SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A Amendment No. 1 (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly period ended July 4, 1998 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 000-24918 --------- SHIVA CORPORATION (Exact name of registrant as specified in its charter) Massachusetts 04-2889151 ------------- ---------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 28 Crosby Drive, Bedford, MA 01730 (Address of principal executive offices, including Zip Code) (781) 687-1000 (Registrant's telephone number, including area code) -------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES /X/ NO / / The number of shares outstanding of the registrant's Common Stock as of July 4, 1998 was 30,330,020. 1 RESTATEMENT OF FINANCIAL STATEMENTS AND CHANGES TO CERTAIN INFORMATION While responding to a comment letter received from the staff of the Securities and Exchange Commission (the "SEC"), the Company reviewed staff guidance issued on September 15, 1998 with respect to the method used to value acquired in-process research and development ("R&D") associated with the Company's acquisition of Isolation Systems Limited ("Isolation") in the first quarter of 1998. As a result of this review, the Company has modified the method used to value such acquired in-process R&D. Initial calculations to value the acquired in-process R&D were based upon a methodology that focused on the after-tax cash flows attributable to the technology on an overall basis, without regard to the stage of completion of individual projects, and the selection of an appropriate rate of return to reflect the risk associated with the stage of completion of the technology. Revised calculations were based upon the methodology set forth in the SEC's September 1998 letter to the AICPA that requires consideration of the stage of completion of the individual in-process R&D projects at the date of acquisition. As a result of applying the revised calculations, the Company has restated its financial statements for the quarters ended April 4, July 4, and October 3, 1998 (See Note 9 to the Company's consolidated financial statements). This Quarterly Report on Form 10Q/A amends and restates items 1 and 2 of Part I and item 6 of Part II of the Company's Quarterly Report on Form 10-Q previously filed for the quarter ended July 4, 1998. 2 SHIVA CORPORATION Consolidated Balance Sheet (in thousands, except share related data) July 4, January 3, 1998 1998 ----------- ----------- (unaudited) (As Restated- See Note 9) Assets Current assets: Cash and cash equivalents $ 21,113 $ 58,915 Short-term investments 45,914 36,868 Accounts receivable, net of allowances of $8,148 at July 4, 1998 and $8,037 at January 3, 1998 19,493 23,169 Inventories 10,939 14,058 Deferred income taxes 8,683 8,683 Prepaid expenses and other current assets 2,102 2,369 -------- -------- Total current assets 108,244 144,062 Property, plant and equipment, net 20,185 26,093 Deferred income taxes 13,311 8,840 Goodwill, net 31,987 - Other assets 4,885 3,251 -------- -------- Total assets $178,612 $182,246 ======== ======== Liabilities and stockholders' equity Current liabilities: Accounts payable $ 6,542 $ 9,376 Accrued expenses 28,692 22,304 Deferred revenue 5,002 4,068 -------- -------- Total current liabilities 40,236 35,748 Deferred income taxes 561 554 -------- -------- Total liabilities 40,797 36,302 -------- -------- Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value; 1,000,000 shares authorized, none issued - - Common stock, $.01 par value; 100,000,000 shares authorized, 30,436,135 and 29,605,848 shares issued and outstanding at July 4, 1998 and January 3, 1998, respectively 304 296 Additional paid-in capital 154,688 153,036 Treasury stock at cost, 106,115 shares at July 4, 1998 (1,307) - Unrealized gain on investments 32 110 Cumulative translation adjustment (244) (308) Accumulated deficit (15,658) (7,190) -------- -------- Total stockholders' equity 137,815 145,944 -------- -------- Total liabilities and stockholders' equity $178,612 $182,246 ======== ======== <FN> The accompanying notes are an integral part of the consolidated financial statements. 3 SHIVA CORPORATION Consolidated Statement of Operations (in thousands, except per share data) (unaudited) Three months ended Six months ended ---------------------- ---------------------- July 4, June 28, July 4, June 28, 1998 1997 1998 1997 -------- -------- -------- -------- (As Restated- (As Restated- See Note 9) See Note 9) Revenues: Product $27,678 $33,598 $57,494 $58,966 Service 8,460 1,628 16,634 3,169 Licenses and Royalties 2,156 4,512 2,197 8,762 ------- ------- ------- ------- Total revenues 38,294 39,738 76,325 70,897 ------- ------- ------- ------- Cost of revenues: Product 12,524 14,256 25,879 34,343 Service 5,038 1,693 10,232 3,245 ------- ------- ------- ------- Total cost of revenues 17,562 15,949 36,111 37,588 ------- ------- ------- ------- Gross profit 20,732 23,789 40,214 33,309 ------- ------- ------- ------- Operating expenses: Research and development 4,640 5,778 9,221 11,739 Selling, general and administrative 14,994 20,409 29,802 38,307 In-process research and development - - 2,100 - Goodwill amortization 2,908 - 2,908 - Restructuring expenses 9,435 - 11,065 - ------- ------- ------- ------- Total operating expenses 31,977 26,187 55,096 50,046 ------- ------- ------- ------- Loss from operations (11,245) (2,398) (14,882) (16,737) Interest income 891 938 2,014 1,900 Interest and other income (expense), net 614 (146) 415 (268) -------- ------- -------- -------- Loss before income taxes (9,740) (1,606) (12,453) (15,105) Income tax benefit (3,117) (610) (3,985) (5,739) -------- ------- --------- -------- Net loss $(6,623) $ (996) $ (8,468) $(9,366) ======== ======== ========= ======== Net loss per share - basic and diluted $ (0.22) $ (0.03) $ (0.28) $ (0.32) ======== ======== ========= ======== Shares used in computing net loss per share - basic and diluted 30,277 29,128 30,065 29,050 ======== ======== ========= ======== <FN> The accompanying notes are an integral part of the consolidated financial statements. 4 SHIVA CORPORATION Consolidated Statement of Cash Flows Increase (Decrease) in Cash and Cash Equivalents (in thousands) (unaudited) Six Months Ended ----------------------- July 4, June 28, 1998 1997 ------- -------- (As Restated- See Note 9) Cash flows from operating activities Net loss $ (8,468) $ (9,366) Adjustments to reconcile net loss to net cash provided by operating activities: In-process research and development 2,100 - Depreciation and amortization 9,005 4,631 Non-cash restructuring charge 3,570 - Deferred income taxes (4,023) (6,443) Changes in assets and liabilities, net of effects of acquisition: Accounts receivable 4,531 13,640 Inventories 3,221 2,162 Prepaid expenses and other current assets 310 19 Accounts payable (3,353) (4,239) Accrued expenses 6,341 (420) Deferred revenue 929 571 Other long-term liabilities - (17) -------- -------- Net cash provided by operating activities 14,163 538 -------- -------- Cash flows from investing activities Purchases of property, plant and equipment (2,257) (5,910) Payments for acquisition (39,912) - Capitalized software development costs (88) (399) Purchases of short-term investments (27,119) (10,686) Proceeds from maturity and sales of short-term investments 17,995 16,109 Change in other assets (330) (824) -------- -------- Net cash used by investing activities (51,711) (1,710) --------- --------- Cash flows from financing activities Principal payments on long-term debt and capital lease obligations (117) (229) Purchases of treasury stock (1,307) - Proceeds from exercise of stock options 1,212 671 --------- --------- Net cash provided (used) by financing activities (212) 442 --------- --------- Effects of exchange rate changes on cash and cash equivalents (42) 583 --------- --------- Net decrease in cash and cash equivalents (37,802) (147) Cash and cash equivalents, beginning of period 58,915 72,067 --------- --------- Cash and cash equivalents, end of period $ 21,113 $ 71,920 ========= ========= <FN> The accompanying notes are an integral part of the consolidated financial statements. 5 SHIVA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. BASIS OF PRESENTATION: The accompanying unaudited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, and have been prepared by the Company in accordance with generally accepted accounting principles. In the opinion of management, these unaudited consolidated financial statements contain all adjustments necessary for a fair presentation of the Company's financial position, results of operations and cash flows at the dates and for the periods indicated. Such adjustments are of a normal recurring nature, except for the restructuring charges incurred during the three-month and six- month periods ended July 4, 1998 and the in-process R&D charges incurred during the six-month period ended July 4, 1998. While the Company believes that the disclosures presented are adequate to make the information not misleading, these consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended January 3, 1998. The results of operations for the three-month and six-month periods ended July 4, 1998 are not necessarily indicative of the results expected for the full fiscal year. 2. EARNINGS PER SHARE: The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share," and has restated earnings per share amounts for all periods presented herein. Three months ended Six months ended ------------------------- ------------------------ July 4, June 28, July 4, June 28, 1998 1997 1998 1997 ------------ ----------- ------------ ---------- (As Restated (As Restated See Note 9) See Note 9) Net Loss ($6,623,000) ($996,000) ($8,468,000) ($9,366,000) ============ =========== ============ ============ Weighted average shares outstanding 30,276,645 29,128,123 30,065,206 29,049,872 Common-equivalent shares outstanding - - - - ------------ ----------- ------------ ------------ Weighted average and common-equivalent shares outstanding 30,276,645 29,128,123 30,065,206 29,049,872 ------------ ----------- ------------ ------------ Basic and diluted net loss per share ($0.22) ($0.03) ($0.28) ($0.32) ============= =========== ============ ============ 3. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS: At July 4, 1998, the Company had cash and cash equivalents of $21,113,000 and $45,914,000 of short-term investments, including an unrealized gain of $32,000 recorded as a separate component of stockholders' equity. The Company's short-term investments at July 4, 1998, classified as available-for-sale, consist of municipal securities, corporate debt securities, certificates of deposit, and U.S. Treasury securities, with various maturity dates through June 2000. 6 4. INVENTORIES: Inventories consist of the following: (in thousands) July 4, January 3, 1998 1998 ---- ---- Raw materials $ 5,150 $ 7,199 Work-in-process 126 57 Finished goods 5,663 6,802 ------- ------- $10,939 $14,058 ======= ======= 5. COMPREHENSIVE LOSS: In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income." The Company adopted SFAS 130 on January 4, 1998, which establishes standards for reporting comprehensive income and its components in the consolidated financial statements. Comprehensive loss, as restated, for the three-month and six-month periods ended July 4, 1998 was $6,733,000 and $8,478,000, respectively, and includes the after-tax effect of foreign currency translation adjustments and unrealized holding losses arising during the period. 6. ACQUISITION: On March 26, 1998, the Company acquired Isolation, a leading developer of virtual private networking ("VPN") hardware and software solutions based in Toronto, Ontario in exchange for cash paid by the Company from its existing cash and short-term balances. The acquisition was accounted for as a purchase. Accordingly, the purchase price of approximately $39,912,000 was allocated to the underlying assets and liabilities based on their respective fair values at the date of closing. The estimated fair value of the net assets acquired was $617,000, and $2,100,000 of the purchase price was allocated to in-process R&D. The amount allocated to in-process R&D was determined based upon the methodology set forth in the SEC's September 1998 letter to the AICPA that requires consideration of the stage of completion of the individual in-process R&D projects at the date of acquisition. The in-process R&D was expensed upon acquisition, as it was determined that technological feasibility had not been established and no alternative uses existed. The excess of the purchase price over the net assets acquired and the in-process R&D is being amortized on a straight-line basis over three years. This excess approximated $37,195,000, and consisted of $34,895,000 recorded as goodwill, while the remaining amount, which has been included in other assets in the accompanying financial statements, consisted of $2,000,000 related to developed technology and $300,000 related to an assembled workforce. Pursuant to an indemnification agreement with Isolation, the Company has a contingent liability up to a maximum of approximately $6,500,000 in relation to certain foreign tax liabilities and associated interest. The obligations of Shiva only arise if Isolation is assessed or reassessed on the basis that a portion of the property sold is of a particular nature. The purpose of the agreement was to ensure that Isolation and its shareholders were not subject to adverse tax consequences as a result of the terms of the Company's agreement to acquire Isolation. The following summary, prepared on an unaudited pro forma basis, combines the results of operations as if Isolation had been acquired as of December 29, 1996; however the one-time charge of $2,100,000 as a result of the purchase price allocated to in- process R&D has been excluded due to its non-recurring nature. The pro forma results have been adjusted in each of the periods presented below to reflect the loss of interest income as a result of the cash used in the acquisition as well as the amortization of goodwill resulting from the transaction. 7 (in thousands) Three-months ended Six-months ended ------------------------ ------------------------ July 4, June 28, July 4, June 28, 1998 1997 1998 1997 ----------- ----------- --------- ---------- (As Restated (As Restated See Note 9) See Note 9) Total revenues $ 38,294 $ 39,890 $ 77,583 $ 71,276 Operating loss (11,245) (6,118) (15,901) (24,414) Net loss (6,623) (3,538) (9,392) (14,589) ========= ========= ========= ========= Net loss per share - basic and diluted $ (0.22) $ (0.12) $ (0.31) $ (0.50) ========= ========= ========= ======== The unaudited pro forma results are not necessarily indicative of what actually would have occurred if the acquisition had been in effect for the entire periods presented. In addition, they are not intended to be a projection of future results and do not reflect any synergies that might be achieved from combined operations. 7. RESTRUCTURING EXPENSES: In the three-month period ended July 4, 1998, the Company approved and implemented a restructuring program to align its financial model with its strategic focus on providing remote access solutions for business. The plan included a reduction of the Company's worldwide workforce by approximately 130 employees, most of which were based in Europe and the remainder in the United States. A majority of these employees identified were terminated on July 13, 1998 and the remaining terminations are expected to be substantially complete by the end of fiscal 1998. The Company recorded restructuring expenses of $9,435,000 in the three-month period ended July 4, 1998, which included $4,585,000 for severance, benefits and other personnel-related expenses, $3,570,000 in non-cash expenses for fixed asset write-downs, and $647,000 in advertising and marketing, and $633,000 in transition and other costs. As of July 4, 1998, $1,186,000 of severance, benefits and other personnel-related costs and $217,000 of transition and other costs had been paid, and approximately $4,462,000 remained as an accrued liability. In addition, the Company recorded $1,630,000 of restructuring expenses during the first quarter of fiscal 1998. These expenses, comprised of severance-related costs of $1,482,000 and transition and other costs of $148,000, were the result of the restructuring of the Company's sales and marketing operations. Substantially all of these costs have been paid. 8. RECENTLY ENACTED ACCOUNTING PRONOUNCEMENTS: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133). FAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999. FAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. For fair-value hedge transactions in which the Company is hedging changes in an asset's, liability's, or firm commitment's fair value, changes in the fair value of the derivative instrument will generally be offset in the income statement by changes in the hedged item's fair value. For cash-flow hedge transactions, in which the Company is hedging the variability of cash flows related to a variable-rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified as earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. The ineffective portion of all hedges will be recognized in current- period earnings. The Company has not yet determined the impact that the adoption of FAS 133 will have on its earnings or statement of financial position. 8 9. RESTATEMENT: While responding to a comment letter received from the staff of the SEC, the Company reviewed staff guidance issued on September 15, 1998 with respect to the method used to value acquired in- process R&D associated with the Company's acquisition of Isolation in the first quarter of 1998. As a result of this review, the Company has modified the method used to value such acquired in-process R&D. Initial calculations to value the acquired in-process R&D were based upon a methodology that focused on the after-tax cash flows attributable to the technology on an overall basis, without regard to the stage of completion of individual projects, and the selection of an appropriate rate of return to reflect the risk associated with the stage of completion of the technology. Revised calculations were based upon the methodology set forth in the SEC's September 1998 letter to the AICPA that requires consideration of the stage of completion of the individual in-process R&D projects at the date of acquisition. After applying the revised calculations, the Company has restated its financial statements for the quarters ended April 4, 1998 and July 4, 1998 and has decreased the amount of the purchase price allocated to acquired in-process R&D associated with the Isolation acquisition from $34,500,000 to $2,100,000 and increased goodwill by $32,400,000. Goodwill is being amortized over a three year period. The Company has also stated the amount of goodwill amortization as a separate line item in the consolidated statement of operations; goodwill amortization had been included in the Company's selling, general and administrative expenses prior to the restatement for the three-month and six-month periods ended July 4, 1998. A summary of the significant effects of the restatement are as follows (in thousands): 9 Statement of Operations: Three months Six months Ended Ended July 4, 1998 July 4, 1998 ------------- ------------ Operating expenses: As previously reported $29,277 $ 84,796 Adjustment related to in-process R&D and goodwill amortization 2,700 (29,700) --------- ---------- Restated 31,977 55,096 ========= ========== Loss before income taxes: As previously reported (7,040) (42,153) Adjustment related to in-process R&D and goodwill amortization (2,700) 29,700 ---------- ---------- Restated (9,740) (12,453) ========== ========== Income tax benefit: As previously reported (2,253) (13,489) Adjustment related to in-process R&D and goodwill amortization (864) 9,504 ---------- ---------- Restated (3,117) (3,985) ========== ========== Net loss: As previously reported (4,787) (28,664) Adjustment related to in-process R&D and goodwill amortization (1,836) 20,196 ---------- ---------- Restated (6,623) (8,468) ========== ========== Net loss per share - basic and diluted: As previously reported (0.16) (0.95) Adjustment related to in-process R&D and goodwill amortization (0.06) 0.67 ---------- ---------- Restated $ (0.22) $ (0.28) ========== ========== Balance Sheet: July 4, 1998 -------------------------- As Previously Reported As Restated ------------- ----------- Goodwill, net (1) $ - $ 31,987 Other assets (1) 7,172 4,885 Long-term deferred income taxes 22,815 13,311 Total assets 158,416 178,612 Total stockholders' equity 117,619 137,815 <FN> (1) Goodwill, net, in the amount of $2,287 was included in other assets prior to restatement. 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Restatement While responding to a comment letter received from the staff of the SEC, the Company reviewed staff guidance issued on September 15, 1998 with respect to the method used to value acquired in- process R&D associated with the Company's acquisition of Isolation in the first quarter of 1998. As a result of this review, the Company has modified the method used to value such acquired in-process R&D. Initial calculations to value the acquired in-process R&D were based upon a methodology that focused on the after-tax cash flows attributable to the technology on an overall basis, without regard to the stage of completion of individual projects, and the selection of an appropriate rate of return to reflect the risk associated with the stage of completion of the technology. Revised calculations were based upon the methodology set forth in the SEC's September 1998 letter to the AICPA that requires consideration of the stage of completion of the individual in-process R&D projects at the date of acquisition. After applying the revised calculations, the Company has restated its financial statements for the quarters ended April 4, 1998 and July 4, 1998 and has decreased the amount of the purchase price allocated to acquired in-process R&D associated with the Isolation acquisition from $34,500,000 to $2,100,000 and increased goodwill by $32,400,000. Goodwill is being amortized over a three year period. The Company has also stated the amount of goodwill amortization as a separate line item in the consolidated statement of operations; goodwill amortization had been included in the Company's selling, general and administrative expenses prior to the restatement for the three-month and six-month periods ended July 4, 1998. Results of Operations Nortel Agreement. On February 27, 1998, the Company signed a new multi-year agreement (the "1998 Agreement") with Northern Telecom Inc. ("Nortel"). The Company and Nortel have been working together to provide remote access equipment to service providers since 1995. Under the new agreement, Nortel issues purchase orders for a minimum of $5,000,000 per quarter to purchase the Company's products with a minimum aggregate amount of $40,000,000 over the term of the contract, which began in the three-month period ended April 4, 1998. The Company's ability to recognize revenue related to these purchase orders, however, may be impacted by several factors including, but not limited to, the timing of the orders placed, the ability of the Company to ship products in a timely fashion and product availability. These OEM purchases from Nortel replace the minimum royalty arrangement with the Company that was in effect during fiscal 1997. In addition, the Company received total professional services revenue of $12,000,000 during the first two quarters of fiscal 1998 from Nortel related to the development of carrier class remote access technology. The OEM purchases and professional services are expected to result in higher revenues from Nortel in fiscal 1998 which will carry lower gross margins than achieved in 1997. Gross margins on sales to Nortel are expected to decline in fiscal 1998 primarily due to the fact that a significant portion of the revenues from Nortel in fiscal 1997 consisted of royalty revenues, with little or no direct cost, related to the Rapport 112, an OEM version of the LanRover Access Switch. On April 23, 1998, Nortel exercised its option under the 1998 Agreement to license certain Shiva technology. Pursuant to the terms of the agreement, Shiva will record a total of $26,000,000 ratably over ten quarters, or $2,600,000 per quarter, which began in the second quarter of fiscal 1998, for the license and other items related to intellectual property. Proceeds from this license agreement will be accounted for as $2,000,000 in LanRover Access Switch revenue and $600,000 in other income per quarter over the license term. Revenues. Revenues in the three-month and six-month periods ended July 4, 1998 were $38,294,000 and $76,325,000, respectively, compared to $39,738,000 and $70,897,000 in the comparable periods in fiscal 1997, respectively. The 4% decrease in revenues in the three-month period ended July 4, 1998 was primarily due to lower volume shipments of the Company's LanRover and LanRover Access Switch products. Revenues increased 8% in the six-month period ended July 4, 1998 compared to the corresponding period in fiscal 1997 principally due to higher service revenues, which increased to $16,634,000 in the six-month period ended July 4, 1998 from $3,169,000 during the comparable 11 period in fiscal 1997. This increase was primarily due to $12,000,000 in professional services revenue from Nortel related to the development of carrier class remote access technology pursuant to the 1998 Agreement. This increase in service revenues was partially offset by lower product and license and royalty revenues. Revenues in the six-month period ended June 28, 1997 were negatively impacted by price protection provisions of $6,700,000, of which $3,900,000 related to the LanRover and $2,800,000 related to the LanRover Access Switch due to increased price competition and price reductions on the V. 34 modem card due to the availability of 56K modem technology in the access concentrator market. Price protection rights require the Company to grant retroactive price adjustments for inventories of the Company's products held by distribution partners if the Company lowers its prices for such products. Revenues from the LanRover Access Switch in the three-month and six-month periods ended July 4, 1998 decreased to $14,978,000 and $29,517,000, respectively, from $19,882,000 and $31,248,000 in the comparable periods in fiscal 1997, primarily due to lower volume shipments. Revenues from the LanRover Access Switch in fiscal 1997 included minimum royalty revenues from Nortel that were based on sales of the Nortel Rapport 112, an OEM version of the LanRover Access Switch. These royalty revenues, which will not recur in fiscal 1998 as outlined above, were partially offset by price protection provisions of $2,800,000 recorded in the first quarter of fiscal 1997 as outlined above. Revenues from the LanRover product line in the three-month and six-month periods ended July 4, 1998 decreased to $8,392,000 and $18,138,000, respectively, from $13,433,000 and $25,763,000 in the comparable periods in fiscal 1997, primarily due to lower volume shipments. LanRover revenues in the six-month period ended June 28, 1997 were negatively impacted by price protection provisions of $3,900,000 as previously mentioned. Revenues from the Company's other remote access products increased to $5,228,000 and $9,179,000, respectively, in the three-month and six-month periods ended July 4, 1998 from $3,035,000 and $7,032,000 in the comparable periods in fiscal 1997. The increase in the three-month and six-month periods ended July 4, 1998 was primarily related to sales of the Shiva AccessPort product for the small office and home office market and the introduction of the LanRover VPN Gateway product as a result of the acquisition of Isolation on March 26, 1998, partially offset by decreased revenues from certain other products. The Company provides its distributors and resellers with product return rights for stock balancing and product evaluation. Revenues were reduced by provisions for product returns of $1,993,000, or 5% of gross revenues, and $5,316,000, or 7% of gross revenues, in the three-month and six-month periods ended July 4, 1998, respectively. Provisions for product returns in the corresponding periods in fiscal 1997 were $726,000, or 2% of gross revenues, and $11,345,000, or 14% of gross revenues. The decrease in the provision for product returns in the six-month period ended July 4, 1998 compared to the same period in fiscal 1997 was primarily a result of provisions recorded in the first quarter of fiscal 1997 to account for slow-moving and discontinued products in the Company's North American distribution channels. Revenues from OEM customers represented 35% and 32% of revenues in the three-month and six-month periods ended July 4, 1998, respectively, compared to 19% and 25% in the comparable periods in fiscal 1997. The increase in OEM revenues was primarily due to increased revenues from Nortel, partially offset by decreased revenues from IBM. International revenues accounted for 32% and 36% of revenues in the three-month and six-month periods ended July 4, 1998, respectively, compared with 45% and 53% in the corresponding periods in fiscal 1997. International revenues were lower in the three-month and six-month periods ended July 4, 1998 due to weakness in Europe and the Pacific Rim. International revenues represented a higher proportion of total revenues in the six- month period ended June 28, 1997 due to the impact of the return provisions and price protection provisions that significantly reduced revenues from the Company's North American distribution channels in 1997. Gross Profit. Gross profit was $20,732,000 and $40,214,000, in the three-month and six-month periods ended July 4, 1998, respectively, compared to $23,789,000 and $33,309,000 in the comparable periods in fiscal 1997. This represented 54% and 53% of revenues in the three-month and six-month periods ended July 4, 1998, respectively, compared to 60% and 47% in the 12 corresponding periods in 1997. Gross profit in the six-month period ended June 28, 1997 included the negative impact of price protection provisions of $6,700,000, as discussed above, and provisions for slow-moving inventories. The provisions for slow- moving inventories increased cost of revenues by $6,463,000, and related to V.34 modem cards, for which demand had decreased due to the availability of 56K modem technology, and certain other products. Excluding the impact of these provisions, gross profit as a percentage of revenues would have been 60% in the six-month period ended June 28, 1997. Gross profit as a percentage of revenues was negatively impacted in the three-month and six-month periods ended July 4, 1998 due to the professional services revenue and OEM product revenues from Nortel. Each of these revenue streams from Nortel carried lower gross profit percentages than the Company's non-Nortel product revenues, and significantly lower gross profit percentages than the Nortel royalty revenues recorded in the year earlier periods. The lower gross profit percentages on the professional services revenue and the OEM product revenues from Nortel are partially offset by the 100% gross profit on the $2,000,000 LanRover Access Switch revenue related to the previously mentioned license agreement with Nortel. In the future, the Company's gross margins may be affected by several factors, including but not limited to the competitive pricing environment, product mix, the distribution channels used, changes in component costs and the introduction of new products. Research and Development. Research and development expenses during the six-month period ended July 4, 1998 related to the development of new and existing remote access products, including products which incorporate technology to support virtual private networking. Research and development expenses decreased to $4,640,000 and $9,221,000 in the three-month and six-month periods ended July 4, 1998 from $5,778,000 and $11,739,000 during the comparable periods in fiscal 1997. The decrease in these expenses was primarily due to the restructuring of the Nortel arrangement in fiscal 1998 under which Nortel contracted with the Company for the development of carrier class remote access technology. Under the terms of the 1998 Agreement, the Company has recognized $6,000,000 in professional services revenue during each of the first two quarters of fiscal 1998 as work was performed. Accordingly, expenses related to these development efforts of $3,711,000 and $7,422,000 in the three-month and six- month periods ended July 4, 1998, respectively, have been included in cost of service revenues in the accompanying statement of operations. Customer funded development fees under cost sharing relationships (including those with Nortel in fiscal 1997), which are reflected as an offset to research and development expenses, were $1,818,000 and $3,454,000 in the three- month and six-month periods ended June 28, 1997. There were no such fees recorded in the three-month and six-month periods ended July 4, 1998. There were no capitalized software development costs in the three-month period ended July 4, 1998, compared with $245,000 for the comparable period in fiscal 1997. Capitalized software development costs were $88,000 for the six-month period ended July 4, 1998, compared with $400,000 in the comparable period in fiscal 1997. Gross research and development expenses increased to $8,352,000 and $16,731,000, respectively, in the three-month and six-month periods ended July 4, 1998 from $7,840,000 and $15,593,000 in the comparable periods in fiscal 1997. The Company anticipates continued significant investment in research and development primarily focused on providing remote access solutions for the business access market. Selling, General and Administrative. Selling, general and administrative expenses decreased to $14,994,000 and $29,802,000 in the three-month and six-month periods ended July 4, 1998 from $20,409,000 and $38,307,000 in the comparable periods in fiscal 1997. These expenses represented 39% of revenues in the three- month and six-month periods ended July 4, 1998, respectively, compared to 51% and 54% in the corresponding periods in 1997. The decrease in gross expenses was due to several factors, including lower personnel costs due to the restructuring of the Company's sales and marketing organization as discussed below, as well as decreased costs incurred for travel, channel and marketing programs, trade shows, recruiting, temporary help and various facilities related expenses. These decreases were partially offset by increased bad debt expense. Selling, general and administrative expenses in the three-month and six-month periods ended June 28, 1997 are net of expenses reimbursed by Nortel of $1,532,000 and $2,208,000, respectively, related to Shiva's Service Provider Group (SPG), a worldwide business unit comprised of technical sales and support personnel that had been dedicated to marketing Nortel's remote access equipment to carriers and service providers through the first quarter of fiscal 1998. Expenses reimbursed by Nortel in the first quarter of 1998 were $1,018,000. Nortel no longer funds the SPG unit. In-Process Research and Development. In connection with the acquisition of Isolation in the first quarter of fiscal 1998, the Company allocated $2,100,000 of the purchase price to in-process R&D. This allocation represented the estimated fair value based 13 on risk-adjusted cash flows related to the incomplete research and development projects. At the date of acquisition, the development of these projects had not yet reached technological feasibility and the research and development in progress had no alternative future uses. Accordingly, these costs were expensed as of the acquisition date. At the acquisition date, the nature of the acquired in-process R&D principally related to redesign of the technology and software operating system to develop next-generation VPN software technology that would be compliant with evolving industry standards. The remaining efforts included the completion of certain design, coding, prototyping, and testing activities that were necessary to establish that the proposed VPN technologies met their design specifications, including functional, technical, and economic performance requirements. This product would become the basis for the Company's future integrated VPN / remote access products. The Company anticipates incurring total costs of approximately $1,000,000 to $2,000,000 over the next several quarters, at which time the Company expects to begin selling such products. Management believes the Company has a reasonable chance of successfully completing the in-process R&D, however, there is risk associated with the completion of the projects and there can be no assurance that the developed products will meet with either technological or commercial success. Failure to successfully complete the projects and/or market the resulting products would have a material adverse effect on the results of operations and financial condition of the Company in future periods. The value assigned to purchased in-process R&D was determined by estimating the costs to develop the purchased in-process R&D into commercially viable products, estimating the stage of completion, estimating the resulting net cash flows from the projects and discounting the net cash flows to their present value. The revenue projection used to value the in-process R&D was based on estimates of relevant market sizes and growth factors, expected trends in technology and the nature and expected timing of new product introductions by the Company and its competitors. The estimated revenues for the in-process R&D assumed compound annual growth rates of 90% in the five years following introduction, assuming the successful completion and market acceptance of the products. The estimated revenues for the in- process R&D products were expected to peak within four to five years and then decline sharply as other new products and technologies entered the market. Gross margins and operating expenses were estimated based on historical results and management beliefs regarding anticipated factors affecting profit margins. The Company anticipated that gross margins as a percentage of revenues would decline over time as new competitors and competing technologies entered the marketplace. Additionally, the Company anticipated that operating expenses as a percentage of revenues would decline over time due to purchasing power increases and general economies of scale. The rates utilized to discount the net cash flows to their present value were based on cost of capital calculations. Due to the nature of the forecast and the risks associated with the projected growth, profitability and developmental projects, a discount rate of 30 percent was deemed appropriate for the in- process R&D. This discount rate was commensurate with Isolation's stage of development and the uncertainties in the economic estimates as described above. The Company believed that the foregoing assumptions used in Isolation's in-process R&D analysis were reasonable at the time of the acquisition. No assurance can be given, however, that the underlying assumptions used to estimate product sales, development costs or profitability, or the events associated with such projects, will transpire as estimated. Actual revenues with respect to acquired in-process R&D have been lower than previous estimates. The Company believes that expenses incurred to date associated with the development of the in-process R&D projects have been higher than the Company's previous estimates. The Company has completed many components of the original in- process R&D project, and continues to work towards its completion. There have been delays in the project due to changes in technological and market requirements for VPN systems and changes in the Company's research and development staff. In addition, factors such as changing development priorities to meet evolving customer requirements have delayed the development 14 process as well. The risks associated with these efforts are still considered high and no assurance can be made that the products resulting from in-process R&D will meet with market acceptance. In addition, delays in the introduction of such products may have an adverse impact on the Company's results of operations and financial condition in future periods. Goodwill Amortization. The Company recorded amortization expense of $2,908,000 in the three-month period ended July 4, 1998 related to its acquisition of Isolation. At July 4, 1998, the Company had net goodwill of $31,987,000 remaining to amortize over three years from the date of acquisition of Isolation. Restructuring Expenses. The Company recorded restructuring expenses of $9,435,000 and $11,065,000 in the three-month and six- month periods ended July 4, 1998, respectively. Restructuring expenses primarily consisted of $4,585,000 in severance, benefits and other personnel-related expenses, $3,570,000 in non-cash expenses for fixed asset write-downs, $647,000 in advertising and marketing, and $633,000 in transition and other costs. These restructuring expenses were primarily a result of a formal plan announced by the Company on April 15, 1998 to restructure its worldwide operations and align its financial model with the recently announced strategic focus on providing remote access solutions for business. Specifically, Shiva will close operations at the Edinburgh, Scotland, facility and will relocate certain technical support staff to the Wokingham, United Kingdom, facility. The Edinburgh facility was primarily focused on jointly funded engineering activities with Nortel. The Company further expects to take an additional charge of $1,000,000 to $3,000,000 in the third quarter of 1998 to complete its restructuring effort. This will bring total anticipated 1998 restructuring charges to $12,000,000 to $14,000,000, which includes $1,630,000 of charges related to the restructuring of the Company's sales and marketing operations, which were recorded in the first quarter of 1998. The Company anticipates that substantially all of the cash charges will be paid out from the Company's cash and short-term investment balances by the end of fiscal 1998. Interest Income and Expense. Interest income decreased during the three-month period ended July 4, 1998 over the corresponding period in fiscal 1997 primarily as a result of the cash used in the acquisition of Isolation. Interest income increased during the six-month period ended July 4, 1998 over the corresponding period in fiscal 1997 primarily due to the Company's shift from federal tax-exempt securities into taxable securities, which resulted in a higher overall yield on its investments. Interest and other income (expense) for the three-month period ended July 4, 1998 increased due to the inclusion of $600,000 of income resulting from the previously mentioned option exercised by Nortel for certain other items related to intellectual property. Income Tax Benefit. The Company's effective tax rate in each of the three-month and six-month periods ended July 4, 1998 was 32%, down from 38% in each of the three-month and six-month periods ended June 28, 1997, primarily due to the impact of nondeductible restructuring charges. Foreign Currency Fluctuations Foreign currency fluctuations did not have a significant impact on the comparison of the results of operations in the three-month and six-month periods ended July 4, 1998 with those of the comparable periods in fiscal 1997. However, the Company's international operations will continue to be exposed to adverse movements in foreign currency exchange rates which may have a material adverse impact on the Company's financial results. The Company enters into forward exchange contracts to hedge those currency exposures related to certain assets and liabilities denominated in non-functional currencies and does not generally hedge anticipated foreign currency cash flows. Year 2000 The Company recognizes that it must ensure that its products and operations will not be adversely impacted by Year 2000 software failures (the "Year 2000 issue") which can arise in time- sensitive software applications which utilize a field of two digits to define the applicable year. In such applications, a date using "00" as the year may be recognized as the year 1900 rather than the year 2000. The Company is in the process of evaluating its products for Year 2000 compliance and is currently 15 aware that the SpiderManager and the Shiva Access Manager products are not Year 2000 compliant. The SpiderManager product will display the year number in the activity log date field as three digits. The Company believes that this characteristic does not have any system operational implications for the product. Therefore, the Company does not anticipate having to undertake additional research and development efforts or incur additional expenses in this regard. The Shiva Access Manager NT 1.0 product uses only two digits to store year information. The system interprets these two digits as being in the twentieth century before year 2000, and will interpret the two digits as being in the twenty-first century after year 2000. The Company believes that this date calculation methodology could reactivate previously terminated user accounts and may produce incorrect log files if both twentieth and twenty-first century dates are involved. This issue has been corrected in Shiva Access Manager NT version 2.0 and greater, and the company strongly recommends that its customers upgrade to version 2.0 to correct the problem. The Company does not anticipate having to undertake additional research and development efforts or incur additional expenses for this issue. In addition, the Company recently discovered that certain versions of its Shiva Access Manager product may contain an additional Year 2000 issue. The Company is currently investigating this issue, and has not yet determined the nature and extent of this issue. Therefore, the Company can not currently determine the extent of any additional research and development efforts or additional expenses which may be required to remedy this Year 2000 issue. In addition, the Company is in the process of replacing many of its business and operating computer systems with software which, when upgraded, will be Year 2000 compatible. The Company is planning to complete all necessary Year 2000 upgrades of its major systems in 1998, and is currently identifying and developing conversion strategies for its remaining systems that may be impacted by the Year 2000 issue. While the Company does not believe that the Year 2000 issue will have a material impact on the Company, there can be no assurance that unanticipated problems will not arise that will have a material adverse effect on the Company's business and results of operations. Liquidity and Capital Resources As of July 4, 1998, the Company had $21,113,000 of cash and cash equivalents and $45,914,000 of short-term investments. Working capital decreased by 37% to $68,008,000 at July 4, 1998 from $108,314,000 at January 3, 1998. Net cash provided by operations totaled $14,163,000 for the six- month period ended July 4, 1998 compared with $538,000 during the comparable period in fiscal 1997. Net cash provided by operations in the six-month period ended July 4, 1998 resulted primarily from the net loss adjusted for non-cash expenses including in-process R&D, as well as the decrease in accounts receivable and inventories and the increase in accrued expenses, partially offset by a decrease in accounts payable. The decrease in accounts receivable is primarily due to increased collection activities, and the decrease in inventories is due to improved inventory management. The increase in accrued expenses is primarily due to accrued severance costs related to the restructuring of the Company mentioned previously. Net cash provided by operations in the six-month period ended June 28, 1997 resulted primarily from the decrease in accounts receivable, partially offset by the net loss adjusted for non-cash expenses and the increase in deferred income taxes. The decrease in accounts receivable was due to decreased revenue levels and the previously mentioned increase in product return and price protection provisions, as well as increased collection activity. Net cash used by investing activities totaled $51,711,000 for the six-month period ended July 4, 1998, compared to $1,710,000 during the comparable period in fiscal 1997. Investment activity in the six-month period ended July 4, 1998 consisted primarily of payments related to the purchase of Isolation, as well as the net purchase of short-term investments and fixed assets. Investment activity in the six-month period ended June 28, 1997 consisted primarily of purchases of short-term investments and fixed assets, partially offset by proceeds from short-term investments upon maturity or sale. Net cash used by financing activities totaled $212,000 for the six-month period ended July 4, 1998, compared to net cash provided of $442,000 in the comparable period in fiscal 1997. Net cash used by financing activities for the six-month period ended July 4, 1998 primarily consisted of the purchase of treasury stock, partially offset by proceeds from stock option 16 exercises. Net cash provided by financing activities in the six- month period ended June 28, 1997 consisted of proceeds from stock option exercises, partially offset by principal payments on long- term debt and capital lease obligations. The Company has a $5,000,000 unsecured revolving credit facility with a bank which expires in March 1999. The terms of the credit facility require the Company to comply with certain restrictive financial covenants. Borrowings under this facility bear interest at the bank's prime rate. At July 4, 1998, available borrowings were reduced by outstanding letters of credit of $837,000 which expire at various dates in 1998. The Company had no borrowings outstanding under this line at July 4, 1998. At July 4, 1998, the Company was in violation of certain covenants of this credit facility which have been waived by the bank. There can be no assurance that the bank will waive any such violations in the future, which could require the Company to obtain an alternative credit facility on terms less favorable than the current facility. The Company also has a foreign credit facility of approximately $2,613,000, all of which was available at July 4, 1998. Available borrowings under this facility are decreased by guarantees on certain foreign currency transactions. The terms of the foreign credit facility require the Company to comply with certain restrictive financial covenants. There were no borrowings outstanding under this foreign credit facility at July 4, 1998. The Company enters into forward exchange contracts to hedge against certain foreign currency transactions for periods consistent with the terms of the underlying transactions. The forward exchange contracts have maturities that do not exceed one year. At July 4, 1998, the Company had outstanding forward exchange contracts to purchase $5,198,000 and to sell $1,379,000 in various currencies which matured on July 23, 1998. The Company believes that its existing cash and short-term investment balances, together with borrowings available under the Company's bank credit facilities, will be sufficient to meet the Company's cash requirements for at least the next twelve months. Factors That May Affect Future Results Certain information contained herein, and information provided by the Company or statements made by its employees may, from time to time, contain "forward-looking" information which involve risks and uncertainties. Any statements contained in the Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere herein that are not historical facts may be "forward-looking" statements. Certain information contained herein concerning the Company's anticipated plans and strategies for its business, available cash and cash equivalents and sources of financing, research and development and other expenditures, effects of the restructuring actions, ability to achieve Year 2000 compliance, and effects of the 1998 Agreement with Nortel consists of forward-looking statements. Without limiting the foregoing, the words "believes," "expects," "anticipates," "plans," and similar expressions are intended to identify forward- looking statements. The Company's actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below. The Company's quarterly operating results may vary significantly from quarter to quarter depending on factors such as the timing of significant orders and shipments of its products, changes and delays in product development, new product introductions by the Company and its competitors, the mix of distribution channels through which the Company's products are sold and seasonal customer buying patterns. There can be no assurance that the Company will be able to achieve future revenue growth and profitability on a quarterly or annual basis. Revenues can be difficult to forecast due to the fact that the Company's sales cycle varies substantially depending upon market, distribution mechanism and end-user customer. The Company's expense levels are based, in part, on its expectations as to future revenues. If revenue levels are below expectations, operating results may be adversely affected. In addition, the Company's distribution partners typically stock significant levels of inventory, and the Company's revenues may fluctuate based on the level of partner inventories in any particular quarter. The Company has been party to a strategic relationship with Nortel since 1995 which has evolved over time. Under the terms of 17 the 1998 Agreement with Nortel signed on February 27, 1998, Nortel will purchase minimum quarterly amounts of the Company's products within a minimum aggregate amount of $40,000,000 over the term of the contract, which began in the three-month period ended April 4, 1998. There can be no assurance that Nortel will purchase in excess of the minimum amount or that the Company will be able to fulfill such orders from Nortel and thus recognize the revenue associated with such orders, in a linear fashion over the contract term. Non-linear order patterns from Nortel could cause material fluctuations in the Company's quarterly financial results. In addition, the Company has received professional services revenue from Nortel, through the second quarter of fiscal 1998, related to the development of carrier class remote access technology. There is no obligation on the part of Nortel to contract for additional such development services nor does the Company expect to provide such services beyond the second quarter of fiscal 1998. Revenues from Nortel have exceeded 10% of total revenues in the six-month period ended July 4, 1998 and in fiscal 1997 and 1996. On March 26, 1998, the Company completed its acquisition of Isolation, a leading developer of VPN hardware and software solutions based in Toronto, Ontario. Achieving the anticipated benefits of this acquisition or any other acquisitions the Company may undertake will depend in part upon whether the effective integration of the acquired companies' research and development organizations, products and technologies, and sales, marketing and administrative organizations is accomplished in a timely manner. There can be can be no assurance that the Company will be successful in integrating the operations of Isolation. Moreover, the integration process may temporarily divert management attention from the day-to-day business of the Company. Failure to successfully accomplish the integration of Isolation could have a material adverse effect on the Company's business, financial condition and/or results of operations. The Company's LanRover and LanRover Access Switch products are experiencing increased market competition which has caused the Company to take pricing actions and may require the Company to take future pricing actions. The Company provides most of its distribution partners with product return rights for stock balancing or product evaluation and price protection rights. Stock balancing rights permit a return of products to the Company for credit against future product purchases, within specified limits. Product evaluation rights permit end-users to return products to the Company through the distribution partner from whom such products were purchased, within 30 days of purchase if such end-user is not fully satisfied. Price protection rights require the Company to grant retroactive price adjustments for inventories of the Company's products held by distribution partners if the Company lowers its prices for such products. These price protection provisions have adversely affected and may continue to adversely affect revenues and profitability in the future. There can be no assurance that the Company will not expmrience significant returns or price protection adjustments in the future or that the Company's reserves will be adequate to cover such returns and price reductions. The Company increasingly relies on sales of the LanRover Access Switch to achieve its revenue and profitability objectives. Sales of other communications products and other remote access products, including the LanRover product, decreased in the first six months of fiscal 1998 and fiscal 1997, due in part to increased competition. There can be no assurance that the Company will be successful in modifying current product offerings to increase sales of its products. The Company depends on third party distributors and value-added resellers for a significant portion of the Company's revenues. The loss of certain of these distributors and resellers could have a material adverse impact on the Company's results of operations. Moreover, many of these distributors and resellers also act as resellers of competitive products. Therefore, there is risk that these distributors and resellers may focus their efforts on marketing products other than those sold by the Company. This may require the Company to offer various incentives to such distributors and resellers, which may adversely impact the Company's results of operations. The market for the Company's products is characterized by rapidly changing technology, evolving industry standards and frequent new product introductions. The Company's future success will depend on its ability to enhance its existing products and to introduce new products and services to meet and adapt to changing customer requirements and emerging technologies, such as VPN and other technologies. The introduction of new products requires the Company to manage the transition from its older product offerings in order to minimize the impact on customer ordering patterns, avoid excessive levels of obsolete inventories and to ensure that adequate supplies of new products are available to meet customer demand. 18 The Company's success in accomplishing development objectives depends in large part upon its ability to attract and retain highly skilled technical personnel including, in particular, management personnel in the areas of research and development and technical support. Competition for such personnel is intense. There can be no assurance that the Company will be successful in attracting and retaining the personnel it requires to accomplish its objectives. Delays in new product development or the failure of new products to achieve market acceptance, could have a material adverse effect on the Company's operating results. In addition, there can be no assurance that the Company will be successful in identifying, developing, manufacturing or marketing new product or service offerings or enhancing its existing offerings. The Company operates in a highly competitive market that is characterized by an increasing number of well-funded competitors from diverse industry sectors, including but not limited to suppliers of software, modems, terminal servers, routers, hubs, data communications products and companies offering remote access solutions based on emerging technologies, such as switched digital telephone services, remote access service offerings by telephony providers via telephone networks and other providers through public networks such as the Internet. Increased competition could result in price reductions and loss of market share which would adversely affect the Company's revenues and profitability. There can be no assurance that the Company will be able to continue to compete successfully with new or existing competitors. The Company does business worldwide, both directly and via sales to United States-based original equipment manufacturers, who sell such products internationally. The Company expects that international revenues will continue to account for a significant portion of its total revenues. Although most of the Company's sales are denominated in US Dollars, exchange rate fluctuations could cause the Company's products to become relatively more expensive to customers in a particular country, causing a decline in revenues and profitability in that country. In addition, international sales, particularly in Europe, are typically adversely affected in the third quarter due to a reduction in business activities during the summer months. Furthermore, global and/or regional economic factors and potential changes in laws and regulations affecting the Company's business, including without limitation, communications regulatory standards, safety and emissions control standards, difficulty in staffing and managing foreign operations, longer payment cycles and difficulty in collecting foreign receivables, currency exchange rate fluctuations, changes in monetary and tax policies, tariffs, difficulties in enforcement of intellectual property rights and political uncertainties, could have an adverse impact on the Company's financial condition or future results of operations. Some of the Company's products incorporate encryption, or scrambling, features to protect the security, confidentiality, and integrity of text or data transmissions. Products with encryption features are subject to export restrictions under the laws of the U.S., Canada, and other countries. In countries other than the U.S. and Canada, encryption products may also be subject to import and/or use restrictions. These restrictions may require the Company or its customers to obtain licenses; may require technical modifications to products; and may prohibit sales of some products to certain destinations or customers. In light of these restrictions, the Company's products available abroad may contain significantly weaker encryption capabilities than those available in the U.S. and Canada, and there can be no assurance that the Company will continue to be able to export its products to destinations outside of the U.S. and Canada. Accordingly, these restrictions could potentially have an adverse effect on the Company's business, financial conditions, or results of operations. The Company is exposed to potential credit risks as a result of accounts receivable from distributors, resellers, OEM and direct customers, with respect to which the Company does not generally require collateral. The Company is currently dependent on three subcontractors for the manufacture of significant portions of its products. Although the Company believes that there are a limited number of other qualified subcontract manufacturers for its products, a change in subcontractors could result in delays or reductions in product shipments. In addition, certain components of the Company's products are only available from a limited number of suppliers. The inability to obtain sufficient key components as required could also result in delays or reductions in product shipments. Such delays or reductions could have an adverse effect on the Company's results of operations. 19 The market price of the Company's securities could be subject to wide fluctuations in response to quarter-to-quarter variations in operating results, changes in earnings estimates by analysts, and market conditions in the industry, as well as general economic conditions and other factors external to the Company. Other factors that may affect future results include the accuracy of the Company's internal estimates of revenues and operating expense levels, the outcome of the litigation discussed below under "Legal Proceedings," the Company's ability to complete all necessary Year 2000 upgrades in a timely and cost-effective manner, the realization of the intended benefits of the 1998 restructuring, and material changes in the level of customer- funded research and development activities. Because of the foregoing factors, the Company believes that period-to-period comparisons of its financial results are not necessarily meaningful and expects that its results of operations may fluctuate from period to period in the future. 20 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit No. Description of Exhibit - ----------- ---------------------- Exhibit 10.1 Sublease Between Shiva Corporation, Landlord, and Netcentric Corporation, Tenant, dated May 29, 1998 is incorporated herein by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended July 4, 1998 (File No. 000-24918). Exhibit 27.0 Restated Financial Data Schedule. (b) Reports on Form 8-K: The Company filed a Current Report on Form 8-K dated April 9, 1998 pursuant to Item 2 thereof, reporting the completion of its acquisition of substantially all of the assets of Isolation, an Ontario corporation, for approximately US$37,000,000 in cash pursuant to an Asset Purchase Agreement dated as of February 18, 1998 between the Company and Isolation. In addition, the Company assumed substantially all the liabilities of Isolation as part of the acquisition, including the payment of transaction fees associated with the acquisition of approximately in the aggregate of US$1,900,000. 21 SIGNATURE 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. SHIVA CORPORATION Date: January 21, 1999 by: /s/ Robert P. Cirrone --------------------- Senior Vice President, Finance and Administration, and Chief Financial Officer (Principal Financial and Accounting Officer) 22 EXHIBIT INDEX Exhibit No. Description of Exhibit - ----------- ---------------------- Exhibit 10.1 Sublease Between Shiva Corporation, Landlord, and Netcentric Corporation, Tenant, dated May 29, 1998 is incorporated herein by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended July 4, 1998 (File No. 000-24918). Exhibit 27.0 Restated Financial Data Schedule.