1
EX-13 ANNUAL REPORT
STOCK PRICE HISTORY (unaudited)
The following table sets forth the high and low sales prices of the Company's
Common Stock, which trades under the symbol "OPEN", as Reported on the NASDAQ
Stock Market from January 1, 1997 to December 31, 1998. As of December 31, 1998,
the Company had approximately 507 stockholders of record. The Company has paid
no dividends on its Common Stock and anticipates that it will continue to
reinvest earnings to finance future growth.
For year ended December 31, 1998 High Low
- -------------------------------------------------------------------------------------------------------------------
First Quarter 1 3/8 1
Second Quarter 1 21/32 1 1/32
Third Quarter 1 7/16 3/4
Fourth Quarter 1 29/32 11/16
For year ended December 31, 1997 High Low
- -------------------------------------------------------------------------------------------------------------------
First Quarter 3 11/16 1 5/16
Second Quarter 2 15/16 1 7/16
Third Quarter 2 1/2 1 9/16
Fourth Quarter 3 1/2 1 1/32
2
EX-13 (Cont'd) ANNUAL REPORT
SELECTED CONSOLIDATED FINANCIAL DATA
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
- ---------------------------------------------------------------------------------------------------------
Years ended December 31,
(in thousands, except per share data) 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------
Net sales $ 14,326 $ 26,944 $ 45,296 $ 75,323 $ 93,912
Cost of sales 8,596 15,340 25,670 36,664 48,148
- ---------------------------------------------------------------------------------------------------------
Gross profit 5,730 11,604 19,626 38,659 45,764
Operating expenses:
Research and development 4,610 5,987 9,353 8,802 11,162
Selling and marketing 8,018 10,703 15,486 17,903 23,955
General and administrative 5,376 3,870 4,590 4,683 7,065
Restructure costs -- (241) 3,312 -- 6,330
- ---------------------------------------------------------------------------------------------------------
Total operating expenses 18,004 20,319 32,741 31,388 48,512
- ---------------------------------------------------------------------------------------------------------
(Loss) income from operations (12,274) (8,715) (13,115) 7,271 (2,748)
Interest income (expense), net 589 1,052 1,261 1,437 455
Other income -- -- -- -- 1,205
- ---------------------------------------------------------------------------------------------------------
(Loss) income before income taxes (11,685) (7,663) (11,854) 8,708 (1,088)
Provision (benefit) for income taxes 175 184 160 488 251
- ---------------------------------------------------------------------------------------------------------
Net (loss) income ($11,860) ($ 7,847) ($12,014) $ 8,220 ($ 1,339)
- ---------------------------------------------------------------------------------------------------------
Net (loss) income per share -
basic and diluted ($ 0.77) ($ 0.51) ($ 0.77) $ 0.52 ($ 0.09)
Weighted average number of common
shares outstanding- basic and diluted 15,312 15,301 15,630 15,692 14,808
- ---------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET DATA:
Working capital $ 12,436 $ 23,620 $ 30,597 $ 39,006 $ 27,550
Total assets 20,278 33,403 45,571 59,029 56,911
Stockholders' equity 15,151 26,892 35,191 47,323 37,679
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto.
RESULTS OF OPERATIONS
During 1998 the Company completed its corporate repositioning from the LAN
business environment to the Internet Access marketplace.
LAN revenues declined from 32.4% of total revenue in 1997 to 19.9% of total
revenue in 1998. LAN units shipped was reduced from 73% in 1997 to 31% in 1998
of total units shipped. Internet Access products grew from 50.2 % of
total revenue in 1997 to 52.8% of total revenue in 1998 and reached 71% of the
Company's total revenue in the fourth quarter of 1998. Internet Access product
unit shipments represented 27% of the total units shipped in 1997 and 68% in
1998 reflecting the focus of the Company in the growing Internet Access
marketplace. Overall Internet Access product unit shipments increased by 12.7%
in 1998 from 1997 while LAN unit shipments declined by 80.9%.
NET SALES
Product sales decreased by 53.2% to $10,416,000 in 1998 from $22,248,000 in
1997. This decline reflects the completion of OpenROUTE's planned corporate
repositioning from LAN products to Internet Access products. Although overall
product revenue declined in 1998, Internet Access product unit sales increased
12.7% from 1997. Internet Access product revenue declined by 44.7% in 1998
primarily due to a 75% drop in average selling prices of certain older Corporate
Internet Access products. Average selling prices for the Company's GT Internet
Access products, although declining 25% for the year, remained relatively stable
after the first quarter of 1998. LAN product revenue declined to $2,858,000 in
1998 or by 67.2% from 1997 levels. Software licensing revenue in 1998 increased
to $1,663,000 from $895,000 in 1997 primarily reflecting the revenue produced
from a single software licensing agreement with a major international
telecommunications company. The Company expects that it will continue to have
software licensing revenue in the future, however at varying and uncertain
levels since software licensing revenue is an ancillary component of the
Company's core revenue stream but strategic in its promotion of OpenROUTE
routing technology in the marketplace. Service and other sales in 1998 decreased
by 40.9% to $2,247,000 from $3,801,000 in 1997. This decrease was primarily due
to the reduction in service contracts and upgrade revenue worldwide resulting
from the Company's transition to Internet Access products which require less
support services.
Product sales decreased by 30.9% to $22,248,000 in 1997 from $32,175,000 in
1996. This anticipated decline reflects OpenROUTE's continuing product
transition from LAN products to Internet Access products. Although overall
product revenue declined in 1997, GlobeTrotter product revenue increased 76.5%
from 1996 as a result of increased unit sales. Corporate Enterprise and LAN
product revenue declined in 1997 by 43.3% from 1996 levels. Software licensing
revenue in 1997 decreased by 88.1% to $895,000 from $7,530,000 in 1996
reflecting the declining revenue produced from the IBM and Digital Equipment
software licensing agreements. The Company expects that it will continue to have
software licensing revenue in the future, however at varying and uncertain
levels since software licensing revenue is an ancillary component of the
Company's core revenue stream but strategic in its promotion of OpenROUTE
routing technology in the marketplace. Service and other sales in 1997 decreased
by 32.0% to $3,801,000 from $5,591,000 in 1996. This decrease was primarily due
to the reduction in service contracts and upgrade revenue
4
worldwide resulting from the Company's transition to Internet Access products
which require less support services.
International sales accounted for approximately 30.9%,35.4%, and 38.3% of net
sales in 1998, 1997, and 1996, respectively.
GROSS PROFIT
Total price gross profit margin decreased in 1998 to 40.0% from 43.1% in 1997.
Gross margin on product revenue decreased to 34.4% in 1998 from 42.8% in 1997
principally due to the drop in the average selling prices of the Company's
Internet Access products and certain inventory write downs. Gross margin on
service and other revenues declined to 21.7% in 1998 from 31.1% in 1997
primarily due to a decline in service revenue. The decline in the service margin
was offset by the highly profitable software licensing margins.
Total gross profit margin decreased slightly in 1997 to 43.1% from 43.3% in
1996. Gross margin on product revenue improved significantly to 42.8% in 1997
from 35.3% in 1996 principally due to the expansion of the GT product line into
a number of higher margin models as well as to reductions in manufacturing
overhead expenses. Gross margin on service and other revenues also increased to
31.1% in 1997 from 23.0% in 1996 primarily due to improved efficiencies in the
customer service area. However, these improvements were not sufficient to offset
the substantial decline in software licensing revenue which is highly
profitable.
RESEARCH AND DEVELOPMENT
The Company considers product development expenditures to be critical to future
revenues. These activities are closely related to product enhancement and new
product development. The Company's strategy also includes joint development
partnerships to bring new technologies and products to market. All of the
Company's research and development costs to date have been expensed as incurred.
Research and development expenses were $4,610,000 or 32.2%, $5,987,000 or 22.2%,
and $9,353,000 or 20.6% of net sales in 1998, 1997 and 1996, respectively. The
decrease in expenses of $1,377,000 in 1998 from 1997 was primarily due to lower
personnel and personnel-related costs. When comparing 1997 to 1996, the decrease
in research and development expenses of $3,366,000 in 1997 from 1996 was
primarily due to lower personnel and personnel-related costs as well as a more
defined focus on the Internet Access products only.
In 1998 the Company continued to focus its efforts on enhancement of existing
products and the development of new products.
Major efforts in 1997 included the continuing development of the GlobeTrotter
series of products with the introduction of several new models during the year.
SELLING AND MARKETING
Selling and marketing expenses were $8,018,000 or 56.0%, $10,703,000 or 39.7%,
and $15,486,000 or 34.2% of net sales in 1998, 1997 and 1996, respectively. The
decrease in expenses in 1998 from 1997 of $2,685,000 was primarily the result of
lower personnel and personnel-related costs including sales commissions due to
the decline in revenues in 1998 from 1997. The Selling and marketing cost
reduction in 1998 as compared to 1997 is also attributable to the Company's
5
repositioning to focus mainly on the Internet Access products which resulted in
the achievement of marketing cost efficiencies. In 1997 sales and marketing
expenses decreased by $4,783,000 when compared to 1996. This decrease was due
mainly to lower personnel and personnel-related costs.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $5,376,000, $3,870,000, and $4,590,000
in 1998, 1997 and 1996, respectively. The increase in expenses of $1,506,000 in
1998 from 1997 was primarily due to severance payments and accruals that were
made as a result of cost containment measures that were implemented during the
year. Also, additional legal expenses were incurred during 1998 that resulted
from an on-going lawsuit, initiated by OpenROUTE Networks, against two companies
relating to the transfer of OpenROUTE software licensing rights without
OpenROUTE's required consent. When comparing 1997 to 1996, the decrease in
expenses of $720,000 was largely due to lower personnel and personnel-related
costs.
RESTRUCTURING OF OPERATIONS
The Company's management continually reviews methods to reduce the Company's
expense base in response to decreased revenue streams. As a result, the Company
has implemented a series of restructurings, the most recent of which transpired
in 1996. This restructuring of operations was necessary to reestablish the
strategic direction of the Company and better align its operating expenses with
anticipated revenues.
In the fourth quarter of 1996, the Company recorded a $3,312,000 restructuring
charge in connection with its strategic redirection of the Company's business to
the Internet access marketplace. This charge included approximately $410,000 of
severance costs, approximately $785,000 to reduce the Company's occupancy
requirements, approximately $1,922,000 associated with the disposal of fixed
assets, and $195,000 of other costs. During 1996 the cash impact for
restructuring was insignificant and as of December 31, 1996 there was an accrual
of $1,661,000 relating to future spending.
During 1997, the Company incurred cash expenditures in connection with the 1996
restructuring of approximately $495,000 for severance and payroll related costs,
approximately $672,000 as a result of reducing its occupancy costs and $253,000
in other restructuring related costs. Management has determined that all of the
Company's obligations from the 1996 and prior restructurings have been settled.
Accordingly, the Company reversed its remaining restructuring provision of
$241,000 in the third quarter of 1997.
PROVISION FOR INCOME TAXES
In 1998, the Company recorded an income tax provision of $175,000 primarily due
to foreign taxes on income earned outside the United States. The difference
between the effective tax rate and the statutory tax rate for 1998 is mainly due
to net operating loss carryforwards whose future realization is uncertain.
In 1997, the Company recorded an income tax provision of $184,000 primarily due
to foreign taxes on income earned outside the United States. The difference
between the effective tax rate and the statutory tax rate for 1997 is mainly due
to net operating loss carryforwards whose future realization is uncertain.
6
In 1996, the Company recorded an income tax provision of $160,000, primarily due
to foreign taxes on income earned outside the United States. The difference
between the effective tax rate and the statutory tax rate for 1996 is also due
primarily to net operating loss carryforwards whose future realization is
uncertain.
YEAR 2000
The "Year 2000 Issue" is the result of computer programs that were written using
two digits rather than four to define the applicable year. If computer programs
with date sensitive functions are not Year 2000 compliant, they may recognize a
date using "00" as the Year 1900 rather than the Year 2000. This could result in
a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions or
engage in similar normal business activities.
The Company has initiated a program to review the Year 2000 readiness of its
internal systems, the Company's product line, and of third party suppliers and
vendors. The program consists of: (i) inventory of products and suppliers to
determine systems which may encounter date processing problems; (ii) assessment
of the Year 2000 issues presented; (iii) remediation, if necessary, of products
owned or manufactured by the Company; (iv) testing of systems; and (v)
contingency plans. The program's implementation varies depending upon the
problems or issues encountered, and their resolution.
PRODUCTS MANUFACTURED BY THE COMPANY. The Company's main business since its
formation has consisted primarily of the manufacture and sale of: (i) Remote
Access Routers used to access the Internet; (ii) Local Area Network (LAN)
equipment used to link together computers and peripheral devices; and (iii)
Network Interface Cards (NIC), which connect computer workstations to a network.
The Company has installed its own proprietary software in all of its
manufactured Remote Access Routers and LANs, and at times has licensed this
software to third parties. The Company's installed proprietary software and the
products manufactured and sold by the Company, now and in the past, do not track
or report dates, are not date dependent, and are Year 2000 compliant. The
Company's manufactured NIC cards do not contain any date-dependent functions,
and thus also are Year 2000 compliant. Therefore, the Company does not expect
that Year 2000 processing problems will occur in products sold by the Company,
or that Year 2000 product problems would have a material effect on the Company's
business, financial condition, or the results of operations.
INTERNAL BUSINESS SOFTWARE AND SYSTEMS. The Company in 1998 conducted an
inventory of its internal business systems, to determine whether any Year 2000
processing problems existed in critical equipment or systems. As a result, and
as part of a corporate program intended to reduce cycle time and improve
efficiency, the Company purchased new business operations systems which operate
the Company's financial, administrative, business, manufacturing, and customer
service functions. The software vendor has indicated these systems are Year 2000
compliant. The Company has completed the installation of this system in January
1999 and has successfully closed the fiscal month of January and February 1999.
The Company has a one year limited warranty on these systems commencing from the
date of delivery, which would expire before January 1, 2000.
The Company also has installed a new telephone system under a long-term lease
which it understands is Year 2000 compliant. However, if testing demonstrates
unexpected Year 2000 problems in these new systems, there would be no assurance
that the Year 2000 problems would not have a material impact on the Company's
internal operations and would not materially impact the Company's business,
7
financial conditions or results of operations.
The Company expended $340,000 in Year 2000 system costs in 1998. Some of these
costs have been capitalized under generally accepted accounting practices. The
Company expects to incur additional expenditures of $175,000 in 1999 related to
Year 2000 equipment purchases and leases, including consulting fees, license
agreements and lease payments.
READINESS OF THIRD PARTY SUPPLIERS AND VENDORS. The Company relies on third
party suppliers, service providers, and contractors for critical services,
including utility power and telephone, parts and supplies. In addition, the
Company sells its products to customers, including Internet service providers
and others, which are highly dependent on computers, and which could be
adversely affected by their own or their suppliers' lack of Year 2000 readiness.
The Company has conducted an inventory of its critical suppliers, service
providers, and contractors to determine the extent to which the Company's
operations could be affected by those third parties' failure to remedy their own
Year 2000 issues. This exercise was substantially completed in March 1999. Most
of the Company's critical suppliers, service providers, and contractors are also
in the high technology field, thus year 2000 compliance has received intense
attention throughout the vendors' base. OpenRoute's major contract manufacturer,
U.S. Assemblies, has recently completed implementation of the year 2000
compliant version of MAPICS for their Material Resource Planning.
Following completion of its inventory and assessment of third party readiness,
the Company will determine whether testing, verification, or contingency plan
procedures are necessary. The most reasonably likely worst case scenario if
suppliers or customers were not Year 2000 compliant would be interruption in the
Company's ability to manufacture or deliver its products through loss of power,
supply shortages, or disruption of delivery systems, or a material decrease in
the sale of products if customers lose substantial business or divert
substantial resources to uncorrected Internet Year 2000 problems. The Year 2000
readiness of outside suppliers or customers is outside the Company's control.
There can be no assurance that the failure of third party suppliers or the
Company's customers to effectively remedy Year 2000 defects would not have a
material adverse impact on the Company's business, results of operations, or
financial condition.
The above description contains "forward-looking" statements addressing
uncertainties and future events relating to the Company's Year 2000 issues.
These statements are based on assumptions and predictions which are difficult to
verify and may change over time. The Company expects that future events and
information, if known by the Company, may affect assessment of the Year 2000
issues potentially affecting the Company.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivatives Instruments and Hedging Activities" ("SFAS No.
133"). SFAS No. 133 requires companies to recognize all derivatives contracts as
either assets or liabilities in the balance sheet and to measure them at fair
value. If certain conditions are met, a derivative may be specifically
designated as a hedge, the objective of which is to match the timing of gain or
loss recognition on the hedging derivative with the recognition of (i) the
changes in the fair value of the hedged assets or liability or (ii) the earnings
effect of the hedged forecasted transaction. For a derivative not designated as
a hedging instrument, the gain or loss is recognized in income in the period of
change. SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999.
8
Historically, the Company has not entered into derivative contracts either to
hedge existing risks or for speculative purposes. Accordingly, the Company does
not expect adoption of the new standard to affect its financial statements.
LIQUIDITY AND CAPITAL RESOURCES
During 1998, the Company consumed $12,040,000 of cash from operating activities.
This was due primarily to the net operating loss of $11,860,000, an increase in
inventory of $2,836,000, and a decrease in accounts payable and accrued expenses
of $1,384,000. This was offset by depreciation of $1,191,000 and a decrease in
accounts receivable of $2,323,000. Working capital decreased to $12,436,000 in
1998 from $23,620,000 in 1997.
Investing activities during 1998 generated net proceeds of $8,628,000
principally from the sales of marketable securities.
The Company's management believes that if it achieves its twelve month operating
plan, then current levels of cash, cash equivalent, and marketable securities
will satisfy its expected working capital and capital expenditure requirements
through the next twelve months. If the operating plan is not achieved, it is
likely that it will be necessary to secure alternative forms of financing and
there is no assurance that the financing would be available when needed or, on
terms favorable to the Company. Accordingly, the Company's 1998 Report of
Independent Certified Public Accountants includes a going concern explanatory
paragraph. The Company is in the process of obtaining additional working capital
financing to fund expected future growth.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
The 1998 Annual Report, including the President's Letter and the Management's
Discussion and Analysis of Financial Condition and Results of Operations,
contains forward-looking statements within the meaning of the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995. These
forward-looking statements are based on management's current expectations and
involve a number of risks and uncertainties. The Company's future results remain
difficult to predict and may be affected by a number of factors including:
business conditions within the networking industry; timing of orders from and
shipments to major customers; timing of new products introductions; acceptance
of products in the marketplace; increased competition; changes in manufacturing
costs; changes in the mix of product sales and changes in world economic
conditions. Other risk factors are listed from time to time in the required
documents including the Company's Annual Report on Form 10-K, filed with the
Securities and Exchange Commission (SEC).
9
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------------------------------
December 31, 1998 1997
- --------------------------------------------------------------------------------------------------------
(In thousands)
ASSETS
CURRENT:
Cash and cash equivalents $ 2,024 $ 5,317
Marketable securities (Note 3) 3,128 12,443
Accounts receivable less reserve for doubtful accounts of $1,424,000
and $927,000 at December 31, 1998 and 1997, respectively 3,356 6,224
Inventories (Note 4) 8,546 5,710
Deposits and other assets 509 437
- --------------------------------------------------------------------------------------------------------
Total current assets 17,563 30,131
PROPERTY AND EQUIPMENT, NET (Note 5) 2,715 3,272
- --------------------------------------------------------------------------------------------------------
Total assets $ 20,278 $ 33,403
- --------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,449 $ 2,292
Accrued compensation 353 765
Accrued expenses 2,743 2,779
Accrued warranty 582 675
- --------------------------------------------------------------------------------------------------------
Total current liabilities 5,127 6,511
- --------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (NOTES 6,7 AND 11)
STOCKHOLDERS' EQUITY: (NOTE 7)
Preferred stock, par value $.01 per share, authorized 7,500,000 shares,
none issued -- --
Common stock, par value $.01 per share, authorized 30,000,000 shares, issued
15,740,305 and 15,669,524 shares at
December 31, 1998 and 1997, respectively 157 157
Capital in excess of par value 49,418 49,347
Accumulated deficit (33,526) (21,666)
Accumulated other comprehensive income 112 110
Less treasury stock, at cost, 390,769 and 407,435 shares
at December 31, 1998 and 1997, respectively (1,010) (1,056)
- --------------------------------------------------------------------------------------------------------
Total stockholders' equity 15,151 26,892
- --------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 20,278 $ 33,403
- --------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
10
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(NOTE 8)
- -------------------------------------------------------------------------------------------------
Years ended December 31, 1998 1997 1996
- -------------------------------------------------------------------------------------------------
(In thousands, except per share data)
SALES:
Product $ 10,416 $ 22,248 $ 32,175
Service and other 2,247 3,801 5,591
Software licensing 1,663 895 7,530
- -------------------------------------------------------------------------------------------------
Net sales 14,326 26,944 45,296
- -------------------------------------------------------------------------------------------------
COST OF SALES:
Product 6,836 12,722 20,825
Service and other 1,760 2,618 4,307
Software licensing -- -- 538
- -------------------------------------------------------------------------------------------------
Cost of sales 8,596 15,340 25,670
- -------------------------------------------------------------------------------------------------
GROSS PROFIT 5,730 11,604 19,626
- -------------------------------------------------------------------------------------------------
OPERATING EXPENSES:
Research and development 4,610 5,987 9,353
Selling and marketing 8,018 10,703 15,486
General and administrative 5,376 3,870 4,590
Restructure costs (Note 9) -- (241) 3,312
- -------------------------------------------------------------------------------------------------
Total operating expenses 18,004 20,319 32,741
- -------------------------------------------------------------------------------------------------
LOSS FROM OPERATIONS (12,274) (8,715) (13,115)
INTEREST INCOME, net of interest expense of $10,000 in 1996 589 1,052 1,261
- -------------------------------------------------------------------------------------------------
LOSS BEFORE PROVISION FOR INCOME TAXES (11,685) (7,663) (11,854)
PROVISION FOR INCOME TAXES (NOTE 10) 175 184 160
- -------------------------------------------------------------------------------------------------
NET LOSS $(11,860) $ (7,847) $(12,014)
- -------------------------------------------------------------------------------------------------
NET LOSS PER SHARE OF COMMON STOCK - BASIC AND DILUTED $ (.77) $ (.51) $ (.77)
- -------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING - BASIC AND DILUTED 15,312 15,301 15,630
- -------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
11
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Capital in Other
Common Stock Excess of Accumulated Comprehensive
Shares Amount Par Value Deficit Income
- ------------------------------------------------------------------------------------------------------------------------
(In thousands)
BALANCE, December 31, 1995 15,589 $ 156 $49,141 $(1,805) $118
Issuance of common stock 48 - 151 - -
Repurchase of stock as treasury stock - - - - -
Comprehensive income (loss):
Foreign currency translation - - - - 59
Net loss - - - (12,014) -
- ------------------------------------------------------------------------------------------------------------------------
Total comprehensive loss - - - - -
- ------------------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 1996 15,637 156 49,292 (13,819) 177
Issuance of common stock 33 1 55 - -
Repurchase of stock as treasury stock - - - - -
Comprehensive loss:
Foreign currency translation - - - - (67)
Net loss - - - (7,847) -
- ------------------------------------------------------------------------------------------------------------------------
Total comprehensive loss - - - - -
- ------------------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 1997 15,670 157 49,347 (21,666) 110
Issuance of common stock 70 - 71 - -
Issuance of treasury stock - - - - -
Comprehensive income (loss):
Foreign currency translation - - - - 2
Net loss - - - (11,860) -
- ------------------------------------------------------------------------------------------------------------------------
Total comprehensive loss - - - - -
- ------------------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 1998 15,740 $ 157 $49,418 $(33,526) $112
- ------------------------------------------------------------------------------------------------------------------------
Total
Treasury Stock Stockholders'
Shares Amount Equity
- -------------------------------------------------------------------------------------------
(In thousands)
BALANCE, December 31, 1995 81 $ (287) $47,323
Issuance of common stock - - 151
Repurchase of stock as treasury stock 130 (328) (328)
Comprehensive income (loss):
Foreign currency translation - - 59
Net loss - - (12,014)
- -------------------------------------------------------------------------------------------
Total comprehensive loss - - (11,955)
- -------------------------------------------------------------------------------------------
BALANCE, December 31, 1996 211 (615) 35,191
Issuance of common stock - - 56
Repurchase of stock as treasury stock 196 (441) (441)
Comprehensive loss:
Foreign currency translation - - (67)
Net loss - - (7,847)
- -------------------------------------------------------------------------------------------
Total comprehensive loss - - (7,914)
- -------------------------------------------------------------------------------------------
BALANCE, December 31, 1997 407 (1,056) 26,892
Issuance of common stock - - 71
Issuance of treasury stock (17) 46 46
Comprehensive income (loss):
Foreign currency translation - - 2
Net loss - - (11,860)
- -------------------------------------------------------------------------------------------
Total comprehensive loss - - (11,858)
- -------------------------------------------------------------------------------------------
BALANCE, December 31, 1998 390 $(1,010) $15,151
- -------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
12
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
(In thousands)
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net loss $(11,860) $ (7,847) $(12,014)
Adjustments to reconcile net loss to net cash used by
operating activities:
Bad debt provision 545 439 -
Inventory provision - - 2,374
Depreciation and amortization 1,191 1,550 3,401
Restructuring cost - - 1,922
Loss (gain) on disposition of fixed assets 53 198 (117)
Changes in operating assets and liabilities:
Accounts receivable 2,323 962 4,513
Inventories (2,836) 3,027 (6,686)
Deposits and other assets (72) 768 372
Accounts payable
and accrued expenses (1,384) (3,869) (1,326)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash used by operating activities (12,040) (4,772) (7,561)
- ---------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of fixed assets 23 182 117
Capital expenditures (710) (728) (1,600)
Marketable securities sales and maturities 16,980 19,428 15,456
Purchase of marketable securities (7,665) (24,953) (15,511)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities 8,628 (6,071) (1,538)
- ---------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of common stock 71 56 151
Proceeds from issuance of treasury stock 46 - -
Purchase of treasury stock - (441) (328)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 117 (385) (177)
- ---------------------------------------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 2 (67) 59
- ---------------------------------------------------------------------------------------------------------------------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (3,293) (11,295) (9,217)
CASH AND CASH EQUIVALENTS, at beginning of year 5,317 16,612 25,829
- ---------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, at end of year $ 2,024 $ 5,317 $ 16,612
- ---------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for:
Income taxes $ 69 $ 230 $ 321
Interest $ - $ - $ 10
Non-cash financing activities:
Note receivable on sale of fixed assets $ 15 $ 120 $ -
The accompanying notes are an integral part of the consolidated financial
statements.
13
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. OPERATIONS AND OpenROUTE Networks, Inc. (formerly Proteon, Inc.)
MANAGEMENTS PLANS and its subsidiaries (the "Company") develop,
market, and support a wide range of networking
products. The Company is engaged principally in
one business segment in the computer networking
industry having two lines of business; (i)
Internet access and (ii) local area network
access. The Company is positioned to focus on the
Internet access market. The Company's principal
geographic markets include the Americas, Europe
and the Far East.
The Company's consolidated financial statements
have been prepared on the basis that it will
continue as a going concern. The Company has
incurred net losses of approximately $11,860,000,
$7,847,000 and $12,014,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.
The Company's current business strategy is focused
on the emerging Internet access market. As such,
success of future operations is subject to a
number of risks. Principal among these risks are
the successful marketing of its products, rapidly
changing technology, reliance on significant
customers, intense competition from substitute
products and significantly larger companies, and
the ability to obtain financing to fund future
operations. The above factors raise substantial
doubt about the Company's ability to continue as a
going concern.
Management's plans include a continued effort to
gain market share and increase its Internet access
product revenues. The Company has also continued
to monitor cost containment and has a plan to
implement further operating expense reductions as
it deems necessary. Additionally, the Company
is pursuing working capital financing to fund
future operating activities. The Company's ability
to continue as a going concern depends on the
success of management's plans, including obtaining
additional funding or establishing strategic
relationships and achieving projected operating
results. The accompanying consolidated financial
statements do not include any adjustments that
might result from the outcome of this uncertainty.
14
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF
SIGNIFICANT
ACCOUNTING
POLICIES
(Continued)
Principles of The consolidated financial statements
Consolidation include the accounts of OpenROUTE Networks,
Inc. and its subsidiaries. Proteon, Inc.
changed its name to OpenROUTE Networks, Inc.
on June 10, 1998. OpenROUTE Networks, Inc.
was previously the name of a wholly-owned
subsidiary of Proteon, Inc. All intercompany
transactions and balances have been
eliminated in consolidation.
Use of Estimates The preparation of the financial statements
in conformity with generally accepted
accounting principles requires management to
make estimates and assumptions that affect
the reported amounts of assets and
liabilities and disclosure of contingent
assets and liabilities at the date of the
financial statements and the reported
amounts of revenues and expenses during the
reporting period. In particular, the Company
records reserves for estimated product
returns, collectibility of accounts
receivable, estimated inventory obsolescence
and estimated warranty obligations. All
estimates are based upon experience and
actual results could differ from the
estimates and assumptions used by
management.
Revenue The Company recognizes revenue from product
Recognition sales upon shipment of the product. Revenue
from service agreements is recognized
ratably over the term of the agreement.
Revenue from software licensing is
recognized upon performance of milestones
when collectibility is reasonably assured.
Translation of The Company has designated the local
Foreign currency as the functional currency for all
Currencies foreign locations. Accordingly, assets and
liabilities of all foreign subsidiaries
are translated at year-end rates of
exchange, and income statement accounts are
translated at the average rates of exchange
during the year. The resulting translation
adjustments are excluded from net earnings,
and accumulated as a separate component of
stockholders' equity.
Foreign currency transaction gains and
losses are included in results of operations
in the periods in which they occur, and are
immaterial for all periods presented.
Comprehensive In 1998, the Company adopted Statement of
Income (Loss) Financial Accounting Standards ("SFAS") No.
130 "Reporting Comprehensive Income". SFAS
No. 130 establishes rules for the reporting
of comprehensive income (loss) and its
components. Comprehensive income (loss)
consists of net income (loss) and foreign
currency translation adjustments and is
presented in the accompanying consolidated
statements of stockholders' equity. The
adoption of SFAS No. 130 had no impact on
total stockholders' equity. Prior year
financial statements have been reclassified
to conform to the SFAS No. 130 requirements.
15
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF
SIGNIFICANT
ACCOUNTING
POLICIES
(Continued)
Hedging In June 1998, the Financial Accounting
Activities Standards Board issued SFAS No. 133,
"Accounting for Derivatives Instruments and
Hedging Activities" ("SFAS No. 133"). SFAS
No. 133 requires companies to recognize all
derivatives contracts as either assets or
liabilities in the balance sheet and to
measure them at fair value. If certain
conditions are met, a derivative may be
specifically designated as a hedge, the
objective of which is to match the timing of
gain or loss recognition on the hedging
derivative with the recognition of (i) the
changes in the fair value of the hedged
assets or liability or (ii) the earnings
effect of the hedged forecasted transaction.
For a derivative not designated as a hedging
instrument, the gain or loss is recognized
in income in the period of change. SFAS No.
133 is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999.
Historically, the Company has not entered
into derivative contracts either to hedge
existing risks or for speculative purposes.
Accordingly, the Company does not expect
adoption of the new standard to affect its
financial statements.
Cash Equivalents The Company considers all highly liquid
and Marketable instruments purchased with a maturity of
Securities three months or less to be cash
equivalents. Marketable securities consist
of highly liquid investments with maturities
of more than three months when purchased.
Investments are stated at cost, plus accrued
interest, which approximates fair market
value. In addition, the Company classified
all investments as available-for-sale
securities. Realized gains and losses are
determined on the specific identification
method. The marketable securities portfolio
at December 31, 1998 matures at various
dates through September 8, 1999.
Inventories Inventories are stated at the lower of
cost or market, with cost determined under
the first-in, first-out method.
16
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF
SIGNIFICANT
ACCOUNTING
POLICIES
(Continued)
Property and Property and equipment are stated at cost.
Equipment Depreciation and amortization of property
and equipment are computed principally using
the straight-line method over the estimated
useful lives of the assets as follows:
Category Years
--------------------------------------------------
Machinery and equipment 3-5
Furniture and fixtures 7
Leasehold improvements shorter of lease term or
estimated useful life
Maintenance and repairs are charged to
expense as incurred. Upon retirement or
sale, the cost of the disposed assets and
the related accumulated depreciation are
removed from the accounts and any resulting
gain or loss is recorded in the consolidated
statements of operations.
Income Deferred tax assets and liabilities reflect
Taxes the net tax effects of temporary differences
between the carrying amounts of assets and
liabilities for financial reporting purposes
and the amounts used for income tax
purposes. A valuation allowance is provided
for the net deferred tax assets if it is
more likely than not that some or all of the
deferred tax assets will not be realized.
Accrued The Company records a liability for future
Warranty warranty costs based upon the relationship
of prior years' sales to actual warranty
costs which approximates expected future
warranty costs.
17
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF
SIGNIFICANT
ACCOUNTING
POLICIES
(Continued)
Research and Costs incurred in the research and
Development development of software products are
expensed as incurred until the technological
feasibility of the product has been
established. After technological feasibility
is established, any additional costs would
be capitalized. The Company believes the
current process for developing software is
essentially completed concurrently with the
establishment of technological feasibility.
Accordingly, no software development costs
have been capitalized to date.
Concentrations of Financial instruments, which potentially
Credit Risk subject the Company to concentration of
credit risk, are principally cash and cash
equivalents, marketable securities, and
accounts receivable. The Company places its
investments in highly rated financial
institutions and, by policy, limits the
amount of credit exposure to any one
financial institution.
Concentration of credit risk with respect to
accounts receivable is limited to certain
customers with whom the Company makes
substantial sales. Four customers accounted
for approximately 35% of the Company's
outstanding accounts receivable at December
31, 1998 and two customers accounted for
approximately 28% of the Company's
outstanding accounts receivable at December
31, 1997. To reduce credit risk, the Company
performs ongoing credit evaluation, account
monitoring procedures and maintains reserves
for potential losses. These losses have been
within management's expectations.
18
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF
SIGNIFICANT
ACCOUNTING
POLICIES
(Continued)
Net Loss The Company follows SFAS No. 128 "Earnings per Share".
Per Share Under SFAS No. 128, Basic Earnings Per Share (EPS) excludes
the effect of any dilutive options, warrants or
convertible securities and is computed by dividing the
net income (loss) available to common stockholders by the
weighted average number of common shares outstanding for
the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to
issue common stock were exercised. Diluted EPS is
computed by dividing the net income (loss) available to
common stockholders by the sum of the weighted average
number of common shares and common share equivalents
computed using the average market price for the period
under the treasury stock method.
The following table presents the numerator and the
denominator of the basic and diluted EPS computations
shown on the consolidated statements of operations:
--------------------------------------------------------------------------------------
Years ended December 31, 1998 1997 1996
--------------------------------------------------------------------------------------
(In thousands, except per share data)
Basic and diluted EPS computation:
Numerator:
Net loss $ (11,860) $ (7,847) $ (12,014)
Denominator:
Weighted average common
shares outstanding 15,312 15,301 15,630
--------------------------------------------------------------------------------------
Basic and diluted EPS $ (.77) $ (.51) $ (.77)
--------------------------------------------------------------------------------------
Outstanding stock options of 2,269,463, 1,758,605 and
1,272,009 as of December 31, 1998, 1997 and 1996,
respectively, were not included in the diluted EPS
computation because their effect would be antidilutive.
19
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF
SIGNIFICANT
ACCOUNTING
POLICIES
(Continued)
Segment Information In 1998, the Company adopted SFAS No. 131,
"Disclosure about Segments of an Enterprise and
Related Information". SFAS No. 131 established
standards for disclosures regarding products and
services, geographic areas and major customers.
Information for 1997 and 1996 has been restated to
conform with the 1998 presentation (see Note 8).
3. MARKETABLE Marketable securities consists of the following:
SECURITIES
-------------------------------------------------------------
December 31, 1998 1997
-------------------------------------------------------------
(In thousands)
Fixed income securities $ 3,128 $ 7,074
Repurchase agreements - 263
Certificates of deposit - 1,291
Commercial paper - 2,557
U.S. Government securities - 1,258
-------------------------------------------------------------
$ 3,128 $ 12,443
-------------------------------------------------------------
4. INVENTORIES Inventories consist of the following:
-------------------------------------------------------------
December 31, 1998 1997
-------------------------------------------------------------
(In thousands)
Raw materials $2,270 $1,043
Work in process 15 373
Finished goods 6,261 4,294
-------------------------------------------------------------
$8,546 $5,710
-------------------------------------------------------------
20
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. PROPERTY AND Property and equipment consist of the following:
EQUIPMENT
------------------------------------------------------------------
December 31, 1998 1997
------------------------------------------------------------------
(In thousands)
Machinery and equipment $ 11,791 $ 11,492
Furniture and fixtures 593 554
Leasehold improvements 884 1,188
------------------------------------------------------------------
13,268 13,234
Less accumulated depreciation and
amortization 10,553 9,962
------------------------------------------------------------------
Property and equipment, net $ 2,715 $ 3,272
------------------------------------------------------------------
6. COMMITMENTS AND
CONTINGENCIES
Letter of Credit The Company has an outstanding letter of credit of
approximately $288,000 at December 31, 1998, 1997 and
1996. This letter of credit which matures on April
30, 2002, automatically renews annually on December
31. This letter of credit collateralized the
Company's obligation to a third party for a certain
lease transaction.
21
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. COMMITMENTS AND
CONTINGENCIES
(Continued)
Operating Leases The Company leases its office and manufacturing
facilities under operating leases expiring at various
dates through 2002. Under certain leases the Company
is obligated to pay taxes, repairs, and other
operating costs. The Company has the option to extend
the term of the lease of its primary office and
manufacturing facility for two five-year periods
commencing on May 1, 2002 and May 1, 2007. Rental
expense amounted to approximately $1,119,000,
$1,128,000, $1,556,000 in 1998, 1997 and 1996,
respectively. At December 31, 1998, future rental
commitments are approximately as follows:
Years ended December 31, Amount
-------------------------------------------
1999 $ 584,100
2000 547,700
2001 511,100
2002 162,200
-------------------------------------------
$ 1,805,100
-------------------------------------------
7. CAPITAL STOCK
Common Stock The Company has an Employee Stock Purchase Plan (the
"Purchase Plan") available to most full time
employees. Under this plan, 300,000 shares of common
stock were reserved for issuance. Eligible employees
may designate not more than 5% of their cash
compensation to be deducted each pay period for the
purchase of common stock under the Purchase Plan. The
purchase price of the shares under the plan is equal
to the lower of 85% of the fair market value per
share of the stock on the grant date (first day of
the exercise period) or 85% of the fair market value
on the exercise date (the last day of the exercise
period). The fair market value as of a given date is
determined by averaging the last sales price of the
stock for the ten trading days immediately proceeding
the given date.
22
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. CAPITAL STOCK
(Continued)
Common Stock
(Continued) The Company sold 66,084, 32,667 and 41,628 shares to
employees in 1998, 1997 and 1996, respectively, under
the Purchase Plan. At December 31, 1998, 186,316
shares remained unissued under the Purchase Plan. No
compensation cost has been recognized for shares
issued under the Purchase Plan in 1998, 1997 and 1996
since the amount was determined not to be material.
Preferred Stock In 1991, the Shareholders approved the authorization
of 7,500,000 shares of preferred stock. The Board of
Directors is authorized, subject to any limitations
prescribed by law, to issue from time to time such
shares of preferred stock in one or more series. Each
such series of preferred stock will have such number
of shares, designations, preferences, voting power,
qualifications, and special or private rights or
privileges as shall be determined by the Board of
Directors, which may include, among others, dividend
rights, voting rights, preemptive and sinking fund
provisions, liquidation preferences, conversion
rights and preemptive rights. No such shares have
been issued to date.
Stock Options The Company's stock option plans generally provide
for the granting to employees of incentive stock
options to purchase shares of common stock at the
fair market value as defined by the plan on the date
of grant and of non-qualified stock options at no
less than 50% of the fair market value as defined by
the plan on the date of the grant. To date, the
Company has never issued non-qualified stock options
at an exercise price less than the fair market value
on the date of the grant.
Generally, options become exercisable at the rate of
25% at the end of each of the first four
anniversaries of the grant. Options generally expire
ten years from the date of grant, or ninety days from
the date of termination of employment. At December
31, 1998, 2,545,083 shares of common stock were
reserved under the plans and 275,620 shares were
available for grant.
23
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. CAPITAL STOCK
(Continued)
Stock Options
(Continued)
In 1998 and 1996, the Compensation Committee of the
Board of Directors, pursuant to the authority granted
under the Company's 1991 Restated Stock Option Plan,
voted to allow employees of the Company holding
options with exercise prices greater than $1.90 and
$3.625 per share in 1998 and 1996, respectively, to
exchange those options for substitute options having
an option exercise price of $1.90 and $3.625 per
share in 1998 and 1996, respectively.
In February 1998 and in 1996, 799,575 and 707,154
options, respectively, were surrendered by employees
and exchanged for new options at the new option
exercise price and vesting schedule. A summary of the
status of the Company's stock plans as of December
31, 1998, 1997 and 1996, and changes during the years
then ended is presented below:
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
WEIGHTED- Weighted- Weighted-
AVERAGE Average Average
NUMBER EXERCISE Number Exercise Number Exercise
OF OPTIONS PRICE of Options Price of Options Price
- ----------------------------------------------------------------------------------------------------------------------------
Outstanding, at the
beginning of year 1,758,605 $ 2.70 1,272,009 $ 3.34 1,237,649 $ 5.52
Granted 2,412,501 1.31 1,007,805 2.02 1,245,726 4.11
Exercised (4,687) 1.70 - - (6,712) 4.01
Cancelled (1,896,956) 2.51 (521,209) 3.18 (1,204,654) 6.23
- ----------------------------------------------------------------------------------------------------------------------------
Outstanding, at the
end of year 2,269,463 $ 1.38 1,758,605 $ 2.70 1,272,009 $ 3.34
- ----------------------------------------------------------------------------------------------------------------------------
Options exercisable
at year end 687,978 $ 1.87 685,270 $ 3.41 522,064 $ 3.41
- ----------------------------------------------------------------------------------------------------------------------------
Weighted average
fair value of options
granted during the year 2,412,501 $ 0.51 1,007,805 $ 1.34 1,245,726 $ 2.78
- ----------------------------------------------------------------------------------------------------------------------------
24
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. CAPITAL STOCK
(Continued)
Stock Option
(Continued)
The following tables summarize information concerning
outstanding and exercisable options at December 31,
1998.
Options Outstanding
--------------------------------------------------------------------------
Weighted-
Average Weighted-
Range of Remaining Average
Exercise Number of Contractual Exercise
Prices Outstanding Life Price
--------------------------------------------------------------------------
$ .81-$ 1.17 1,264,926 9.5 $ .95
$ 1.23-$ 1.68 238,700 9.2 1.34
$ 1.70-$ 2.10 709,526 9.3 1.91
$ 2.56-$ 3.63 36,311 7.8 2.98
$ 6.00-$ 7.50 20,000 2.4 7.50
--------------------------------------------------------------------------
2,269,463 9.3 $ 1.38
--------------------------------------------------------------------------
Options Exercisable
--------------------------------------------------------------------------
Weighted-
Average Weighted-
Range of Remaining Average
Exercise Number of Contractual Exercise
Prices Exercisable Life Price
--------------------------------------------------------------------------
$ .81-$ 1.17 137,890 9.5 $ .93
$ 1.23-$ 1.68 25,075 8.7 1.43
$ 1.70-$ 2.10 494,826 9.4 1.90
$ 2.56-$ 3.63 10,187 7.5 3.12
$ 6.00-$ 7.50 20,000 2.4 7.50
--------------------------------------------------------------------------
687,978 9.2 $ 1.87
--------------------------------------------------------------------------
25
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. CAPITAL STOCK
(Continued)
Stock Options SFAS No. 123 "Accounting for Stock-Based
(Continued) Compensation" requires that companies either
recognize compensation expense for grants of stock,
stock options, and other equity instruments based on
fair value, or provide pro forma disclosure of net
income (loss) and net income (loss) per share in the
notes to the financial statements. The Company
adopted the disclosure provisions of SFAS No. 123 and
has applied APB Opinion 25 and related
interpretations in accounting for its plans.
Accordingly, no compensation cost has been recognized
for its stock-based plans in 1998, 1997 and 1996.
The Company's net loss and net loss per share for the
years ended December 31, 1998, 1997 and 1996 would
have increased to the pro forma amounts indicated
below, if compensation cost for stock-based plans
were recorded based on the fair value at grant dates.
1998 1997 1996
--------------------- -------------------- --------------------
LOSS Loss Loss
NET PER Net Per Net Per
LOSS SHARE Loss Share Loss Share
---------- ------ -------- ------ ---------- ------
As reported $ (11,860) $ (.77) $ (7,847) $ (.51) $ (12,014) $ (.77)
Pro forma $ (12,007) $ (.78) $ (8,140) $ (.53) $ (12,627) $ (.81)
The fair value of each stock option is estimated on
the date of grant using the Black-Scholes
option-pricing model with the following
weighted-average assumptions: an expected life of six
years, expected volatility of 46% in 1998, 75% in
1997 and 65% in 1996, and no dividends assumed. The
weighted average assumptions for the risk-free
interest rates for 1998, 1997 and 1996 were 5.52%,
6.11% and 6.32%, respectively.
The effects of applying SFAS No. 123 in the above pro
forma disclosure are not indicative of future
amounts. SFAS No. 123 does not apply to awards prior
to 1995, and additional awards in the future years
are anticipated.
26
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. SEGMENT The Company is engaged principally in one business
INFORMATION segment having two lines of business; (i) Internet
AND SIGNIFICANT access and (ii) local area network access. In 1998, 1997
CUSTOMERS and 1996, net sales to one customer accounted for
approximately 12%, 11% and 14% of the Company's total
net sales, respectively. A second significant customer
accounted for approximately 10%, 8% and 14% of total net
sales in 1998, 1997 and 1996, respectively.
27
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. SEGMENT The Company does not have an individual country
INFORMATION that contributes to 10% or more of the total
AND SIGNIFICANT operating data. The geographic distribution of
CUSTOMERS (Continued) the Company's operating data is therefore
summarized as follows:
United Asia
States Pacific Europe Total
---------------------------------------------------------------------------------------
(In thousands)
Year ended December 31, 1998:
Net sales $ 9,894 $ 2,065 $ 2,367 $ 14,326
Loss from operations (10,914) (896) (464) (12,274)
Loss before income taxes (10,325) (896) (464) (11,685)
Total assets 19,698 827 203 20,728
Capital expenditures 673 26 11 710
Depreciation and
amortization 1,104 66 21 1,191
Year ended December 31, 1997:
Net sales $ 17,403 $ 4,182 $ 5,359 $ 26,944
Income (loss) from operations (9,472) (942) 1,699 (8,715)
Income (loss) before income taxes (8,420) (942) 1,699 (7,663)
Total assets 31,101 1,301 1,001 33,403
Capital expenditures 570 144 14 728
Depreciation and
amortization 1,343 49 158 1,550
Year ended December 31, 1996:
Net sales $ 27,941 $ 7,195 $ 10,160 $ 45,296
Income (loss) from operations (13,958) 757 86 (13,115)
Income (loss before income taxes) (12,697) 757 86 (11,854)
Total assets 41,420 2,386 1,765 45,571
Capital expenditures 1,387 137 76 1,600
Depreciation and
amortization 2,853 141 407 3,401
28
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. RESTRUCTURING OF
OPERATIONS
During the fourth quarter of 1996, the Company's
management announced a restructuring plan for the
strategic redirection of the Company. The
restructuring principally addressed the move toward
the rapidly growing Internet/Intranet connectivity
marketplace.
As a result of the restructuring, the Company
recorded a $3,312,000 charge in the fourth quarter of
1996. This included a reduction in the Company's work
force of forty-two employees, or approximately 22%,
accounting for approximately $410,000 of severance
costs. The Company incurred a charge of approximately
$785,000 in connection with the substantial reduction
in its occupancy requirements. In addition, the
charge included approximately $1,922,000 for disposal
of fixed assets and approximately $195,000 of other
costs.
During 1997, the Company incurred cash expenditures
relating to the 1996 restructuring of approximately
$495,000 for severance and payroll related costs,
approximately $672,000 as a result of reducing its
occupancy costs and $253,000 in other restructuring
related costs. Management has determined that all of
the Company's obligations from the 1996 and prior
restructurings have been settled. Accordingly, the
Company reversed its remaining restructuring
provision of $241,000 against operating expenses in
the third quarter of 1997.
29
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INCOME TAXES The provision for income taxes consists of the
following:
--------------------------------------------------------------------------------------
Years ended December 31, 1998 1997 1996
--------------------------------------------------------------------------------------
Current:
Foreign $ 175 $ 156 $ 215
Federal - - (65)
State - 28 10
--------------------------------------------------------------------------------------
$ 175 $ 184 $ 160
--------------------------------------------------------------------------------------
A reconciliation between the Company's
effective tax rate and the U.S. statutory
rate is as follows:
--------------------------------------------------------------------------------------
Years ended December 31, 1998 1997 1996
--------------------------------------------------------------------------------------
U.S. statutory rate (34.0) % (34.0) % (34.0) %
Foreign tax rate differential 1.5 2.4 .1
Change in valuation allowance 34.0 34.0 35.2
---------------------------------------------------------------------------------------
Effective tax rate 1.5 % 2.4 % 1.3 %
---------------------------------------------------------------------------------------
30
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INCOME TAXES A valuation allowance of $17,841,000 and $13,210,000
(Continued) at December 31, 1998 and 1997, respectively has been
recorded to offset the related net deferred tax
assets due to the uncertainty of realizing the
benefit of these assets. The following is a summary
of the significant components of the Company's
deferred tax assets and liabilities:
--------------------------------------------------------------------------------------
December 31, 1998 1997
--------------------------------------------------------------------------------------
(In thousands)
Deferred tax assets:
Bad debt reserve $ 580 $ 360
Inventory reserves 678 533
Product warranty 270 262
Federal tax benefit of net operating loss
carryforwards 11,256 7,889
State tax benefit of net operating loss
carryforwards 2,301 1,827
Tax credit carryforwards 1,298 912
Alternative minimum tax credit 699 699
Depreciation 76 144
Other items 683 584
--------------------------------------------------------------------------------------
Total deferred tax assets 17,841 13,210
Valuation allowance for deferred tax assets (17,841) (13,210)
--------------------------------------------------------------------------------------
Net deferred tax assets $ - $ -
--------------------------------------------------------------------------------------
31
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INCOME TAXES As of December 31, 1998, the Company had net
(Continued) operating loss carryforwards, subject to review by
the Internal Revenue Service and state taxing
authorities of approximately $33,000,000 and
$48,000,000 for federal and state income tax
purposes, respectively. The federal net operating
losses begin to expire in 2010 and the state net
operating losses began to expire in 1998. Similarly,
research and development credit carryforwards of
approximately $1,298,000 were available on December
31, 1998, expiring at various dates through 2005.
11. RETIREMENT Eligible employees are permitted to contribute to the
SAVINGS PLAN 401(k) Plan through payroll deductions within statutory
limitations and subject to any limitations included in the
401(k) Plan. The Plan provides for the matching
contribution by the Company in an annual amount not to
exceed 2% of a participant's compensation. The Company
contributed approximately $116,000, $128,000 and $185,000
to the plan in 1998, 1997 and 1996, respectively.
12. SELECTED Selected quarterly financial data for the years ended
QUARTERLY December 31, 1998 and 1997 is as follows:
FINANCIAL DATA
(Unaudited)
Basic and
Diluted
Year ended Net Gross Net Net Loss
December 31, 1998 Sales Profit Loss Per Share
--------------------------------------------------------------------------------------
(In thousands, except per share data)
First Quarter $ 4,188 $ 1,615 $ (2,513) $ (.17)
Second Quarter 4,825 2,093 (3,876) (.25)
Third Quarter 2,168 740 (3,573) (.23)
Fourth Quarter 3,145 1,282 (1,898) (.12)
--------------------------------------------------------------------------------------
$ 14,326 $ 5,730 $ (11,860) $ (.77)
--------------------------------------------------------------------------------------
32
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. SELECTED QUARTERLY
FINANCIAL DATA
(Unaudited)
(Continued) Basic and
Diluted
Year ended Net Gross Net Net Loss
December 31, 1997 Sales Profit Loss Per Share
-----------------------------------------------------------------------------------
(In thousands, except per share data)
First Quarter $ 9,125 $ 4,256 $ (313) $ (.02)
Second Quarter 7,748 3,748 (1,133) (.07)
Third Quarter 5,006 1,754 (2,894) (.19)
Fourth Quarter 5,065 1,846 (3,507) (.23)
--------------------------------------------------------------------------------------
$ 26,944 $ 11,604 $ (7,847) $ (.51)
--------------------------------------------------------------------------------------
The 1997 fourth quarter operating loss reflects
approximately $880,000 or $.06 per share of certain
adjustments and accruals relating to business
operations in the Asia Pacific region, as well as
certain employee incentive programs.
13. VALUATION AND
QUALIFYING ACCOUNTS
Balance at Balance at
Allowance for Beginning Provision End of
Doubtful Accounts of Period for Bad Debt Write-offs Period
---------------------------- ---------- ------------ ---------- ----------
Year ended December 31, 1998 $926,608 $496,909 $ 0 $1,423,517
Year ended December 31, 1997 $671,755 $346,833 $ (91,980) $926,608
Year ended December 31, 1996 $889,276 -- $(217,521) $ 671,755
33
OPENROUTE NETWORKS, INC.
(FORMERLY PROTEON, INC.)
AND SUBSIDIARIES
- --------------------------------------------------------------------------
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
OpenROUTE Networks, Inc.
Westborough, Massachusetts
We have audited the accompanying consolidated balance sheet of OpenROUTE
Networks, Inc. (Formerly Proteon, Inc.) and subsidiaries as of December 31,
1998, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of OpenROUTE Networks,
Inc. and subsidiaries at December 31, 1998, and the results of their operations
and their cash flows for the year then ended, in conformity with generally
accepted accounting principles.
The accompanying 1998 consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated financial statements, the Company has incurred significant
losses during each of the three years ended December 31, 1998. The Company's
current business strategy is focused on the emerging Internet access market. As
such, success of future operations is subject to a number of risks. Principal
among these risks are the successful marketing of its Internet access products,
rapidly changing technology, reliance on significant customers, intense
competition from substitute products and significantly larger companies, and the
ability to obtain financing to fund future operations. These factors raise
substantial doubt about the Company's ability to continue as a going concern
until the Company successfully obtains additional funding or establishes
strategic relationships and achieves projected operating results. Management's
plans are also described in Note 1. The accompanying consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
BDO Seidman, LLP
Boston, Massachusetts
February 12, 1999
34
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of OpenROUTE Networks, Inc.:
We have audited the accompanying consolidated balance sheet of OpenROUTE
Networks, Inc. as of December 31, 1997, and the related consolidated statements
of operations, stockholders' equity and cash flows for the years ended December
31, 1997 and 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of OpenROUTE
Networks, Inc. as of December 31, 1997, and the consolidated results of its
operations and its cash flows for the years ended December 31, 1997 and 1996 in
conformity with generally accepted accounting principles.
PricewaterhouseCoopers LLP
Boston, Massachusetts
February 11, 1998, except as to the segment
information for the years ended December 31,
1997 and 1996 presented in Note 8, for which
the date is March 26, 1999.