UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File Number 0-50464
NX NETWORKS, INC.
(Exact name of registrant as specified in charter)
DELAWARE 54-1345159
(State of Incorporation) (IRS Employer Identification No.)
13595 DULLES TECHNOLOGY DRIVE
HERNDON, VIRGINIA 20171
(Address of principal executive offices) (Zip Code)
(703) 742-6000
(Registrant's telephone number, including area code)
Indicate by check number 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
------------ -------------
At August 14, 2001, there were 48,478,813 shares of the registrant's
Common Stock, $.05 par value per share, outstanding.
NX NETWORKS, INC.
FORM 10-Q
JUNE 30, 2001
INDEX
Page No.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS 3
PART I - FINANCIAL INFORMATION (UNAUDITED)
ITEM 1 -- FINANCIAL STATEMENTS
Unaudited Condensed Consolidated Statements of Operations
for the six and three months ended June 30, 2001 and 2000 4
Unaudited Condensed Consolidated Balance Sheets as of
June 30, 2001 and December 31, 2000 5
Unaudited Condensed Consolidated Statements of Cash Flows
for the six months ended June 30, 2001 and 2000 6
Notes to Unaudited Condensed Consolidated Financial Statements 7
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS 17
ITEM 3 -- QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK 27
PART II -- OTHER INFORMATION
ITEM 1 -- LEGAL PROCEEDINGS 27
ITEM 2 -- CHANGES IN SECURITIES AND USE OF PROCEEDS 29
ITEMS 3 THROUGH 5 31
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K 32
SIGNATURE
EXHIBIT INDEX
2
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Some of the information set forth in this quarterly report includes
"forward looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. In addition, from time to time, we may publish
"forward-looking statements" within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act or make oral statements that constitute
forward-looking statements. These forward-looking statements may relate to
matters such as anticipated financial performance, future revenues or earnings,
business prospectus, projected ventures, new products, anticipated market
performance and similar matters. The words "budgeted," "anticipate," "project,"
"estimate," "expect," "may," "believe," "potential" and similar statements are
intended to be among the statements that are forward looking statements. Because
these statements reflect the reality of risk and uncertainty that is inherent in
our business, actual results may differ materially from those expressed or
implied by the forward-looking statements. You are cautioned not to place undue
reliance on these forward-looking statements, which are made as of the date of
this quarterly report.
The Private Securities Litigation Reform Act of 1995 provides a safe
harbor for forward-looking statements. In order to comply with the terms of the
safe harbor, we caution you that a variety of factors could cause our actual
results to differ materially from the anticipated results or other expectations
expressed in our forward-looking statements. These risks and uncertainties, many
of which are beyond our control, include, but are not limited to those set forth
under the caption "Certain Factors Which May Affect Future Results" on page 22
of this quarterly report and in our filings with the SEC.
3
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NX NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share amounts)
Six Months ended Three Months Ended
June 30, June 30,
2001 2000 2001 2000
---- ---- ---- ----
Revenues:
Product $ 4,083 $ 13,477 $ 2,216 $ 6,424
Service and other 2,918 3,896 1,417 2,006
------- -------- ------- -------
Total revenues 7,001 17,373 3,633 8,430
Cost of revenues:
Product 3,000 8,362 1,566 4,179
Service and other 1,664 2,497 746 1,193
------ -------- ------- -------
Total cost of revenues 4,664 10,859 2,312 5,372
Gross profit 2,337 6,514 1,321 3,058
Operating expenses:
Sales and marketing (exclusive of stock compensation of $133 and $0 in the six
and three months ended June 30, 2001, respectively and $147 and $124 in the six 4,391 7,772 1,579 3,799
and three months ended June 30, 2000, respectively )
Research and development (exclusive of stock compensation of $4,060 and $1,992 in
the six and three months ended June 30, 2001, respectively and $2,280 and $1,681 5,582 7,641 2,371 4,966
in the six and three months ended June 30, 2000, respectively)
General and administrative (exclusive of stock compensation of $987 and $2 in the
six and three months ended June 30, 2001, respectively and $6,989 and 5,333 4,571 2,142 2,222
$1,116 in the six and three months ended June 30, 2000, respectively)
In-process research and development 30,800 --
Amortization of acquired intangibles 4,553 13,274 2,276 8,131
Stock compensation expense 5,180 9,416 1,994 2,921
Impairment of acquired intangibles and goodwill 3,685 -- 3,685 --
Restructuring charge -- 427 -- --
------- -------- ------- ------
Total operating expenses 28,724 73,901 14,047 22,039
Loss from operations (26,387) (67,387) (12,726) (18,981)
Interest expense (310) (190) (147) (12)
Interest income 64 310 18 239
Other income (expense), net (464) 219 22 142
-------- -------- ---------- ---------
Net loss (27,097) (67,048) (12,833) (18,612)
Dividend on preferred stock 2,477 -- 1,015 --
--------- --------- ---------- ---------
Net loss attributable to common stockholders $(29,573) $(67,048) $(13,848) $(18,612)
========= ========= ========== =========
Basic and diluted loss per common share $ (0.63) $ (2.03) $ (0.29) $ (0.53)
========= ========= ========= =========
Weighted average common shares outstanding 42,982 33,037 44,411 34,846
========= ========= ========= =========
See notes to unaudited condensed consolidated financial statements.
4
NX NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
As of As of
June 30, December 31,
2001 2000
--------------------- -------------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $1,836 $4,659
Accounts receivable, net 994 1,604
Stock subscription receivable, subsequently -- 1,147
collected
Inventories 3,279 4,928
Other current assets 1,353 512
--------- ----------
Total current assets 7,462 12,850
Property and equipment, net 2,677 3,508
Goodwill and intangibles, net 20,054 28,292
Deposits and other assets 434 605
--------- ----------
TOTAL ASSETS $30,627 $ 45,255
========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $8,110 $7,391
Accrued liabilities 6,391 6,704
Note Payable to vendor 4,387 6,353
--------- ----------
Total current liabilities 18,888 20,448
--------- ----------
Long-term liabilities 150 735
--------- ----------
TOTAL LIABILITIES $19,038 $21,183
--------- ----------
Series B redeemable, convertible preferred stock, $0.05
par
value; 640,000 shares authorized; 333,333 shares
issued and outstanding (aggregate liquidation -- 2,117
preference of $2,117 as of December 31, 2000)
Commitments and contingencies
Stockholders' equity:
Series B convertible preferred stock, $0.05 par value; 2,474 --
640,000 shares authorized; 333,333 shares issued and
outstanding (aggregate liquidation preference of $2,474)
Series C convertible preferred stock, $0.05 par value; 2,594 --
15,400 shares authorized, issued and outstanding (aggregate
liquidation preference of $2,594)
Series D convertible preferred stock, $0.05 par value; 1,693 --
11,734 shares authorized, issued and outstanding (aggregate
liquidation preference of $1,693)
Series E convertible preferred stock, $0.05 par value; 2,100
19,000 shares authorized, issued and outstanding (aggregate
liquidation preference of $2,100)
Common stock, $0.05 par value; 85,000,000 and 55,000,000 2,222 2,030
shares authorized, respectively; 44,441,000 and
40,606,000 shares issued and outstanding, respectively
Additional paid-in capital 282,498 277,778
Deferred compensation (4,517) (8,460)
Accumulated deficit (282,685) (253,112)
Warrants 6,296 4,749
Note receivable from stockholder (1,000) (1,000)
Accumulated other comprehensive loss (86) (30)
--------- ----------
Total stockholders' equity 11,529 21,955
--------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 30,627 $ 45,255
========= ==========
See notes to unaudited condensed consolidated financial statements.
5
NX NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
(in thousands)
SIX MONTHS ENDED JUNE 30,
--------------------------------------
2001 2000
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (27,097) $ (67,048)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 5,519 14,395
Impairment of acquired intangibles and goodwill 3,685
Non-cash interest expense pursuant to issuance of warrants 501 --
In-process research and development -- 30,800
Stock compensation expense 5,180 9,416
Changes in assets and liabilities:
Accounts receivable 610 2,734
Inventories 1,649 252
Other current assets (841) (441)
Deposits and other assets 171 (198)
Note payable to vendor (1,966)
Accounts payable 719 1,039
Accrued liabilities (513) 145
Other liabilities -- (201)
------------- ------------
Net cash used in operating activities (12,383) (9,107)
------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for acquisition of Aetherworks, net of cash acquired (9,558)
Purchases of property and equipment (135) (156)
Notes receivable from shareholder -- (1,000)
------------- -----------
Net cash used in investing activities (135) (10,714)
------------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment on line of credit, net (1,058)
Proceeds from stock sale, net offering costs 25,086
Proceeds from the issuance of preferred stock 6,436 --
Proceeds from issuance of common stock 2,000
Proceeds from exercise of stock options 168 5,158
Proceeds from employee stock purchase plan 65
Collection of stock subscription receivable 1,147 --
------------ ----------
Net cash provided by financing activities 9,751 29,251
------------ ----------
Effect of foreign currency exchange rate changes on cash and cash (56) (45)
equivalents
Net (decrease) increase in cash and cash equivalents (2,823) 9,385
Cash and cash equivalents, beginning of period 4,659 5,930
------------ -----------
Cash and cash equivalents, end of period $ 1,836 $ 15,315
============ ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 305 $ 12
============ ===========
See notes to unaudited condensed consolidated financial statements.
6
Nx NETWORKS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY:
BASIS OF PRESENTATION
The accompanying condensed unaudited financial statements included
herein have been prepared by the Company in accordance with generally accepted
accounting principles for interim financial information and pursuant to the
rules and regulations of the Securities and Exchange Commission ("SEC") for
reporting on Form 10-Q. Accordingly, certain information and footnote
disclosures required for complete financial statements are not included herein.
It is recommended that these condensed financial statements be read in
conjunction with the financial statements and related notes as reported in our
Annual Report Form 10-K for the year ended December 31, 2000 filed with the SEC
in April 2001.
In the opinion of management, all adjustments, consisting of normal
recurring adjustments, considered necessary for a fair presentation of the
condensed consolidated financial position, results of operations, and cash flows
at the dates and for the periods presented have been included. The results of
operations for the three and six months ended June 30, 2001 may not be
indicative of the results that may be expected for the year ending December 31,
2001 or any other period within calendar year 2001.
BUSINESS DESCRIPTION
Nx Networks, Inc. ("Nx Networks" or the "Company") a Delaware
Corporation (formerly Netrix Corporation), is a provider of internet telephony
and data networking solutions. The Company combines patented, switched,
compressed voice and data technology with advanced packet data networking
capabilities to provide networking solutions that improve network performance
and deliver an array of tangible network services. The Company is headquartered
in Herndon, Virginia and conducts operations out of its locations in the United
States and the United Kingdom. The Company's customers include service
providers, multinational corporations and government agencies.
GOING CONCERN AND OTHER IMPORTANT RISK FACTORS
The Company has reported a net loss in each of the last seven years.
The Company's ability to generate operating income is in large part dependent on
its success at increasing sales of its products and/or controlling costs. The
Company's plan to increase revenue through sales of its products continues to
evolve; however, due to market conditions, competitive pressures and other
factors beyond its control there can be no assurance that the Company will be
able to adequately increase product sales in the future. The Company's success
is also dependent on its ability to generate adequate cash for operations and
capital needs. For the six months ended June 30, 2001, the Company's operating
activities used cash of approximately $ 12.4 million, primarily due to continued
losses from operations. As of June 30, 2001, the Company had approximately $1.8
million in cash and cash equivalents. Total current liabilities as of June 30,
2001 were approximately $18.9 million and exceeded current assets by
approximately $11.4 million. Since year-end, the Company has raised
approximately $9.8 million in equity financing. The Company will require
additional funding in September 2001 to continue operations. If funding is
insufficient or unavailable, or the Company experiences shortfalls in
anticipated revenues or increases in anticipated expenses, the Company would
further reduce headcount, defer vendor payments, sell operating assets and/or
seek protection under the bankruptcy code.
As of June 30, 2001, the Company has a payment obligation of
approximately $4.4 million to SMTC, the third party contract manufacturer of
substantially all of its products. A majority of the Company's inventory is at
SMTC's premises. The Company has agreed upon a payment schedule with SMTC and
delivered an unsecured promissory note to SMTC. Until SMTC has been repaid, the
Company is required to pay in advance for all fabrication costs. If the Company
does not adhere to the payment schedule, SMTC has informed the Company that they
will not ship any products on its behalf. If the Company is unable to raise
sufficient capital to adhere to the payment schedule and the manufacturer ceases
7
to ship products on the Company's behalf, then a material and adverse result to
the Company's operations could occur. Currently, the Company is in default of
the agreement because it could not adhere to the payment terms. SMTC has
indicated a willingness to renegotiate the agreement.
To meet its operating requirements for the remainder of 2001, the
Company will have to generate additional cash other than through operations. The
means by which the Company could raise the necessary funds include the sale of
assets, including intellectual property and proprietary technology, the sale of
equity, borrowings, the sale of selected operations, or establishing one or more
strategic partnerships. Although the Company believes it has the ability to
generate additional equity and cash through such sales and borrowings, such
sales may be dilutive and there can be no assurances that adequate funds will be
available, or available on terms that are reasonable or acceptable to the
Company. If the Company is unable to generate adequate cash, there will be a
material and adverse effect on the business and financial condition of the
Company, to the extent that a sale, liquidation or restructuring of the Company
will be required, in whole, or in part. The Company's return to profitability
also depends upon the Company's ability to improve its customer service,
operational, financial and management information systems, including its
contract management, inventory management and other systems.
The above factors raise substantial doubt about the Company's ability
to continue as a going concern. The accompanying financial statements have been
prepared on the basis that the Company will continue as a going concern. The
financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
The Company's operations are subject to certain risks and uncertainties
including, among others, rapidly changing technology and markets, current and
potential competitors with greater financial, technological, production and
marketing resources, reliance on certain sole source suppliers and third party
contract manufacturers, and dependence on key management personnel. Future
operating results may be affected by a number of other factors including the
timing of new products in the market place, competitive pricing pressures and
economic conditions. As the market for the Company's products is characterized
by rapidly changing technology, the development, introduction and evolution of
the competitive products may require a significant investment of financial
resources. While the Company has generally been able to obtain adequate supplies
of components to date, the interruption or termination of the Company's current
manufacturing relationship could have an adverse effect on the Company's
operating results.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
ACQUISITION OF AETHERWORKS
On March 16, 2000, the Company completed the merger of AetherWorks
Corporation ("AetherWorks"), a development stage company with no revenue since
its inception in 1993, with and into a wholly-owned subsidiary of the Company
ours pursuant to the terms of the Agreement and Plan of Acquisition
("Agreement") dated December 31, 1999. The acquisition was accounted for under
the purchase method of accounting.
Under the terms of the AetherWorks transaction, the holders of
AetherWorks common stock, warrants and stock options converted at a rate of 1.38
shares of Nx Networks common stock, warrants, and stock options. The Company
issued 2,301,436 shares of common stock and 867,687 warrants and options to
acquire the outstanding AetherWorks common stock. The Company's shares were
valued at $22.94, the average of closing prices for three days before and after
March 16, 2000. The warrants and options issued were valued at approximately
$18.0 million using the Black-Scholes model assuming 130 percent volatility, a
risk free interest rate of 6.3 % and an expected life of three years. Pursuant
to the Agreement, the Company settled an $8.0 million obligation of AetherWorks
upon the closing of the acquisition.
8
At closing, the Company also issued to AetherWorks' employees options
to acquire a total of 1.0 million shares of its common stock. The options have
an exercise price of $6.81 per share and vest quarterly until January 1, 2002.
The Company recorded deferred compensation expense of $16.1 million for the
difference between the exercise price and the fair market value of the stock on
the date of grant. This expense will be amortized over the options vesting
period of which approximately $3.4 million and $1.7 million was expensed in the
six and three months ended June 30, 2001.
Pursuant to the Agreement, the Company was required to issue additional
shares of common stock if the average closing price of its common stock for the
fifteen-day trading period ending October 31, 2000, did not equal or exceed
$22.50 per share, provided that the total number of shares of common stock
issued would not exceed 19.9% of the total of our outstanding common stock on
March 16, 2000. Under the Agreement, the Company was also required to make an
equivalent adjustment to the warrants and options to proportionately increase
the number of shares and reduce the per share exercise price. The Company's
common stock had an average closing price of $2.93 during the fifteen-day
trading period ended October 31, 2000.
On December 29, 2000, the Company entered into a settlement agreement
(the "Settlement") with the former owners of AetherWorks, to issue 4,777,973
additional shares of the Company's common stock, as well as additional options
and warrants to acquire 1,846,551 shares of the Company's common stock. Pursuant
to the Agreement and the Settlement, the exercise price of the majority of the
options and warrants was reduced to $1.60 per share. The listing requirements of
the NASDAQ Stock Market prohibit the Company from issuing more than 19.9% of its
common stock in a merger transaction without obtaining the consent of our
stockholders. As of December 31, 2000, 3,262,160 of the additional 4,777,973
common shares were issued and outstanding. The remaining 1,515,813 shares were
issued upon stockholder approval on March 6, 2001.
The purchase price of AetherWorks, including transaction costs of $0.4
million, was $79.1 million. A summary of assets and liabilities acquired, at
estimated fair market value was as follows (in thousands):
Current assets $ 99
Property and equipment 1,403
Assembled workforce 300
In-process research and development 30,800
Goodwill 50,229
Current liabilities (3,700)
------
Total $79,131
=======
The amount allocated to acquired intangibles and goodwill is being
amortized over their estimated useful lives of 4 years using the straight-line
method.
The unaudited pro forma information presented for the six months ended
June 30, 2000, reflects the acquisition of AetherWorks as if the acquisition had
occurred on January 1, 2000, excluding the one time $30.8 million IPR&D charge
in connection with the AetherWorks acquisition. The results are not necessarily
indicative of future operating results or of what would have occurred had the
acquisition actually been consummated on that date (in thousands, except per
share data):
Six months ended
June 30, 2000
(unaudited)
----------
Revenues $ 17,373
Net loss attributable to common stockholders (41,963)
Net loss per share attributable to common stockholders $ (1.27)
9
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews its long-lived assets, including property and
equipment, acquired intangibles and goodwill for impairment whenever events or
changes in circumstances indicate that the carrying amount of the assets may not
be fully recoverable. To determine recoverability of its long-lived assets, the
Company evaluates the probability that future, undiscounted, net cash flows will
be less than the carrying amount of the assets. If future estimated undiscounted
cash flows are less than the carrying amount of long-lived assets, then such
assets are written down to their fair value.
In the second quarter of 2001, after considering developments in the
capital markets and the telecommunications industry, the downturn in our market
capitalization, our liquidity problems and the decrease in 2001 product sales,
we reviewed the carrying value of our long-lived assets. Our long-lived assets
are primarily goodwill and intangibles resulting from the acquisitions of
OpenROUTE in 1999 and AetherWorks in the first quarter of 2000. We determined
that these assets were impaired due to uncertainties in our sales forecasts
resulting from past performance, liquidity and current industry conditions. We
reviewed future undiscounted cash flows from OpenROUTE acquired product lines
and technologies and determined the related long-lived assets to be impaired.
These assets with a combined carrying value of $15.7 million at December 31,
2000 were written down in the second quarter to $9.4 million, their estimated
fair value based upon discounted cash flows.
The Company's estimates of anticipated net revenues, the remaining
estimated lives of intangible assets, or both, could be reduced significantly in
the future due to changes in technologies, regulation, available financing or
intense competition. As a result the carrying amount of long-lived assets could
be further reduced in the future.
10
2. NEW ACCOUNTING PRONOUNCEMENTS:
In June 1998 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair value. SFAS No. 133 requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. SFAS No. 133 is effective for fiscal years beginning after June 15, 2000.
The Company determined that the adoption of SFAS No. 133 on January 1, 2001, had
no material effect on its financial statements.
In July 2001, the FASB issued Statement of Financial Standards No. 42,
"Accounting for Goodwill" (SFAS 142"). SFAS 142 establishes accounting standards
for existing goodwill related to purchase business combinations. Under the
Statement, the Company would discontinue the periodic amortization of goodwill
effective with adoption of the new Statement. Also, the Company would have to
test any remaining goodwill for possible impairment within six months of
adopting the Statement, and periodically thereafter, based on new valuation
criteria set forth in the Statement. Further, the Statement has new criteria for
purchase price allocation. The Statement becomes effective January 1, 2002. The
Company has not done the analysis to determine the impact of this Statement.
3. INVENTORIES:
Inventories consisted of the following (in thousands):
AS OF AS OF
JUNE 30, 2001 DECEMBER 31, 2000
------------- -----------------
Raw materials $1,071 $ 1,164
Work-in-process -- 40
Finished goods 2,208 3,724
--------- -------
Total inventories $ 3,279 $ 4,928
========= =======
Our products are subject to technological change and changes in the
respective competitive markets. Management has provided reserves for excess and
obsolete inventories. It is possible that new product launches could result in
unforeseen changes in inventory requirements for which no reserve has been
provided.
4. EQUITY:
PRIVATE PLACEMENT
On March 28, 2001, the Company completed a private placement by issuing
and selling 2,207,018 shares of common stock at $0.9062 per share.
On April 20, 2001 the Company issued 7,405 shares of common stock in
full satisfaction of an indemnification obligation to Bryan Holley, who formerly
was an executive officer and a director. The number of shares was fixed by
dividing the dollar amount due to Mr. Holley by $1.05, which represented the
last reported closing price of the Company's common stock on the day of the
Company's agreement with Mr. Holley.
11
PREFERRED STOCK
On December 29, 2000, the Company completed a private placement by
selling and issuing 333,333 shares of Series B 8% redeemable, convertible
preferred stock (the "Series B Preferred Stock"), par value $0.05 per share, at
a price of $7.50 per share, and by issuing warrants to purchase 666,667 shares
of common stock at an exercise price of $0.90 per share. Each share of Series B
Preferred Stock has a liquidation preference equal to its purchase price, plus
accrued and unpaid dividends. Dividends are cumulative and compound quarterly.
Dividends will be paid semi-annually on May 31 and November 30 of each year, and
are payable in cash or shares of common stock at the option of the Company.
On January 17, 2001, the Company completed a private placement by
selling and issuing 15,400 shares of Series C 8% redeemable, convertible
preferred stock (the "Series C Preferred Stock"), par value $0.05 per share, at
a price of $162.50 per share. Each share of Series C Preferred Stock has a
liquidation preference equal to its purchase price, plus accrued and unpaid
dividends. Dividends are cumulative and compound quarterly. Dividends will be
paid semi-annually on May 31 and November 30 of each year, and are payable in
cash or shares of common stock at the option of the Company.
The Series B and C Preferred Stock are convertible at any time after
stockholder approval to increase the Company's authorized common shares by at
least 10 million (the "Conversion Date"). After the Conversion Date and prior to
redemption, the Series B Preferred Stock is convertible into common stock at a
conversion rate equal to ten shares of common stock for each share of Series B
Preferred Stock. The shares are redeemable at the option of the holder for cash
equal to $7.50 per share of Series B Preferred Stock plus an amount equal to
110% of the difference between the conversion price and the current market price
per share of the Company's common stock if the Conversion Date does not occur
before September 30, 2001. After the Conversion Date and prior to redemption,
the Series C Preferred Stock is convertible into common stock at a conversion
rate equal to 100 shares of common stock for each share of Series C Preferred
Stock. The shares are redeemable at the option of the holder for cash equal to
$162.50 per share of Series C Preferred Stock plus an amount equal to 110% of
the difference between the conversion price and the current market price per
share of the Company's common stock if the Conversion Date does not occur before
September 30, 2001.
On March 6, 2001, the Company's stockholders approved an increase in
the Company's authorized common shares from 55 million to 85 million, and as of
March 6, 2001, the Conversion Date, the Series B and C Preferred Stock are no
longer redeemable at the option of the holder. The market value of the Company's
common stock on the date of issuance of the Series C Preferred Stock was $2.25
per share. The fair value of the Series C Preferred Stock's beneficial
conversion feature, reflective of the difference between the conversion price of
the Series C Preferred Stock and the market value of the underlying common stock
on the date of issuance, constitutes for accounting purposes, a dividend by the
Company. A beneficial conversion feature of $0.2 and $1.2 million has been
reflected as a non-cash dividend charge to earnings in the consolidated
statement of operations in the three and six months ending June 30, 2001,
respectively.
On March 6, 2001, the Company completed a private placement by selling
and issuing 11,734 shares of Series D 8% convertible preferred stock (the
"Series D Preferred Stock"), par value $0.05 per share, at a price of $140.62
per share, and by issuing warrants to purchase 234,676 shares of common stock at
an exercise price of $2.11 per share. Each share of Series D Preferred Stock has
a liquidation preference equal to its purchase price, plus accrued and unpaid
dividends. Dividends are cumulative and compound quarterly. Dividends will be
paid semi-annually on June 30 and December 31 of each year, and are payable in
cash or shares of common stock at the option of the Company. Prior to
redemption, the Series D Preferred Stock is convertible into common stock at a
conversion rate equal to 100 shares of common stock for each share of Series D
Preferred Stock. The market value of the Company's common stock on the date of
issuance of the Series D Preferred Stock was $1.4062 per share. The fair value
of the Series D Preferred Stock's beneficial conversion feature, reflective of
the difference between the conversion price of the Series D Preferred Stock and
the market value of the underlying common stock on the date of issuance,
constitutes for accounting purposes, a dividend by the Company. A beneficial
conversion feature of $0.3 million has been reflected as a non-cash dividend
charge to earnings in the consolidated statement of operations in the first
quarter of 2001.
During the six and three months ended June 30, 2001, the Company has
accrued dividends of approximately $0.2 and $0.1 million respectively, at a rate
of 8 percent per annum on the Series B, C and D Preferred Stock.
12
On May 14, 2001, the Company completed a private placement by selling
and issuing 19,000 shares of Series E 8% convertible preferred stock (the
"Series E Preferred Stock"), par value $0.05 per share, at a price of $126.50
per share, and by issuing warrants to purchase 380,000 shares of common stock at
an exercise price of $1.438 per share. Each share of Series E Preferred Stock
has a liquidation preference equal to its purchase price, plus accrued and
unpaid dividends. Dividends are cumulative and compound quarterly. Dividends
will be paid annually on April 30 of each year, and are payable in cash or
shares of common stock at the option of the Company. The Series E Preferred
Stock was initially convertible into common stock at a conversion rate equal to
100 shares of common stock for each share of Series E Preferred Stock. However,
after an initial period the conversion price of the Series E Preferred Stock
will be fixed by reference to the volume weighted average sales price ("VWAP")
of the Company's common stock. Specifically, the Series E Preferred Stock will
have a conversion price per share equal to the lesser of (1) $1.265 or (2) 87%
of the VWAP during the five days preceding a notice of conversion, subject to a
minimum conversion price of $0.575 per share. A beneficial conversion feature of
$0.7 million has been reflected as a non-cash dividend charge to earnings in the
consolidated statement of operations in the second quarter of 2001. On July 5,
2001, all of the Series E preferred stock was converted to 4,037,256 shares of
common stock.
WARRANTS
On December 29, 2000, in connection with the sale of the Series B
Preferred Stock, the Company issued redeemable warrants to purchase 666,667
shares of common stock at an exercise price of $0.90 per share. The warrants
were valued at $0.4 million, using the Black-Scholes pricing model. The warrants
are redeemable at the option of the holder for cash equal to 110% of the
difference between the exercise price and the current market price per share of
the Company's common stock if the Conversion Date, as previously defined, does
not occur before September 30, 2001. As a result of the redemption provision, as
of December 31, 2000, the warrants are classified as a long-term liability in
the accompanying balance sheet. On March 6, 2001, the Company's stockholders
approved an increase in the Company's authorized common shares from 55 million
to 85 million, and as of March 6, 2001, the Conversion Date, the warrants are no
longer redeemable at the option of the holder. As of March 6, 2001, the warrants
were valued at $0.9 million, using the Black-Scholes pricing model. A charge of
$0.5 million (representing the difference between the fair value at December 31,
2000, and the fair value on March 6, 2001) has been included in other expense in
the statement of operations for the quarter ended March 31, 2001.
On March 6, 2001, in connection with the sale of the Series D Preferred
Stock, the Company issued redeemable warrants to purchase 234,676 shares of
common stock at an exercise price of $2.11 per share. The warrants were valued
at $0.3 million, using the Black-Scholes pricing model.
On May 14, 2001, in connection with the sale of the Series E Preferred
Stock, the Company issued redeemable warrants to purchase 380,000 shares of
common stock at an exercise price of $1.44 per share. The warrants were valued
at $0.3 million, using the Black-Scholes pricing model.
13
5. COMPREHENSIVE LOSS:
Comprehensive income (loss) is the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from non-owner sources. Other comprehensive income (loss) refers to revenue,
expenses, gains and losses that under generally accepted accounting principles
are included in comprehensive income (loss), but excluded from net income
(loss). For the six months ended June 30, 2001 and June 30, 2000, the elements
within other comprehensive income, net of tax, consist solely of foreign
currency translation adjustments. Comprehensive loss for the three and six
months ended June 30, 2001 is $12.8 million and $27.1 million respectively.
6. SEGMENT INFORMATION:
The Company's two reportable segments are products and services. The
Company evaluates the performance of its segments based on gross profit. The
Company provides enterprise-wide disclosures about revenues by segment,
long-lived assets by geographic area and revenues from major customers.
Revenues consisted of the following (in thousands):
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2001 2000 2001 2000
---- ---- ---- ----
PRODUCT GROUP
2200 $ 1,744 $ 4,442 $ 909 $ 2,929
2500 982 5,475 426 2,248
3000 292 105 212 105
S1000 40 -- 21 --
S10 -- 213 -- 8
Telecom -- 53 -- 5
Internet Access 975 2,869 648 1,078
LAN 50 320 -- 51
---------- --------- -------- ---------
Total product revenues 4,083 13,477 2,216 6,424
Service revenues 2918 3,896 1,417 2,006
---------- --------- -------- ---------
Total revenues $ 7,001 $ 17,373 $ 3,633 $ 8,430
========= ======== ========= =========
GEOGRAPHIC INFORMATION
The Company sells its products and services through its locations in
the United States and its foreign affiliates in the United Kingdom, Hong Kong,
France and Italy. Information regarding revenues and long-lived assets
attributable to the United States and to all foreign countries is stated below.
The geographic classification of product and service revenues is based upon the
location of the customer.
The Company's product and service revenues for the six and three months
ended June 30, 2001 and June 30, 2000 were generated in the following geographic
regions (in thousands):
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
2001 2000 2001 2000
--------- --------- --------- ---------
United States $ 3,150 $ 9,023 $ 1,785 $ 4,257
Europe, Middle East and Africa 2,555 5,238 1,237 2,219
Pacific Rim, Latin America
and South America 1,296 3,112 611 1,954
-------- --------- -------- --------
Total $ 7,001 $ 17,373 $ 3,633 $ 8,430
======== ========= ======== ========
Included in domestic product and service revenues are sales through
systems integrators and distributors to the Federal Government of $0.7 and $0.5
for the six months ended June 30, 2001 and 2000, respectively. For the three
14
months ended June 30, 2001 and 2000 these sales were $0.3 and $0.0,
respectively.
The Company's long-lived assets including goodwill and acquired
intangibles were located as follows (in thousands):
AS OF AS OF
JUNE 30, 2001 DECEMBER 31, 2000
------------- -----------------
United States $ 22,622 $ 31,686
United Kingdom 109 114
--------- --------
Total long-lived assets $ 22,731 $ 31,800
========= ========
Approximately $20.1 million and $28.3 million of the Company's
long-lived assets as of June 30, 2001 and December 31, 2000, respectively,
relate to goodwill and intangibles recorded in connection with our acquisitions
in 1999 and 2000.
SIGNIFICANT CUSTOMERS
No customer accounted for greater than 10% of total revenues for the
six months ended June 30, 2001. One customer accounted for greater than 10% of
total revenue for the three months ended June 30, 2001 and two customers for the
three and six months ended June 30, 2000 (in thousands).
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
2001 2000 2001 2000
---------- ---------- ------- ---------
Distributor 1
Product * $ 2,383 $ 431 $ 1,427
Service * 24 * 84
Distributor 2
Product * 1,184 * 1,082
Service * 292 * *
* Revenue accounted for less than 10% of total revenues for the period.
7. STOCK COMPENSATION EXPENSE:
The expense for the six months ended June 30, 2001 is for below market
stock options granted to former AetherWorks employees in 2000 of $3.4 million,
acceleration and modification of stock options of terminated employees of $0.2
million, stock options granted below market value to members of the Board of
Directors and CEO of $0.6 million, stock options granted to outside advisors of
$0.5 million, compensation charge for the promissory note with an employee
collateralized by the Company's common stock of $0.3 million and the charge
associated with re-pricing employee stock options in December 2000 of $0.2
million. The expense for the three months ended June 30, 2001 is for below
market stock options granted to former AetherWorks employees in 2000 of $1.7
million and acceleration and modification of stock options of terminated
employees of $0.3.
8. FOREIGN CURRENCY EXCHANGE GAINS AND LOSSES:
Generally, assets and liabilities denominated in foreign currencies are
translated into US dollars at current exchange rates. Operating results are
translated into US dollars using the average rates of exchange prevailing during
the period. Gains or losses resulting from translation of assets and liabilities
15
are included in the accumulated other comprehensive loss account in
stockholders' equity, except for the translation effect of intercompany balances
that are anticipated to be settled in the foreseeable future. The Company had no
foreign exchange gains or losses for the six months ended June 30, 2001 and
2000.
9. BASIC AND DILUTED EARNINGS (LOSS) PER SHARE:
Basic earnings (loss) per share amounts are computed using the weighted
average number of common shares. Diluted earnings (loss) per share amounts are
computed using the weighted average number of common shares and common
equivalent shares having a dilutive effect during the periods; however, for the
three and six months ended June 30, 2001 and June 30, 2000, the effect of common
stock equivalents has not been considered as they would have been antidilutive.
10. COMMITMENTS AND CONTINGENCIES:
LITIGATION
In November 2000, the Company was served with complaints in purported
class action proceedings. The complaints allege violation of the federal
securities laws in connection with statements and disclosures made by certain of
the Company's executives between December 8, 1999 and April 24, 2000. The
complaints seek unspecified damages. The Company believes the allegations in the
complaints are without merit, and intends to vigorously defend its position in
this litigation.
In November 2000, the Company was served with a complaint in a
purported class action proceeding. The complaint alleges that between July 27
and November 2, 2000 the Company breached securities laws in connection with the
circumstances that led the Company to restate the financial statements for the
quarter ended June 30, 2000. The complaint seeks unspecified damages. The
Company believes it has meritorious defenses and intends to vigorously defend
this litigation.
In addition to the legal proceedings discussed above, the Company is
periodically involved in disputes arising from normal business activities. In
the opinion of management, adequate provision for any potential losses has been
made in the accompanying financial statements. Resolution of these matters may
require the payment of certain amounts by the Company which have been provided
for by the Company in the financial statements. Assuming the Company is able to
raise additional capital, these payments will not have a material adverse effect
upon the financial position or future operating results of the Company. The need
for additional capital is discussed at note 1, above, under the caption
`Going Concern and Other Important Risk Factors.'
SECURITIES AND EXCHANGE COMMISSION INVESTIGATION
The Securities and Exchange Commission has commenced an investigation
into the matters surrounding the Company's restatement of revenues for its
quarter ended June 30, 2000. For the quarter ended June 30, 2000, the Company
restated revenues from $10.4 million to $8.4 million for sales made to two of
its value added resellers ("VARs"). These sales were dependent upon the payment
to the VARs from their customers.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The results of operations for the six months ended June 30, 2001,
reflect a 59% decrease in revenues, a 57% decrease in cost of revenues and a 61%
decrease in the loss from operations over the results for the six months ended
June 30, 2000. Our performance was adversely impacted by a number of factors
including:
16
o A downturn in the capital markets and the telecommunications
industry that adversely impacted the demand for our products.
o Delays in bringing our 3000 and 6000 series products to market.
o Re-direction of the sales force towards Tier 1 CLEC's and
ILEC's and away from Tier 2 and 3 customers. The development of
those relationships will take longer to solidify.
Improvements in future performance is dependent upon our ability to
raise financing to fund our revised business strategy. Our marketing and sales
strategy will focus upon:
o Leveraging our expertise in the Voice over Packet industry to
gain a leading market share in IP Centrex solutions for RBOC's
looking to migrate customers off a traditional voice
transmission infrastructure onto a data transmission
infrastructure without the risk of them losing the voice
traffic and revenue to an alternative provider.
o Leveraging our position in the Managed Router Services sector
by providing an attractive alternative solution to Cisco's CPE
Routers (or become a second source vendor to enterprises who
have an existing deployment of Cisco Routers).
o Realigning our sales organization from a geographic focus to a
carrier-centered sales effort and increase marketing focus on
Carriers (e.g. Verizon) and Tier 1 ISPs (e.g. UUNet).
RECENT DEVELOPMENTS
New Chief Executive Officer
On November 10, 2000, Steven Francesco resigned as our chief executive
officer. Mr. Francesco had been chief executive officer since April 1999, and
was responsible for the merger with OpenROUTE and the acquisition of
AetherWorks. Mr. Francesco continued to serve as Chairman of the Board of
Directors until February, 2001, when John DuBois succeeded him in that position.
On December 28, 2000, John DuBois entered into an employment agreement
to become our Chief Executive Officer effective in January 2001. In connection
with accepting the position, Mr. DuBois entered into a three-year employment
agreement with us and he also became a member of our Board of Directors. In
February 2001, he succeeded Mr. Francesco as Chairman of the Board.
Securities And Exchange Comission Investigation
The Securities and Exchange Commission has commenced an investigation
into the matters surrounding our restatement of revenues for the quarter ended
June 30, 2000. For the quarter ended June 30, 2000, we restated revenues from
$10.4 million to $8.4 million for sales made to two of our value added resellers
("VARs"). These sales were made to VARs whose payment to Nx Networks was
dependent upon payment from their customers.
Reduction In Force
In March 2001, we reduced our workforce by approximately 40 employees,
representing approximately 22% of our workforce. In July 2001, we reduced our
workforce by approximately 38 employees, representing approximately 30% of our
workforce. A portion of the positions were eliminated for the purpose of
reducing expenses and the remainder were eliminated because they related to
products and initiatives that are not part of our business plans on a
going-forward basis.
17
Closing Offices
In May 2001 we closed our California office and released the majority of
the personnel. We were successful in negotiating a release from a long-term
lease saving us approximately $60,000 per month. In July 2001, we closed our
European offices and released the majority of the personnel.
NET LOSS
For the three months ended June 30, 2001, we had a net loss of $12.8
million, compared to a net loss of $18.6 million for the three months ended June
30, 2000. The decreases in net loss resulted from decreases in sales and
marketing expense of $2.2 million, R&D expense of $2.6 million, G&A expense of
$0.1 million, amortization of acquired intangibles of $5.9 million and stock
compensation expense of $0.9 million. For the six months ended June 30, 2001, we
had a net loss of $27.1 million, compared to a net loss of $67.0 million for the
six months ended June 30, 2000. The decreases in net loss resulted from
decreases in stock compensation expense of $4.2 million, R&D expenses of $2.0
million, non-cash charges for in-process R&D expense of $30.8 million, sales and
marketing expense of $3.4 million and amortization of acquired intangibles of
$8.7 million.
REVENUES
For the three months ended June 30, 2001, revenues decreased $4.8
million or 57% to $3.6 million, from $8.4 million for the three months ended
June 30, 2000. For the six months ended June 30, 2001, revenues decreased $10.4
million, or 60% to $7.0 million, from $17.4 million for the six months ended
June 30, 2000. For the three months ended June 30, 2001 product revenues
decreased $4.2 million or 65% to $2.2 million from $6.4 million for the three
months ended June 30, 2000. For the six months ended June 30, 2001 product
revenue decreased to $9.4 million or 70% to $4.1 million from $13.5 million for
the six months ended June 30, 2000. The decrease in product revenue is a result
of the general decline in the demand for telecom equipment particularly from
Tier 2 and Tier 3 CLEC's which were a primary sales target for us in 2000.
During the first quarter the sales team was revamped to direct their efforts to
Tier 1 CLEC's and ILEC's. In addition, product changes are being made to insure
our products are attractive to our newly defined target market.
For the three months ended June 30, 2001 service revenues decreased
$0.6 million or 29% to $1.4 million from $2.0 million for the three months ended
June 30, 2000. For the six months ended June 30, 2001 service revenues decreased
$1.0 million or 25% to $2.9 million from $3.9 million for the six months ended
June 30, 2000. The decrease is primarily a result of a program instituted last
year that built in one year of service into the product cost. In addition, the
overall decline in product sales results in the lower potential customer base
for service contracts and therefore lower service revenue. We has implemented a
program to require service contracts on all product shipped which should have
the result of increasing service revenue as product sales increase.
GROSS PROFIT
For the three months ended June 30, 2001, gross profit decreased by
$1.7 million, or 57%, to $1.3 million, from $3.1 million for the three months
ended June 30, 2000. As a percentage of revenues, gross profit was 36% for the
three months ended June 30, 2001 and 2000. For the six months ended June 30,
2001 gross profit decreased $4.2 million or 64% to $2.3 million from $6.5
million for the six months ended June 30, 2000. As a percentage of revenues,
gross profit decreased to 33% for the six months ended June 30, 2001, from 37%
for the six months ended June 30, 2000.
For the three months ended June 30, 2001 gross profit from product
revenue decreased $1.5 million or 67% to $0.7 million from $2.2 million from the
three months ended June 30, 2000. For the six months ended June 30, 2001, gross
profit from product decreased $3.9 million or 76% to $1.2 million from $5.1
million for the six months ended June 30, 2000.
For the three months ended June 30, 2001 gross profit from service
revenues decreased $0.2 million or 29% to $0.6 million from $0.8 million for the
three months ended June 30, 2000. For the six months ended June 30, 2001 gross
18
profit from service revenue decreased $0.1 million or 10% to $1.3 million from
$1.4 million for the six months ended June 30, 2000.
The six month gross profit percentage changes are primarily a result of
a lower-margin product mix, a greater proportion of sales made through
distributors, which generally have higher discounts than direct retail sales,
and competitive pricing pressures. The gross profit in any particular quarter is
dependent upon the mix of products sold and the channels of distribution. As a
result, the gross profit on a quarter to quarter basis can vary within a wide
range.
SALES AND MARKETING
For the three months ended June 30, 2001 sales and marketing expenses
decreased by $2.2 million, or 58%, to $1.6 million from $3.8 million for the
three months ended June 30, 2000. The total decrease includes decreases in wages
and salaries of $0.5 million, sales commission expense of $0.6 million,
recruiting expense of $0.1 million, travel expense of $0.2 million, marketing
expense of $0.3 million and bad debt expense of $0.4 million. For the six months
ended June 30, 2001 sales and marketing expenses decreased $3.4 million, or 44%,
to $4.4 million from $7.8 million for the six months ended June 30, 2000. The
total decrease includes decreases in wages and salaries of $0.5 million, sales
commission expense of $0.9 million, marketing expense of $0.8 million, travel
expense of $0.4 million and bad debt expense of $0.7 million. The decrease also
resulted from a reduction in advertising expenses, participation in trade shows
and the production of marketing materials associated with the new Nx Networks
logo, name and products.
RESEARCH AND DEVELOPMENT
For the three months ended June 30, 2001, research and development
expenses decreased $2.6 million or 52% to $2.4 million from $5.0 million for the
three months ended June 30, 2000. The total decrease includes decreases in wages
and salaries of $1.0 million, new product materials $0.5 million, depreciation
expense of $0.5 million, consulting and engineering expense of $0.3 million,
rent expense of $0.1 million, and travel expense of $0.1 million. For the six
months ended June 30, 2001, research and development expenses decreased $2.0
million or 27% to $5.6 million from $7.6 million for the six months ended June
30, 2000. The decrease includes decreases in wages and salaries of $0.8 million,
new product materials of $0.4 million, consulting fees and other engineering
expense of $0.2 million and depreciation expense of $0.6 million. All of our
research and development costs are expensed to operations as incurred during the
periods reported. We have closed the California office and anticipate a
reduction in rent expense on a going forward basis.
General and Administrative
For the three months ended June 30, 2001 general and administrative
("G&A") expenses decreased $0.1 or 4% to $2.1 million from $2.2 million for the
three months ended June 30, 2000. For the six months ended June 30, 2001 G&A
expenses increased $0.7 million or 16% to $5.3 million from $4.6 million for the
six months ended June 30, 2000. The net increase represents decreases in wages
and salaries of $0.2 million, telephone expense of $.02 million, rent expense of
$0.3 million, and increases in legal and accounting fees of $1.3 million.
IMPAIRMENT OF LONG-LIVED ASSETS
In the second quarter of 2001, after considering developments in the
capital markets and telecommunications industry, the downturn in our market
capitalization, our liquidity problems and the decrease in 2001 product sales,
we reviewed the carrying value of our long-lived assets. Our long-lived assets
are primarily goodwill and intangibles resulting from the acquisitions of
OpenROUTE in 1999 and AetherWorks in the first quarter of 2000. We determined
that these assets were impaired due to uncertainties in our sales forecasts
resulting from past performance, liquidity and current industry conditions. We
reviewed future undiscounted cash flows from OpenROUTE acquired product lines
and technologies and determined the related long-lived assets to be impaired. As
a result, we incurred an impairment charge of $3.7 million for the three months
ended June 30, 2001. These assets had a combined carrying value of $15.7 million
at December 31, 2000, and were written down in the second quarter to $9.4
19
million, their estimated fair value based upon discounted cash flows.
AMORTIZATION OF ACQUIRED INTANGIBLES
For the three months ended June 30, 2001 amortization expense decreased
$5.8 million to $2.3 million from $8.1 million for the three months ended June
30, 2000. For the six months ended June 30, 2001 amortization expense decrease
$8.7 million to $4.5 million from $13.3 million for the six months ended June
30, 2000. The decrease in amortization expense is associated with the reduction
in goodwill as a result of the impairment charge we incurred at December 31,
2000.
STOCK COMPENSATION
For the six months ended June 30, 2001, stock compensation expense
decreased $0.9 million to $2.0 million from $2.9 million for the six months
ended June 30, 2000. The change is primarily associated with stock options
granted at below market value to former AetherWorks employees in conjunction
with the closing of the merger for $3.4 million, acceleration and modification
of stock options of terminated employees of $0.2 million, stock options granted
below market value to members of the Board of Directors and CEO of $0.6 million,
stock options granted to outside advisors of $0.5 million, compensation charge
for the promissory note with an employee collateralized by common stock in us
owned by the employee of $0.3 million and the charge associated with re-pricing
employee stock options in December 2000 of $0.1 million. The expense for the
three months ended June 30, 2001 is for below market stock options granted to
former AetherWorks employees in 2000 of $1.7 million and acceleration and
modification of stock options of terminated employees of $0.3.
INTEREST AND OTHER INCOME, NET
For the three months ended June 30, 2001, the Company had net interest
expense of $107,000 compared to net interest expense of $369,000 for the three
months ended June 30, 2000. For the six months ended June 30, 2001, We had net
interest expense of $209,000 compared to net interest and other income of
$339,000 for the six months ended June 30, 2000.
LIQUIDITY AND CAPITAL RESOURCES
RECENT DEVELOPMENTS
On January 17, 2001 we raised $2.5 million through a private placement
of Series C preferred stock. The Series C preferred stock bears a dividend of 8%
per annum, which we can elect to pay in cash or shares of common stock, and the
Series C preferred stock has a liquidation preference equal to the purchase
price per share plus the amount of any accrued but unpaid dividends. The Series
C preferred stock is convertible into 1,540,000 shares of common stock at a
conversion price of $1.625 per share.
On March 6, 2001 we raised $1.65 million through a private placement of
Series D preferred stock and warrants. The Series D preferred stock bears a
dividend of 8% per annum, which we can elect to pay in cash or shares of common
stock, and the preferred stock has a liquidation preference equal to the
purchase price per share plus the amount of any accrued but unpaid dividends.
The preferred stock is convertible into 1,173,373 shares of common stock at a
conversion price of $1.41 per share. The warrants are exercisable for 234,676
shares of common stock at an exercise price of $2.11 per share.
On March 28, 2001 we raised $2.0 million through a private placement of
common stock. We sold 2,207,018 shares of common stock at $0.9062 per share, the
last reported sales price on the day the financing closed.
On April 20, 2001 we issued 7,405 shares of common stock in full
satisfaction of an indemnification obligation to Bryan Holley, who formerly was
an executive officer and a director. The number of shares was fixed by dividing
20
the dollar amount due to Mr. Holley by $1.05, which represented the last
reported closing price of our common stock on the day of our agreement with Mr.
Holley.
On May 15, 2001 we raised $2.4 million through a private placement of
Series E preferred stock. The Series E preferred stock bears a dividend of 8%
per annum, which we can elect to pay in cash or shares of common stock, and the
Series E preferred stock has a liquidation preference equal to the purchase
price per share plus the amount of any accrued but unpaid dividends. Each share
of the Series E preferred stock has an initial conversion price of $1.265 per
share, and the number of shares of common stock initially issuable under the
terms of the Series E preferred stock is 1.9 million shares. However, after an
initial period the conversion price of the Series E preferred stock will be
fixed by reference to the volume weighted average sales price (VWAP) of our
common stock. Specifically, the Series E preferred stock will have a conversion
price per share equal to the lesser of (1) $1.265 or (2) 87% of the VWAP during
the five days preceding a notice of conversion, subject to a minimum conversion
price of $0.575 per share. On July 5, 2001 all of the Series E Preferred Stock
was converted to 4,037,256 shares of common stock.
As of June 30, 2001, we had approximately $1.8 million in cash and cash
equivalents. Total current liabilities as of June 30, 2001 were approximately
$18.9 million and exceeded current assets by approximately $11.4 million. Since
year-end, we have raised approximately $9.8 million in equity financing. We will
require additional financing in September 2001 to continue operations. If
financing is insufficient or unavailable or if we experience shortfalls in
anticipated revenues or increases in anticipated expenses, we would further
reduce headcount, defer vendor payments, sell operating assets and/or seek
protection under the bankruptcy code.
We have a payment obligation of approximately $4.4 million to SMTC, the
third party contract manufacturer of substantially all of its products. A
majority of our inventory is at SMTC's premises. We have agreed upon a payment
schedule with SMTC and delivered an unsecured promissory note to SMTC. Until
SMTC has been repaid, we are required to pay in advance for all fabrication
costs. If we do not adhere to the payment schedule, SMTC has informed us that
they will not ship any products on our behalf. If we are unable to raise
sufficient capital to adhere to the payment schedule and the manufacturer ceases
to ship products on our behalf, then a material and adverse result to our
operations could occur. Currently, we are in default of the agreement because we
could not adhere to the payment terms. SMTC has indicated a willingness to
renegotiate the agreement.
To meet our operating requirements for the remainder of 2001, we will
have to generate additional cash other than through operations. The means by
which we could raise the necessary funds include the sale of assets, including
intellectual property and proprietary technology, the sale of equity,
borrowings, the sale of selected operations, or establishing one or more
strategic partnerships. Although we believe we have the ability to generate
additional equity and cash through such sales and borrowings, such sales may be
dilutive and there can be no assurances that adequate funds will be available,
or available on terms that are reasonable or acceptable to us. If we are unable
to generate adequate cash, there will be a material and adverse effect on the
business and financial condition of us, to the extent that a sale, liquidation
or restructuring of us will be required, in whole, or in part. Our return to
profitability also depends upon our ability to improve our customer service,
operational, financial and management information systems, including its
contract management, inventory management and other systems.
The financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might be necessary should we be unable to
continue as a going concern. In their report on our December 31, 2000 financial
statements, our independent public accountants expressed substantial doubt as to
our ability to continue as a going concern.
For the six months June 30, 2001, we used $12.4 million of cash in
operations compared to $8.9 million for the six months ended June 30, 2000. This
increase in cash used in operations was due to our operating losses. Non-cash
items consisted of depreciation and amortization of $5.5 million, stock
compensation expense of $5.2 million, and interest expense pursuant to the
issuance of the warrants totaling $0.5 million and goodwill impairment charges
of $3.7 million. Inventory levels at June 30, 2001, decreased $1.6 million to
$3.3 million compared to $4.9 million at December 31, 2000. This decrease is the
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result of lower product purchases, the ability to fill orders from existing
inventory and a one-time overhead adjustment which reduced the inventory
carrying value. With the exception of certain strategic purchases needed to
complete work in process and complete items for finished goods, we anticipate
that purchases will remain flat through the second quarter as we use in-house
inventory to fulfill sales orders.
Capital expenditures for the six months ended June 30, 2001 and 2000
were $0.1 million.
CERTAIN FACTORS WHICH MAY AFFECT FUTURE RESULTS
The following important factors, among others, could cause our actual
results to differ materially from those indicated by forward-looking statements
made in this quarterly report and presented elsewhere by management from time to
time.
OUR INDEPENDENT PUBLIC ACCOUNTANTS HAVE EXPRESSED SUBSTANTIAL DOUBT ABOUT OUR
ABILITY TO CONTINUE AS A GOING CONCERN
Arthur Andersen LLP, in their report with respect to the audit of our
financial statements for the period ending December 31, 2000, expressed
substantial doubt as to our ability to continue as a going concern. Our current
liabilities exceed our current assets by $11.4 million. In order to continue as
a going concern, we must obtain additional financing or obtain cash through
other means, which could include, among others, a sale of assets, a sale of
selected operations or the establishment of strategic partnerships. If we cannot
obtain sufficient cash from these activities, then we will have to further
reduce headcount and other expenses, defer vendor payments and/or seek
protection under the bankruptcy code. Our financial statements have been
prepared on the basis that we will continue as a going concern. Our financial
statements do not include any adjustments relating to the recoverability and
classification of asset carrying amounts or the amount and classification of
liabilities that might be necessary should we be unable to continue as a going
concern.
WE HAVE INCURRED LOSSES FROM OPERATIONS IN EACH OF THE LAST SEVEN YEARS AND MAY
NEVER BE PROFITABLE.
For the six months ended June 30, 2001 and 2000, respectively, we
incurred net losses of approximately $27.1 million and $67.0 million. Our
cumulative losses since inception are $283 million. For the six months ended
June 30, 2001, we generated negative cash flow form operations of $12.4 million.
We may never achieve or sustain profitability or generate positive cash flow. If
we do not become profitable, we will have to obtain capital from other sources
or cease operations.
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WE REQUIRE ADDITIONAL CAPITAL TO CONTINUE OUR OPERATIONS, AND WE CANNOT BE
CERTAIN THAT THE NECESSARY FUNDS WILL BE AVAILABLE
Our current available cash and our anticipated cash from operations are
insufficient to fund our operations until we are able to attain profitability.
We will require additional cash to continue our operations in September 2001.
These funds will be available only if we sell securities or some of our assets.
We cannot assure you that we will be able to obtain financing on terms favorable
to us, or at all. If we obtain additional funds by selling any of our equity
securities, the percentage ownership of our stockholders will be reduced,
stockholders may experience additional dilution, or the equity securities may
have rights, preferences or privileges senior to the common stock. If we obtain
additional funds by selling assets, there can be no assurance that we will be
able to negotiate a favorable price for those assets or that the loss of those
assets will not affect our future business prospects. If adequate funds are not
available to us or available to us on satisfactory terms, we may be required to
further reduce headcount and other expenses, defer vendor payments, modify our
business strategy and/or seek protection under the bankruptcy code.
WE HAVE SIGNIFICANT ACCOUNTS PAYABLE OBLIGATIONS
As a result of our current financial condition, our accounts payable
balance is significant in relation to our available cash balance. This makes it
more difficult to satisfy the payment demands of all of our vendors on a timely
basis and it makes it more difficult to convince vendors that they will be paid
all amounts to which they are entitled despite our low balance of available
cash. We do not have sufficient cash to fund all of these obligations if our
vendors demand payment in advance or demand payment of all currently outstanding
amounts payable. Certain of our vendors have demanded payment of the amounts due
to them. For those vendors who provide equipment or services necessary for us to
generate revenue we have negotiated extended payment terms and/or payments from
our available resources. Certain vendors have commenced litigation against us
seeking to compel payment of amounts they claim they are owed, as described
below in Part II, Item 1 - Legal Proceedings in this quarterly report.
WE ARE INVOLVED IN A NUMBER OF LAWSUITS SEEKING SIGNIFICANT DAMAGES AGAINST
THE COMPANY
We are engaged in a number of legal actions. These include two class
action lawsuits alleging violations of securities laws, a patent infringement
action and numerous breach of contract actions arising out of our failure to pay
amounts claimed to be due. The class action lawsuits and the patent infringement
action do not specify the amount of monetary damages sought by the respective
plaintiffs, but any amount claimed will be significant in relation to our
available cash resources. The breach of contract actions generally specify the
amount of damages sought, and the aggregate amount claimed in these actions, and
in many of the individual actions, exceeds our available resources. We cannot
assure you that if we are ultimately found liable for monetary damages in one or
more of these actions that, at the time we are found liable, we will have the
necessary capital to satisfy the related judgment.
WE RELY TO A LARGE EXTENT ON INDEPENDENT DISTRIBUTION CHANNELS AND THE LOSS OF A
SIGNIFICANT NUMBER OF DISTRIBUTORS COULD ADVERSELY EFFECT US
We rely on reseller channels, including distributors and systems
integrators, for a significant portion of our revenues. In particular, in
foreign markets we often have one distributor designated for an entire country,
and that distributor provides local support and service for our products. The
loss of one or more significant resellers could adversely affect our business in
terms of:
o lost revenues;
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o lost market presence; and
o the difficulties we would encounter in servicing customers
introduced to us by our resellers if we do not have other
resellers in that geographic area.
WE HAVE A SIGNIFICANT PAYMENT OBLIGATION TO OUR PRIMARY MANUFACTURER, AND IF WE
DO NOT MAINTAIN OUR PAYMENT SCHEDULE THE MANUFACTURER MAY CEASE SHIPPING OUR
PRODUCTS
We authorized our primary manufacturer, SMT Centre, to purchase a
substantial amount of parts, materials and long lead-time items during 2000 in
anticipation of a significant increase in product sales during the year. Our
sales did not reach the levels we expected, and we have not utilized a
substantial amount of the raw materials. Accordingly, we have a payment
obligation of approximately $4.4 million to SMT Centre to pay for the cost of
these materials. We have agreed upon a payment schedule with SMT Centre, and
during the period we are paying down the obligation SMT Centre is requiring us
to pay in advance for all fabrication costs. If we do not adhere to the payment
schedule or if we do not pay fabrication costs in advance, SMT Centre has
expressed its intent not to ship any products on our behalf. We are not
currently in complience with the payment schedule, but SMT has experienced
willingness to negotiate a new payment schedule. We must raise additional
capital to maintain a payment schedule and pay the fabrication costs. If SMT
Centre ceases to ship products on our behalf, then a material and adverse result
to our revenues could occur. Also, if the SMT Centre brings a legal action to
collect the outstanding amount, we do not have sufficient current financial
resources to pay this obligation.
WE ARE EXPOSED TO POTENTIAL DELAYS IN PRODUCT SHIPMENTS BECAUSE WE CONTRACT OUT
PRODUCT MANUFACTURING AND SOME COMPONENTS FOR OUR PRODUCTS ARE AVAILABLE ONLY
FROM A SINGLE SUPPLIER OR A LIMITED NUMBER OF SUPPLIERS
We rely on others to manufacture our products and product components
and this dependence exposes us to potential interruptions or delays in product
delivery. An interruption could have a short- term effect on our revenues and a
longer-term effect on our ability to market our products. Currently, we rely on
SMT Centre as the single manufacturer to assemble and test our voice products.
Also, some of the components we use in our products are available from only one
source or a limited number of suppliers. Although we have been able to obtain
our products and these components to date, our inability to develop alternative
sources if and as required in the future, or to obtain sufficient sole source or
limited source components as required, could result in delays or reductions in
product shipments.
OUR BUSINESS WILL SUFFER IF WE LOSE CERTAIN KEY PERSONNEL OR FAIL TO ATTRACT AND
RETAIN OTHER QUALIFIED PERSONNEL
The success of our business is dependent, to a significant extent, upon
the abilities and continued efforts of our management, sales and engineering
personnel, many of whom would be difficult to replace. We do not have employment
contracts with many of our key employees and we do not have "key man" life
insurance on any of our officers or directors.
Our success will also depend on our ability to attract, retain and
motivate qualified management, sales and engineering executives and other
personnel who are in high demand and who often have multiple employment options.
In addition, as a result of our financial condition and the changes to
technology-based industries, and particularly telecommunications companies, over
the past year, many employees that we would like to retain may decide to pursue
other opportunities or we may be forced to increase their compensation to retain
them.
OUR INTELLECTUAL PROPERTY RIGHTS ARE AN IMPORTANT PROTECTION FOR OUR PRODUCTS,
AND WE COULD BE ADVERSELY AFFECTED IF OUR RIGHTS ARE CHALLENGED OR CIRCUMVENTED
BY COMPETITORS
Our ability to compete successfully within our industry is dependent in
part upon:
o patents and nondisclosure agreements that we have obtained;
o technical measures that we take to protect confidential
information; and
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o trade secret, copyright and trademark laws that we rely on to
establish and protect our proprietary rights.
If any of our proprietary rights are successfully challenged or
circumvented by competitors, or if other companies are able to market
functionally similar products, systems or processes without infringing our
proprietary rights, then our results of operations and the value of our common
stock could be materially and adversely affected. In addition, legal proceedings
to enforce intellectual property rights are expensive given the technical nature
of the legal and functional analysis. Given our current financial condition, we
could experience difficulty funding enforcement of our intellectual property
rights.
THE MARKET PRICE OF OUR COMMON STOCK IS VOLATILE
The stock prices for many companies in the telecommunications equipment
sector have experienced wide fluctuations that have often been unrelated to
their operating performance. We have been, and we are likely to continue to be,
subject to these fluctuations. The market price of our common stock has been and
can be expected to be significantly affected by factors such as:
o quarterly variations in our results of operations;
o the announcement of new services or service enhancements by us
or our competitors;
o technological innovations by us or our competitors;
o changes in earnings estimates or buy/sell recommendations by
analysts;
o the operating and stock price performance of other comparable
companies; and
o general market conditions or market conditions specific to
particular industries.
OUR STOCK PRICE IS CURRENTLY BELOW THE MINIMUM THRESHOLD REQUIRED BY THE NASDAQ
STOCK MARKET, AND IF OUR STOCK PRICE DOES NOT RISE WE EXPECT TO BE DELISTED BY
THE NASDAQ STOCK MARKET
On July 24, 2001, we were notified by the Nasdaq Stock Market that we
have failed to maintain a closing bid price of $1.00 per share for 30
consecutive trading days. If our common stock has not had a closing bid price in
excess of $1.00 for at least ten consecutive trading days on or before
October 22, 2001, we expect that our common stock will be delisted from the
Nasdaq Stock Market. If we are delisted from the Nasdaq Stock Market, our common
stock will trade on the over-the-counter market. We expect that if we change
from the Nasdaq National Market to the over-the-counter market, there will be an
adverse effect on the liquidity and value of our common stock.
IN DECEMBER 2000 WE RE-PRICED SUBSTANTIALLY ALL OF OUR STOCK OPTIONS TO A LOWER
EXERCISE PRICE, AND THE RESULTING ACCOUNTING CHARGES MAY CAUSE OUR FUTURE
EARNINGS TO FLUCTUATE WIDELY
As part of a program to retain our employees, we adopted a program to
re-price the options of our employees. We also re-priced the options issued to
our board of directors and to our former chairman of the board. Under the
program, each of these persons exchanged their current stock options for newly
issued stock options with an exercise price of $0.75 per share. Approximately
7.3 million options were exchanged to obtain the lower exercise price. Under
applicable accounting rules, we will have to account for future variations in
the price of our common stock above $0.75 per share as compensation expense
until the re-priced options are either exercised, cancelled or expire. As of
June 30, 2001, $0.1 million of compensation expense was recorded based on the
performance of our common stock in that quarter. Accordingly, our operating
results and earnings per share will be subject to potentially significant
fluctuations based upon changes in the market price of our common stock.
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OUR CERTIFICATE OF INCORPORATION AND BY-LAWS CONTAIN PROVISIONS THAT COULD DELAY
OR PREVENT A CHANGE IN CONTROL
Provisions of our certificate of incorporation and by-laws may have the
effect of discouraging, delaying or preventing a take-over attempt that could be
in the best interests of our stockholders. These include provisions that:
o separate our board of directors into three classes;
o limit the ability of our stockholders to call special
stockholder meetings;
o require advance notice of nominations for directors and
stockholder proposals to be considered at stockholder meetings;
and
o require a vote greater than two-thirds to remove directors from
office or amend many of the provisions of our certificate of
incorporation and by-laws.
Our board of directors also has the right, without further action of
the stockholders, to issue and fix the terms of preferred stock, which could
have rights senior to the common stock. We are also subject to the "business
combination" provisions of the Delaware General Corporate Law, which impose
procedures impeding business combinations with "interested stockholders" that
are not approved of by our board of directors.
RAPIDLY CHANGING TECHNOLOGY MAY MAKE OUR PRODUCTS OBSOLETE OR UNMARKETABLE
We have focused our products on the edge of the Internet and telephony
market. This market is characterized by rapid technological change, frequent new
product introduction and evolving industry standards. The introduction of
products embodying new technologies by our competitors and the emergence of new
industry standards could render our existing products obsolete and could cause
new products to be unmarketable. Under these circumstances, our revenue would be
adversely affected.
Our success will depend on the ability to address the increasingly
sophisticated needs of customers, to enhance existing products and to develop
and introduce, on a timely basis, new competitive products that keep pace with
technological development and emerging industry standards. If we cannot
successfully identify, manage, develop manufacture or market product
enhancements or new products, our business will be materially and adversely
affected.
OUR INDEPENDENT PUBLIC ACCOUNTANTS HAVE IDENTIFIED WEAKNESSES IN OUR FINANCIAL
SYSTEMS AND CONTROLS, AND IF WE DO NOT REMEDY THE WEAKNESSES, WE MAY HAVE
DIFFICULTY EFFECTIVELY MANAGING OUR BUSINESS AND PREPARING TIMELY FINANCIAL
REPORTS
In connection with conducting the audit of our year 2000 financial
statements, our independent public accountants identified a number of
deficiencies in the design and operation of our internal accounting controls.
Although our accountants did not qualify their audit opinion with respect to
these matters, they advised us that we must remedy the identified problems. The
deficiencies identified generally included insufficient resources in the
accounting and finance department, insufficient ledger detail, insufficient
computerized information systems, insufficient closing processes and the need
for additional policies and procedures to ensure proper, timely recordation of
financial statement information. We have reviewed the findings of our
accountants with our Audit Committee and taken actions to remedy each of the
identified deficiencies. If we are unable to remedy the deficiencies identified
by our accountants, we could have difficulties in preparing and maintaining the
systems and reports we need to effectively manage our business and ensure timely
financial reporting. These difficulties could result in adverse effects on our
business.
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A PORTION OF OUR REVENUES ARE DERIVED FROM INTERNATIONAL SALES, WHICH ARE
SUBJECT TO FOREIGN REGULATORY STANDARDS AND CURRENCY EXCHANGE RATE FLUCTUATIONS
International sales accounted for 55% and 48% of our total revenues in
the first six months of 2001 and 2000, respectively, and international sales
will continue to be significant to us. The conduct of international operations
subjects us to certain risks. Foreign regulatory bodies continue to establish
standards different from those in the United States, and our products are
designed generally to meet those standards. Our inability to design products in
compliance with such foreign standards could have an adverse effect on our
operating results. Also, our international business may be affected by changes
in demand resulting from fluctuation in currency exchange rates and tariffs and
difficulties in obtaining export licenses. We do not expect that we will hedge
against fluctuations in currency exchange rates.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our results of operations will be adversely impacted by increases in
the price of our stock as a result of additional stock compensation expense
associated with the re-pricing of approximately 7.3 million of our employees'
stock options. A significant portion of our revenues are derived from
international sales which could be adversely affected by foreign currency
exchange rate fluctuations. We are not a party to any other market risk
sensitive instruments that are material to us, our financial position or results
of operations, either for trading purposes or otherwise.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Cabletron Systems, Inc. filed a civil complaint against AetherWorks
Corporation, OpenROUTE Networks, Inc. and Netrix Corporation (the Defendants) on
June 5, 2000 in the United States District Court for the District of
Massachusetts. Docket # 00-CV-11105 RWZ is assigned to this matter. In its
complaint, Cabletron alleges that the Defendants have infringed seven Cabletron
patents and Cabletron seeks injunctive relief and unspecified monetary damages
against the Defendants. We answered the complaint by denying the allegations
contained therein. Discovery is underway.
Cabletron sought permission of the Court to amend its complaint to
increase the number of patents it alleges have been infringed, but this was
denied. We have notified certain of our equipment providers that we claim
indemnification from them because the infringements alleged by Cabletron appear
to relate to the equipment those suppliers provided to us. In addition, in July
2001 we filed a motion for summary judgment in this action based on a number of
defenses, including Cabletron's lack of standing, non-infringement, and laches
and estoppel. We also requested the Court to award us attorneys fees because
Cabletron did not contact us regarding the alleged infringements prior to
commencing its lawsuit. This motion is pending. Based upon discussions with
counsel and the information currently available to us, we believe we have
meritorious defenses to the claims by Cabletron, and we will continue to
vigorously defend this action.
In November 2000 we were served with complaints in purported class
action proceedings captioned TRACY REESE AND CHRISTINE JOYCE V. BRYAN HOLLEY,
STEVEN T. FRANCESCO AND NX NETWORKS, INC., Civil Action No. 00-CV-11850-JLT and
MARC JACOBSEN V. BRYAN HOLLEY, STEVEN T. FRANCESCO AND NX NETWORKS, INC., Civil
Action No. 00-CV-11999-JLT. Each complaint was originally filed September 2000
in the United States District Court for the District of Massachusetts. In May
2001, the plaintiffs filed an amended complaint consolidating the two actions
and dropping Mr. Holley as a defendant. The amended complaint alleges violation
of the federal securities laws in connection with statements by Steven
Francesco, our former chief executive officer and chairman of the board, and
disclosures in our press releases made between December 8, 1999 and April 24,
2000 that purportedly caused the price of our common stock to rise during this
period. The complaints seek unspecified damages. In June 2001 we filed our
answer to this action and a motion to dismiss. The motion to dismiss is pending
before the court. We believe the allegations in the amended complaint are
without merit, and we intend to vigorously defend ourselves in this litigation.
We have notified our insurance carrier regarding the claims.
In November 2000, we were served with a complaint in a purported class
action proceeding captioned ROY WERBOWSKI V. NX NETWORKS, INC., STEVEN FRANCESCO
AND PETER KENDRICK, Civil Case No. 00-1967-A. The complaint was originally filed
27
in November 2000 in the United States District Court, Eastern District of
Virginia. In May 2001, the plaintiffs filed an amended complaint. The amended
complaint alleges that between July 27 and November 2, 2000 statements made by
Steven Francesco, our former chief executive officer and chairman of the board,
and Peter Kendrick, our chief financial officer, and disclosures in press
releases we issued violated federal securities laws. We reported our financial
results for the period ending June 30, 2000 on July 27, 2000 and we restated
those results on November 2, 2000. The plaintiff's allege that we improperly
recognized revenue in the period ending June 30, 2000 and made misleading
statements regarding our success in order to falsely create the appearance
of prospering performance and financial results. The amended complaint seeks
unspecified damages. In June 2001, we filed our answer to this action and a
motion to dismiss. The motion is pending before the court. We believe we have
meritorious defenses in this litigation, and we intend to vigorously defend
ourselves. We have notified our insurance carrier regarding the claims.
In January, 2001 we were served with a complaint captioned MANAGEMENT
INFORMATION CONSULTING, INC. ("MIC") V. NX NETWORKS, INC. This action was filed
in the Alexandria Division Court for the Commonwealth of Virginia, and the case
is assigned No. CL01-45. In the complaint, MIC claims entitlement to
approximately $150,000 in payment for web site development services performed by
it. We dispute that this amount is due, based upon the quality and quantity of
services provided by MIC. We have filed an answer denying the claims and we
intend to vigorously defend ourselves in this litigation.
An action captioned K.S. TELECOM, INC. ("K.S. TELECOM") V. NX NETWORKS,
INC. was commenced in July, 2000 in the Southern District of New York, and it is
assigned case number 00 Civ. 3375 (KMW). In this action, we are named as a third
party defendant by K.S. Telecom under a number of legal theories in an action
brought against K.S. Telecom by Netrix Leasing, LLC, an unrelated entity. Netrix
Leasing LLC had purchased equipment from us and leased it to K.S. Telecom.
Netrix Leasing alleges that K.S. Telecom subsequently defaulted on the lease
payment obligations. In its third-party complaint, K.S. Telecom alleges that it
breached its lease because of our failure to properly prepare, install and
repair the equipment. In its complaint, K.S. Telecom seeks damages against us
equal to approximately $177,000 plus any amounts they are found to owe to Netrix
Leasing. Netrix Leasing is seeking approximately $550,000 pursuant to its
original complaint against K.S. Telecom, representing lease amounts past due of
approximately $78,000 and acceleration of future payments under the lease of
approximately $472,000. We responded to the third-party complaint of K.S.
Telecom by denying all of their allegations and we sought dismissal of the
claims in a summary judgment motion. On March 7, 2001, the court ruled that
certain of the claims against us must be dismissed, but that other claims may
proceed. Specifically, the court ruled that K.S. Telecom could proceed to try to
prove its allegation that it is a third party beneficiary of our agreements with
Netrix Leasing and that we breached obligations to K.S. Telecom under those
agreements. We believe we have meritorious defenses to the claims of K.S.
Telecom, and we intend to vigorously defend this action.
In January 2001, we were informed that a former employee in France has
obtained a trial court ruling in France related to his termination in 1997. The
amount of the award to him is approximately 800,000 French Francs, and using an
exchange rate into U.S. dollars of 7:1, this is approximately $100,000.
Approximately $25,000 of the amount represents payment of a disputed bonus, and
approximately $75,000 represents an award of punitive damages. We are appealing
this ruling because we believe the award of punitive damages is unjustified.
In May 2001, we were served with a complaint captioned MANAGEMENT
RECRUITERS - MONTICELLO, L.L.C. V. NETRIX CORPORATION, CIVIL CASE NO. 00-1867-1.
The case was filed in the Circuit Court for the County of Albermarle in the
Commonwealth of Virginia. The complaint demands payment of approximately
$50,000 for recruiting expenses allegedly incurred by us in 2000. We are
reviewing the complaint, and expect that we will settle this matter.
In May 2001, we were served with a complaint captioned U.S. ASSEMBLIES
NEW ENGLAND, INC. V. OPENROUTE NETWORKS, INC. AND NETRIX CORPORATION D/D/A NX
NETWORKS, Civil Case No. BRCV 2001-00551A. The case was filed in the Superior
Court for the Commonwealth of Massachusetts in Bristol, Massachusetts. The
complaint alleges that we owe U.S. Assemblies approximately $1.0 million,
representing (1) claimed amounts for products delivered of $$700,000 less an
offset due us of $120,000, (2) $40,000 of work in process and (3) $360,000 for
inventory purchased on our behalf. We are reviewing the complaint, and have not
28
yet filed an answer. Based upon our initial review of the allegations set forth
in the complaint, we expect to deny entirely the allegations related to any
amounts for inventory purchased on our behalf and for work-in-process. We also
expect to dispute the amount claimed by U.S. Assemblies for products delivered
and to assert various other defenses to the claims by U.S. Assemblies. In
addition, we expect to assert counterclaims against U.S. Assemblies for breach
of contract related to production delays they incurred in manufacturing products
for us and for amounts payable by them to us. We will vigorously defend this
action.
In July 2001, Gallagher Harnett & Lagalante LLP filed a complaint
against Nx Networks, Inc. in the United States District Court for the Eastern
District of Virginia. This action has been assigned case no. CA-01-1944-A. The
complaint alleges that Gallagher Harnett & Lagalante LLP is entitled to $329,058
for legal services rendered to us. We dispute the amount claimed to be due
because we have issued warrants to purchase common stock to the law firm in full
payment of certain of their invoices. We will defend ourselves vigorously in
this matter.
In July 2001, Softalia, Inc. filed a complaint against Nx Networks,
Inc., Netrix Corporation and John DuBois, our chief executive officer. The case
was filed in the Circuit Court of Fairfax County in Virginia, and the action has
been assigned cast number L196805. In the complaint Softalia alleges that we owe
them $505,672 for development services performed on our behalf. They also allege
that Nx Networks is not authorized to do business in the Commonwealth of
Virginia, as a result of which John DuBois can be found personally liable for
the amount in dispute. We will file an answer disputing the amount claimed to be
due by Softalia since a portion of the work they seek payment for was not
authorized by us or used by us. We will also seek dismissal of the claims
against Mr. DuBois since Nx Networks is the legal successor to Netrix
Corporation, which is authorized to conduct business in the Commonwealth of
Virginia. We will vigorously defend this action.
In July 2001, Key3media Events, Inc., filed a complaint against Nx
Networks, Inc. in its own capacity and as the successor to OpenRoute Networks,
Inc. Key3media alleges that OpenRoute breached a commitment to participate in a
trade show in 1998, which resulted in $33,000 of actual damages and permitted
Key3media to recover $7,500 of liquidated damages. In addition, Key3media
claims Nx Networks breached a commitment to participate in a trade show in 2001,
which resulted in $12,190 of damages to Key3media. We are reviewing the
complaint, and have not yet adopted a position with respect to this matter.
In addition to the legal proceedings discussed above, we are
periodically involved in disputes arising from normal business activities. In
our opinion, adequate provision for any potential losses has been made in the
accompanying financial statements. In our opinion, resolution of these
matters will require the payment of certain amounts by us and, assuming we are
able to raise additional capital, these payments will not have a material
adverse effect upon our financial position or future operating results. The need
for additional capital is discussed at note 1, above, under the caption `Going
Concern and Other Important Risk Factors.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
On January 17, 2001 we raised $2.5 million through a private placement
of 15,400 shares of Series B 8% convertible preferred stock at a purchase price
of $162.50 per share. The preferred stock bears a dividend of 8% per annum,
which we can elect to pay in cash or shares of common stock. The preferred stock
has a liquidation preference equal to the purchase price per share plus the
amount of any accrued but unpaid dividends. The preferred stock is convertible
into 1,540,000 shares of common stock at a conversion price of $1.625 per share.
We can redeem the preferred stock at a price of $500.00 per share if our common
stock trades at or above $5.00 per share for 10 consecutive trading days.
In January 2001, we issued 25,000 warrants to Christian & Timbers, an
executive recruiting firm, as partial compensation related to our hiring John
DuBois as our Chief Executive Officer. The warrants expire in January 2006 and
have an exercise price of $1.20 per share.
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In March 2001 we issued 1,515,813 shares and 50,877 warrants to the
former owners of AetherWorks Corporation. This issuance was made pursuant to a
settlement agreement with the holders and was completed when our stockholders
approved the issuance at the March 6, 2001 special meeting of stockholders.
On March 6, 2001 we raised $1.65 million through a private placement of
Series D 8% convertible preferred stock and warrants at a purchase price of
$141.00 per share of preferred stock. The preferred stock bears a dividend of 8%
per annum, which we can elect to pay in cash or shares of common stock, and the
preferred stock has a liquidation preference equal to the purchase price per
share plus the amount of any accrued but unpaid dividends. The preferred stock
is convertible into 1,173,373 shares of common stock at a conversion price of
$1.41 per share. We can redeem the preferred stock at a price of $500.00 per
share if our common stock trades at or above $5.00 per share for 10 consecutive
trading days. The warrants expire on March 6, 2006 and are exercisable for
234,676 shares of common stock at an exercise price of $2.11 per share.
On March 28, 2001 we raised $2.0 million through a private placement of
common stock. We sold 2,207,018 shares of common stock at $0.9062 per share, the
last reported sales price on the day the financing closed.
On April 20, 2001 we issued 7,405 shares of common stock in full
satisfaction of an indemnification obligation to Bryan Holley, who formerly was
an executive officer and a director. The number of shares was fixed by dividing
the dollar amount due to Mr. Holley by $1.05, which represented the last
reported closing price of our common stock on the day of our agreement with Mr.
Holley.
On May 15, 2001 we raised $2.4 million through a private placement of
Series E 8% convertible preferred stock and warrants at a purchase price of
$126.50 per share of preferred stock. The preferred stock had a dividend of 8%
per annum, which we could elect to pay in cash or shares of common stock, and
the Series E preferred stock had a liquidation preference equal to the purchase
price per share plus the amount of any accrued but unpaid dividends. Each share
of the preferred stock had an initial conversion price of $1.265 per share, and
the number of shares of common stock initially issuable under the terms of the
Series E preferred stock was 1.9 million shares. However, after an initial
period the conversion price of the Series E preferred stock became fixed by
reference to the volume weighted average sales price (VWAP) of our common stock.
Specifically, the Series E preferred stock had a conversion price per share
equal to the lesser of (1) $1.265 or (2) 87% of the VWAP during the five days
preceding a notice of conversion, subject to a minimum conversion price of
$0.575 per share. Accordingly, between the common stock prices of $1.46 and
$0.66, the number of shares of common stock we had to issue upon conversion of
the Series E preferred stock fluctuated. The range was between 1.9 million
shares at a VWAP of $1.46 (reflecting a conversion price of $1.265 per share) to
4.2 million shares at a VWAP of $0.66 (reflecting a conversion price of $0.575
per share). On July 5, 2001 all of the Series E Preferred Stock was converted
into 4,037,256 shares of common stock. The warrants expire on May 15, 2006 and
are exercisable for 1,900,000 shares at an exercise price of $1.44 per share.
In issuing all of the above securities, we relied upon the exemption
from registration under the Securities Act provided by Section 4(2) of the
Securities Act because each of the purchasers of securities was an accredited
investor.
ITEM 3. NOT APPLICABLE.
ITEM 4. NOT APPLICABLE
ITEM 5. NOT APPLICABLE.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
30
Exhibit
Number Description
- ------ -----------
3.1 Amendment to Certification of Incorporation of Nx Networks, Inc. dated March 2001 (filed as
Exhibit 4.6 to our Annual Report on Form 10-K for the year ended December 31, 2000).
4.1 Specimen certificate of common stock of Nx Networks, Inc. (filed as Exhibit 4.1 to our
Registration Statement on Form S-3 filed on January 17, 2001 File No. 333-53852 (the "January
2001 S-3")).
4.2 Certificate of designations for the form of Series C 8% convertible preferred stock (filed as
Exhibit 4.4 to our Annual Report on Form 10-K for the year ended December 31, 2000).
4.3 Certificate of designations for the form of Series D 8% convertible preferred stock (filed as
Exhibit 4.5 to our Annual Report on Form 10-K for the year ended December 31, 2000).
4.4 Form of Warrant. (filed as Exhibit 4.3 to the January 2001 S-3).
4.5 Subscription Agreement related to the March 2001 private placement of common stock (filed as Exhibit 4.4 to
our Annual Report on Form 10-K for the year ended December 31, 2000).
4.6 Certificate of designations for the form of Series E 8% convertible preferred stock (filed as
Exhibit 4.1 to our Current Report on Form 8-K dated May 16, 2001).
4.7 Form of warrant related to the Series E 8% convertible preferred stock (filed as Exhibit 10.3
to our Current Report on Form 8-K dated May 16, 2001).
4.8 Securities Purchase Agreement related to the Series E 8% convertible preferred stock (filed as
Exhibit 10.1 to our Current Report on Form 8-K dated May 16, 2001).
10.1 1999 Long Term Incentive Plan of Netrix Corporation, as amended (incorporated by reference to
Exhibit 10.9 to our quarterly report on Form 10-Q filed on November 15, 1999).
10.2 Amended and Restated 1997 Stock Option Plan of AetherWorks Corporation. (filed as Exhibit
10.16 to the January 2001 S-3).
10.3 Amendment to the 1999 Long Term Incentive Plan dated March 7, 2001 (filed as Exhibit 10.31 to
the Annual Report on Form 10-K for the year ended December 31, 2000).
10.4 Termination Agreement dated March 22, 2001 between Nx Networks, Inc. and Greg McNulty (filed
as Exhibit 10.32 to the Annual Report on Form 10-K for the year ended December 31, 2000).
10.5 Amended and Restated Promissory Note, dated May 7, 2001, issued by Jonathan Sachs to Nx
Networks, Inc. (filed as Exhibit 10.5 to our quarterly report on Form 10-Q filed on May 21,
2001)
10.6 Termination Agreement dated May 2001 between Nx Networks, Inc. and Water Tower II, LLC. (
filed as Exhibit 10.6 to our quarterly report on Form 10-Q filed on May 21, 2001)
31
Exhibit
Number Description
- ------ -----------
10.7 Promissory Note, dated January 8, 2001 issued by Nx Networks, Inc. to SMT Centre, together with
a related letter of agreement.
(b) Reports on Form 8-K
On May 15, 2001 we filed a current report on Form 8-K with respect to the Series
E preferred stock.
On July 23, 2001 we filed a current report on Form 8-K with respect to dismissal
of Arthur Andersen as our independent public accountants.
32
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Nx NETWORKS, INC.
Date: August 20, 2001
By: /s/ John DuBois
--------------------------------------
JOHN DUBOIS
CHIEF EXECUTIVE OFFICER
By: /s/ Peter J. Kendrick
-------------------------------------
PETER J. KENDRICK
VICE PRESIDENT FINANCE AND
ADMINISTRATION AND
CHIEF FINANCIAL OFFICER (PRINCIPAL
ACCOUNTING OFFICER)
33
Exhibit Index
Exhibit
Number Description
- ------- -----------
3.1 Amendment to Certification of Incorporation of Nx Networks, Inc. dated March 2001 (filed as
Exhibit 4.6 to our Annual Report on Form 10-K for the year ended December 31, 2000).
4.1 Specimen certificate of common stock of Nx Networks, Inc. (filed as Exhibit 4.1 to our
Registration Statement on Form S-3 filed on January 17, 2001 File No. 333-53852 (the "January
2001 S-3")).
4.2 Certificate of designations for the form of Series C 8% convertible preferred stock (filed as
Exhibit 4.4 to our Annual Report on Form 10-K for the year ended December 31, 2000).
4.3 Certificate of designations for the form of Series D 8% convertible preferred stock (filed as
Exhibit 4.5 to our Annual Report on Form 10-K for the year ended December 31, 2000).
4.4 Form of Warrant. (filed as Exhibit 4.3 to the January 2001 S-3).
4.5 Subscription Agreement related to the March 2001 private placement of common stock (filed as Exhibit 4.4 to
our Annual Report on Form 10-K for the year ended December 31, 2000).
4.6 Certificate of designations for the form of Series E 8% convertible preferred stock (filed as
Exhibit 4.1 to our Current Report on Form 8-K dated May 16, 2001).
4.7 Form of warrant related to the Series E 8% convertible preferred stock (filed as Exhibit 10.3
to our Current Report on Form 8-K dated May 16, 2001).
4.8 Securities Purchase Agreement related to the Series E 8% convertible preferred stock (filed as
Exhibit 10.1 to our Current Report on Form 8-K dated May 16, 2001).
10.1 1999 Long Term Incentive Plan of Netrix Corporation, as amended (incorporated by reference to
Exhibit 10.9 to our quarterly report on Form 10-Q filed on November 15, 1999).
10.2 Amended and Restated 1997 Stock Option Plan of AetherWorks Corporation. (filed as Exhibit
10.16 to the January 2001 S-3).
10.3 Amendment to the 1999 Long Term Incentive Plan dated March 7, 2001 (filed as Exhibit 10.31 to
the Annual Report on Form 10-K for the year ended December 31, 2000).
10.4 Termination Agreement dated March 22, 2001 between Nx Networks, Inc. and Greg McNulty (filed
as Exhibit 10.32 to the Annual Report on Form 10-K for the year ended December 31, 2000).
34
Exhibit
Number Description
- ------- -----------
10.5 Amended and Restated Promissory Note, dated May 7, 2001, issued by Jonathan Sachs to Nx
Networks, Inc. (filed as Exhibit 10.5 to our quarterly report on Form 10-Q filed on May 21,
2001)
10.6 Termination Agreement dated May 2001 between Nx Networks, Inc. and Water Tower II, LLC. (
filed as Exhibit 10.6 to our quarterly report on Form 10-Q filed on May 21, 2001)
10.7 Promissory Note, dated January 8, 2001 issued by Nx Networks, Inc. to SMT Centre, together with
a related letter of agreement.
35