors, many of whom have substantially greater resources, and therefore may be better able to withstand an extended period of downward pricing pressure.
Variations in timing of sales may cause significant fluctuations in future operating results. Because a significant portion of our business may be derived from orders placed by a limited number of large customers, including original equipment manufacturers, the timing of such orders can cause significant fluctuations in our operating results. Anticipated orders from customers may fail to materialize. Delivery schedules may be deferred or canceled for a number of reasons, including changes in specific customer requirements or economic conditions. The adverse impact of a shortfall in our revenues may be magnified by our inability to adjust spending to compensate for such shortfall. Announcements by our competitors or us of new products and technologies could cause customers to defer purchases of our existing products, which would also have a material adverse effect on our business and operating results. As a result of these and other factors, it is likely that in some or all future periods our operating results will be below the expectations of investors, which would likely result in a significant reduction in the market price of our common stock.
We depend on purchase orders from key customers and failure to receive significant purchase orders in the future would cause a decline in our operating results
Historically, a significant portion of our sales has been to relatively few customers, although the composition of these customers has varied. Revenues from our ten largest customers for the quarters ended June 30, 2003 and 2002, accounted for approximately 80% of total revenues in each quarter. Revenues from our ten largest customers for the fiscal years ended March 31, 2003, 2002 and 2001, accounted for approximately 62%, 73% and 48%, respectively, of total revenues. Substantially all of our product sales have been made, and are expected to continue to be made, on a purchase order basis. None of our customers has entered into a long-term agreement requiring it to purchase our products. In the future, we will need to gain purchase orders for our products to earn additional revenue. Further, substantially all of our license and other revenues are nonrecurring.
The IP telephony market is subject to rapid technological change and we depend on new product introduction in order to maintain and grow our business
IP telephony is an emerging market that is characterized by rapid changes in customer requirements, frequent introductions of new and enhanced products, and continuing and rapid technological advancement. To compete successfully in this emerging market, we must continue to design, develop, manufacture, and sell new and enhanced semiconductor and IP telephony software products and services that provide increasingly higher levels of performance and reliability at lower cost. These new and enhanced products must take advantage of technological advancements and changes, and respond to new customer requirements. Our success in designing, developing, manufacturing, and selling such products and services will depend on a variety of factors, including:
- the identification of market demand for new products;
- the scalability of our IP telephony software products;
- product and feature selection;
- timely implementation of product design and development;
- product performance;
- cost-effectiveness of products under development;
- effective manufacturing processes; and
- success of promotional efforts.
Additionally, we may also be required to collaborate with third parties to develop our products and may not be able to do so on a timely and cost-effective basis, if at all. We have in the past experienced delays in the development of new products and the enhancement of existing products, and such delays will likely occur in the future. If we are unable, due to resource constraints or technological or other reasons, to develop and introduce new or enhanced products in a timely manner, if such new or enhanced products do not achieve sufficient market acceptance, or if such new product introductions decrease demand for existing products, our operating results would decline and our business would not grow.
The long and variable sales and deployment cycles for our IP telephony products may cause our revenue and operating results to vary
Our IP telephony software and semiconductor products, including our hosted iPBX, Packet8 telephone service and our Audacity family of semiconductors, have lengthy sales cycles, and we may incur substantial sales and marketing expenses and expend significant management effort without making a sale. A customer's decision to purchase our products often involves a significant commitment of its resources and a lengthy product evaluation and qualification process. We do not possess the capital infrastructure required to invest in extensive marketing or advertising campaigns that may be required in order to sell these products. In addition, the length of our sales cycles will vary depending on the type of customer to whom we are selling and the product being sold. Even after making the decision to purchase our products, our customers may deploy our products slowly. Timing of deployment can vary widely and will depend on various factors, including:
- the size of the network deployment;
- the complexity of our customers' network environments;
- our customers' skill sets;
- the hardware and software configuration and customization necessary to deploy our products; and
- our customers' ability to finance their purchase of our products.
As a result, it is difficult for us to predict the quarter in which our customers may purchase our IP telephony products, and our revenue and operating results may vary significantly from quarter to quarter.
We need to retain key personnel to support our products and ongoing operations
The development and marketing of our IP telephony products will continue to place a significant strain on our limited personnel, management, and other resources. While the pace of economic growth in the San Francisco Bay Area (where our corporate headquarters are located) has slowed, competition for highly-skilled engineering, sales, marketing, and support personnel has remained strong. Our future success depends upon the continued services of our executive officers and other key employees who have critical industry experience and relationships that we rely on to implement our business plan. None of our officers or key employees are bound by employment agreements for any specific term. The loss of the services of any of our officers or key employees could delay the development and introduction of, and negatively impact our ability to sell our products which could adversely affect our financial results and impair our growth. We currently do not maintain key person life insurance policies on any of our employees.
We depend on contract manufacturers to manufacture substantially all of our products, and any delay or interruption in manufacturing by these contract manufacturers would result in delayed or reduced shipments to our customers and may harm our business
We outsource the manufacturing of our semiconductor products to independent foundries and as such do not have internal manufacturing capabilities to meet our customers' demands. We have shifted the manufacture of our voice over IP semiconductors to an affiliate of STMicroelectronics NV, or STM, from Taiwan Semiconductor Manufacturing Corporation, or TSMC. STM or its contract manufacturer, TSMC, will be the sole manufacturer of our semiconductor products. Furthermore, to the extent TSMC is utilized, Taiwan is always subject to geological or geopolitical disturbances that could instantly cut off such supply. We also rely on other third party manufacturers for packaging and testing of our semiconductors.
We do not have long-term purchase agreements with our contract manufacturers or our component suppliers. There can be no assurance that our subcontract manufacturers will be able or willing to reliably manufacture our products, in volumes, on a cost-effective basis or in a timely manner. For our semiconductor products, the time to port our technology to another foundry, the time to qualify the new versions of product, and the cost of this effort as well as the tooling associated with wafer production would have a material adverse effect on our business, operating results, and financial condition. For our consumer videophones, IP telephones and media hub devices that are used with our hosted iPBX and Packet8 voice and video IP telephone service, we rely on the availability of these semiconductor products. These devices are also sourced solely from certain overseas contract manufacturers and partners, and are not available from any other manufacturer.
We may not be able to manage our inventory levels effectively, which may lead to inventory obsolescence that would force us to lower our prices
Our products have lead times of up to several months, and are built to forecasts that are necessarily imprecise. Because of our practice of building our products to necessarily imprecise forecasts, it is likely that, from time to time, we will have either excess or insufficient product inventory. Excess inventory levels would subject us to the risk of inventory obsolescence and the risk that our selling prices may drop below our inventory costs, while insufficient levels of inventory may negatively affect relations with customers. For instance, our customers rely upon our ability to meet committed delivery dates, and any disruption in the supply of our products could result in legal action from our customers, loss of customers or harm to our ability to attract new customers. Any of these factors could have a material adverse effect on our business, operating results, and financial condition.
If our products do not interoperate with our customers' networks, orders for our products will be delayed or canceled and substantial product returns could occur, which could harm our business
Many of the potential customers for our hosted iPBX product and Packet8 voice and video IP telephone service have requested that our products and services be designed to interoperate with their existing networks, each of which may have different specifications and use multiple standards. Our customers' networks may contain multiple generations of products from different vendors that have been added over time as their networks have grown and evolved. Our products must interoperate with these products as well as with future products in order to meet our customers' requirements. In some cases, we may be required to modify our product designs to achieve a sale, which may result in a longer sales cycle, increased research and development expense, and reduced operating margins. If our products do not interoperate with existing equipment or software in our customers' networks, installations could be delayed, orders for our products could be canceled or our products could be returned. This could harm our business, financial condition, and results of operations. Our Packet8 telephone service depends on the availability of third party network service providers that provide telephone numbers and PSTN call termination and origination services for our customers. Many of these network service providers are financially affected by the downturn in the telecommunications industry and may be forced to terminate the services that we depend on. The time to interface our technology to another network service provider, if available, and qualify this new service could have a material adverse effect on our business, operating results, and financial condition.
We may have difficulty identifying the source of the problem when there is a problem in a network
Our hosted iPBX and Packet8 IP telephone service must successfully integrate with products from other vendors, such as gateways to traditional telephone systems. As a result, when problems occur in a network, it may be difficult to identify the source of the problem. The occurrence of hardware and software errors, whether caused by our hosted iPBX solution, Packet8 service or another vendor's products, may result in the delay or loss of market acceptance of our products and any necessary revisions may force us to incur significant expenses. The occurrence of some of these types of problems may seriously harm our business, financial condition and results of operations.
Intense competition in the markets in which we compete could prevent us from increasing or sustaining our revenue and prevent us from achieving profitability
We expect our competitors to continue to improve the performance of their current products and introduce new products or new technologies. If our competitors successfully introduce new products or enhance their existing products, this could reduce the sales or market acceptance of our products and services, increase price competition or make our products obsolete. To be competitive, we must continue to invest significant resources in research and development, sales and marketing, and customer support. We may not have sufficient resources to make these investments or to make the technological advances necessary to be competitive, which in turn will cause our business to suffer.
In addition, our focus on developing a range of technology products, including semiconductors and related embedded software, hosted iPBX solutions, and the Packet8 telephone service products, places a significant strain on our research and development resources. Competitors that focus on one aspect of technology, such as software or semiconductors, may have a considerable advantage over us. In addition, many of our current and potential competitors have longer operating histories, are substantially larger, and have greater financial, manufacturing, marketing, technical, and other resources. For example, certain competitors in the market for our semiconductor products maintain their own semiconductor foundries and may therefore benefit from certain capacity, cost and technical advantages. Many also have greater name recognition and a larger installed base of products than we have. Competition in our markets may result in significant price reductions. As a result of their greater resources, many current and potential competitors may be better able than us to initiate and withstand significant price competition or downturns in the economy. There can be no assurance that we will be able to continue to compete effectively, and any failure to do so would harm our business, operating results, and financial condition.
If we do not develop and maintain successful partnerships for IP telephony products, we may not be able to successfully market our solutions
We are entering into new market areas and our success is partly dependent on our ability to forge new marketing and engineering partnerships. IP telephony communication systems are extremely complex and few, if any, companies possess all the required technology components needed to build a complete end to end solution. We will likely need to enter into partnerships to augment our development programs and to assist us in marketing complete solutions to our targeted customers. We may not be able to develop such partnerships in the course of our product development. Even if we do establish the necessary partnerships, we may not be able to adequately capitalize on these partnerships to aid in the success of our business.
Inability to protect our proprietary technology or our infringement of a third party's proprietary technology would disrupt our business
We rely in part on trademark, copyright, and trade secret law to protect our intellectual property in the United States and abroad. We seek to protect our software, documentation, and other written materials under trade secret and copyright law, which afford only limited protection. We also rely in part on patent law to protect our intellectual property in the United States and internationally. We hold fifty-four United States patents and have a number of United States and foreign patent applications pending. We cannot predict whether such pending patent applications will result in issued patents. We may not be able to protect our proprietary rights in the United States or internationally (where effective intellectual property protection may be unavailable or limited), and competitors may independently develop technologies that are similar or superior to our technology, duplicate our technology or design around any patent of ours. We have in the past licensed and in the future expect to continue licensing our technology to others; many of who are located or may be located abroad. There are no assurances that such licensees will protect our technology from misappropriation. Moreover, litigation may be necessary in the future to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of management time and resources and could have a material adverse effect on our business, financial condition, and operating results. Any settlement or adverse determination in such litigation would also subject us to significant liability.
There has been substantial litigation in the semiconductor, electronics, and related industries regarding intellectual property rights, and from time to time third parties may claim infringement by us of their intellectual property rights. Our broad range of technology, including systems, digital and analog circuits, software, and semiconductors, increases the likelihood that third parties may claim infringement by us of their intellectual property rights. If we were found to be infringing on the intellectual property rights of any third party, we could be subject to liabilities for such infringement, which could be material. We could also be required to refrain from using, manufacturing or selling certain products or using certain processes, either of which could have a material adverse effect on our business and operating results. From time to time, we have received, and may continue to receive in the future, notices of claims of infringement, misappropriation or misuse of other parties' proprietary rights. There can be no assurance that we will prevail in these discussions and actions or that other actions alleging infringement by us of third party patents will not be asserted or prosecuted against the Company.
We rely upon certain technology, including hardware and software, licensed from third parties. There can be no assurance that the technology licensed by us will continue to provide competitive features and functionality or that licenses for technology currently utilized by us or other technology which we may seek to license in the future will be available to us on commercially reasonable terms or at all. The loss of, or inability to maintain existing licenses could result in shipment delays or reductions until equivalent technology or suitable alternative products could be developed, identified, licensed and integrated, and could harm our business. These licenses are on standard commercial terms made generally available by the companies providing the licenses. The cost and terms of these licenses individually are not material to our business.
The failure of IP networks to meet the reliability and quality standards required for voice and video communications could render our products obsolete
Circuit-switched telephony networks feature very high reliability, with a guaranteed quality of service. In addition, such networks have imperceptible delay and consistently satisfactory audio quality. Emerging broadband IP networks, such as LANs, WANs, and the internet, or emerging last mile technologies such as cable, digital subscriber lines, and wireless local loop, may not be suitable for telephony unless such networks and technologies can provide reliability and quality consistent with these standards.
Our products must comply with industry standards, FCC regulations, state, country-specific and international regulations, and changes may require us to modify existing products
In addition to reliability and quality standards, the market acceptance of telephony over broadband IP networks is dependent upon the adoption of industry standards so that products from multiple manufacturers are able to communicate with each other. Our IP telephony products rely heavily on standards such as SIP, H.323, MGCP and Megaco to interoperate with other vendors' equipment. There is currently a lack of agreement among industry leaders about which standard should be used for a particular application, and about the definition of the standards themselves. These standards, as well as audio and video compression standards, continue to evolve. We also must comply with certain rules and regulations of the Federal Communications Commission (FCC) regarding electromagnetic radiation and safety standards established by Underwriters Laboratories, as well as similar regulations and standards applicable in other countries. Standards are continuously being modified and replaced. As standards evolve, we may be required to modify our existing products or develop and support new versions of our products. The failure of our products to comply, or delays in compliance, with various existing and evolving industry standards could delay or interrupt volume production of our IP telephony products, which would have a material adverse effect on our business, financial condition and operating results.
Future legislation or regulation of the internet and/or voice and video over IP services could restrict our business or increase our cost of doing business
At present there are few laws, regulations or rulings that specifically address access to or commerce on the internet, including IP telephony. We are unable to predict the impact, if any, that future legislation, legal decisions or regulations concerning the internet may have on our business, financial condition, and results of operations. Regulation may be targeted towards, among other things, assessing access or settlement charges, imposing taxes related to internet communications, imposing tariffs or regulations based on encryption concerns or the characteristics and quality of products and services, imposing regulations and requirements related to the handling of emergency 911 services, any of which could restrict our business or increase our cost of doing business. The increasing growth of the broadband IP telephony market and popularity of broadband IP telephony products and services heighten the risk that governments or other legislative bodies will seek to regulate broadband IP telephony and the internet. In addition, large, established telecommunication companies may devote substantial lobbying efforts to influence the regulation of the broadband IP telephony market, which may be contrary to our interests. Recent federal legislation provides for a significant deregulation of the U.S. telecommunications industry, including the local exchange, long distance and cable television industries. This legislation remains subject to judicial review and additional Federal Communications Commission, or FCC, rulemaking. As a result, we cannot predict the legislation's effect on our future operations. Many regulatory actions are under way or are being contemplated by federal and state authorities regarding important items. These actions could have a material adverse effect on our business, financial condition and operating results.
Potential regulation of internet service providers could adversely affect our operations
To date, the FCC has treated internet service providers as data service providers. Data service providers are currently exempt from federal and state regulations governing common carriers, including the obligation to pay access charges and contribute to the universal service fund. The FCC is currently examining the status of internet service providers and the services they provide. If the FCC were to determine that internet service providers, or the services they provide, are subject to FCC regulation, including the payment of access charges and contribution to the universal service funds, it could have a material adverse effect on our business, financial condition and operating results.
We may lose customers if we experience system failures that significantly disrupt the availability and quality of the services that it provides
The operation of our Packet8 voice and video service depends on our ability to avoid and mitigate any interruptions in service or reduced capacity for customers. Interruptions in service or performance problems, for whatever reason, could undermine confidence in our services and cause us to lose customers or make it more difficult to attract new ones. In addition, because our services may be critical to the businesses of our customers, any significant interruption in service could result in lost profits or other loss to our customers. Although we attempt to disclaim liability in our service agreements, a court might not enforce a limitation on liability, which could expose us to financial loss. In addition, we may provide our customers with guaranteed service level commitments. If we are unable to meet these guaranteed service level commitments as a result of service interruptions, we may be obligated to provide credits, generally in the form of free service for a short period of time, to our customers, which could negatively affect our operating results.
The failure of any equipment or facility on our network, or those of our partners or customers, could result in the interruption of customer service until necessary repairs are made or replacement equipment is installed. Network failures, delays and errors could also result from natural disasters, terrorist acts, power losses, security breaches and computer viruses. These failures, faults or errors could cause delays, service interruptions, expose us to customer liability or require expensive modifications that could have a material adverse effect on our business, financial condition and operating results.
We could be liable for breaches of security on our web site, fraudulent activities of our users, or the failure of third-party vendors to deliver credit card transaction processing services
A fundamental requirement for operating an internet-based, worldwide voice and video telephone service and electronically billing our Packet8 customers is the secure transmission of confidential information over public networks. Although we have developed systems and processes that are designed to protect consumer information and prevent fraudulent credit card transactions and other security breaches, failure to mitigate such fraud or breaches may adversely affect our operating results. The law relating to the liability of providers of online payment services is currently unsettled. We rely on third party providers to process and guarantee payments made by Packet8 subscribers up to certain limits, and we may be unable to prevent our users from fraudulently receiving goods and services. Our liability risk will increase if a larger fraction of our Packet8 transactions involve fraudulent or disputed credit card transactions. Any costs we incur as a result of fraudulent transactions could harm our business. In addition, the functionality of our current billing system relies on certain third-party vendors delivering services. If these vendors are unable or unwilling to provide services, we will not be able to charge for our Packet8 services in a timely or scalable fashion.
Intellectual property and proprietary rights of others could prevent us from using necessary technology to provide IP voice and video services
While we do not know of any technologies that are patented by others that we believe are necessary for us to provide our services, this necessary technology may in fact be patented by other parties either now or in the future. If this technology were held under patent by another person, we would have to negotiate a license for the use of that technology. We may not be able to negotiate such a license at a price that is acceptable. The existence of such a patent, or our inability to negotiate a license for any such technology on acceptable terms, could force us to cease using the technology and offering products and services incorporating the technology.
We may transition to smaller geometry process technologies and higher levels of design integration, which could disrupt our business
We continuously evaluate the benefits, on an integrated circuit, product-by-product basis, of migrating to smaller geometry process technologies in order to reduce costs related to the development and production of our semiconductors or to improve their performance. We believe that the transition of our products to increasingly smaller geometries will be important for us to remain competitive. We have in the past experienced difficulty in migrating to new manufacturing processes - which has resulted and could continue to result in reduced yields, delays in product deliveries, and increased expense levels. Moreover, we are dependent on relationships with our foundry and their partners to migrate to smaller geometry processes successfully. If any such transition is substantially delayed or inefficiently implemented, we may experience delays in product introductions and incur increased expenses. As smaller geometry processes become more prevalent, we expect to integrate greater levels of functionality, as well as customer and third party intellectual property, into our products. We cannot predict whether higher levels of design integration or the use of third party intellectual property will adversely affect our ability to deliver new integrated products on a timely basis, or at all.
If we discover product defects, we may have product-related liabilities which may cause us to lose revenues or delay market acceptance of our products
Products as complex as those we offer frequently contain errors, defects, and functional limitations when first introduced or as new versions are released. We have in the past experienced such errors, defects or functional limitations. We sell products into markets that are extremely demanding of robust, reliable, fully functional products. Therefore, delivery of products with production defects or reliability, quality or compatibility problems could significantly delay or hinder market acceptance of such products, which could damage our credibility with our customers and adversely affect our ability to retain our existing customers and to attract new customers. Moreover, such errors, defects or functional limitations could cause problems, interruptions, delays or a cessation of sales to our customers. Alleviating such problems may require significant expenditures of capital and resources by us. Despite our testing, our suppliers or our customers may find errors, defects or functional limitations in new products after commencement of commercial production. This could result in additional development costs, loss of, or delays in, market acceptance, diversion of technical and other resources from our other development efforts, product repair or replacement costs, claims by our customers or others against us, or the loss of credibility with our current and prospective customers.
We have significant international operations, which subject us to risks that could cause our operating results to decline
In the first quarters of fiscal 2003 and 2002, sales to customers outside of the United States represented 61% and 52% of our total sales. Sales to customers outside of the United States during the years ended March 31, 2003, 2002 and 2001 were 62%, 61% and 69% of total revenues, respectively. The following table illustrates our net revenues by geographic area expressed as a percentage of total revenues for the corresponding period. Revenues are attributed to countries based on the destination of shipment (in thousands):
Three Months Ended
June 30,
--------------------
2003 2002
--------- ---------
United States............................ 39% 48%
Europe................................... 25% 35%
Asia Pacific............................. 36% 17%
--------- ---------
100% 100%
========= =========
Substantially all of our current semiconductor and system-level products are, and substantially all of our future products will be, manufactured, assembled, and tested by independent third parties in foreign countries. International sales and manufacturing are subject to a number of risks, including general economic conditions in regions such as Asia, changes in foreign government regulations and telecommunication standards, export license requirements, tariffs and other trade barriers, potentially adverse tax consequences, fluctuations in currency exchange rates, greater difficulty in collecting accounts receivable and longer collection periods, the impact of recessions in economies outside of the United States, and difficulty in staffing and managing foreign operations. We are also subject to geopolitical risks, such as political, social, and economic instability, potential hostilities, and changes in diplomatic and trade relationships, in connection with our international operations. Taiwan in particular is subject to a high rate of natural disasters, such as earthquakes or typhoons, which could have significant impact on our suppliers and customers due to a delay in operations within that country. In addition, Taiwan's tenuous relationship with mainland China is a source of continuing concern due to potential hostilities. A significant decline in demand from foreign markets could have a material adverse effect on our business, operating results, and financial condition.
The location of our headquarters facility subjects us to the risk of earthquakes
Our corporate headquarters is located in the San Francisco Bay area of Northern California, a region known for seismic activity. A significant natural disaster, such as an earthquake, could have a material adverse impact on our business, operating results, and financial condition.
We may face interruption of production and services due to increased security measures in response to recent and potential future terrorist activities
Our business depends on the free flow of products and services through the channels of commerce. Recently, in response to terrorists' activities and threats aimed at the United States, transportation, mail, financial and other services have been slowed or stopped altogether. Further delays or stoppages in transportation, mail, financial or other services, particularly any such delays or stoppages which harm our ability to obtain an adequate supply of products from our independent suppliers, could harm our business, results of operations and financial condition. Furthermore, we may experience an increase in operating costs, such as costs for transportation, insurance and security as a result of the terrorist activities and potential activities. We may also experience delays in receiving payments from customers that have been affected by the terrorist activities and potential activities. The United States economy in general is being adversely affected by terrorist activities and potential terrorist activities. Any economic downturn could adversely impact our results of operations, impair our ability to raise capital or otherwise adversely affect our ability to grow our business. Moreover, we cannot determine whether other attacks may occur in the future and the effects of such attacks on our business.
These risk factors could cause actual results to differ materially from the results anticipated in forward-looking statements
The reports that we file with the SEC and our other communications may contain forward-looking statements that involve risks and uncertainties. We consider forward-looking statements to be those statements that describe intentions, beliefs, and current expectations with respect to future operating performance. Our actual results could differ materially from those anticipated in our forward-looking statements as a result of certain factors.
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation, as of a date within ninety days of the filing of this Report on Form 10-Q, the Company's Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934) are effective. There have been no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
PART II -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
99.1 Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (This certification, required as Exhibit 31 under Item 601(a) of Regulation S-K, is filed as Exhibit 99.1 pursuant to SEC interim filing guidance.)
99.2 Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (This certification, required as Exhibit 31 under Item 601(a) of Regulation S-K, is filed as Exhibit 99.2 pursuant to SEC interim filing guidance.)
99.3 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (This certification, required as Exhibit 32 under Item 601(a) of Regulation S-K, is furnished in accordance with Item 601(b)(32)(ii) of Regulation S-K as Exhibit 99.3 pursuant to SEC interim filing guidance.)
99.4 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (This certification, required as Exhibit 32 under Item 601(a) of Regulation S-K, is furnished in accordance with Item 601(b)(32)(ii) of Regulation S-K as Exhibit 99.4 pursuant to SEC interim filing guidance.)
(b) Reports on Form 8-K.
None.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: July 25, 2003
8X8, INC. |
(Registrant) |
By: /s/ James Sullivan |
James Sullivan |
Chief Financial Officer, Vice President of Finance and Secretary |