1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10 - Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 25, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period _________ to __________. Commission File Number 0-19175 OPENROUTE NETWORKS, INC. (Exact name of registrant as specified in its charter) Massachusetts 04-2531856 (State or other jurisdiction of incorporation) (IRS Employer Identification Number) Nine Technology Drive, Westborough, MA 01581 (Address of principal executive offices) Registrant's telephone number (508) 898-2800 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve 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 ninety days. YES [X] NO [ ] Indicate number of shares outstanding of each of the issuer's classes of common stock as of September 25, 1999. Common Stock, $0.01 par value 15,525,801 ----------------------------- ------------------ (Title of each class) (Number of shares) 2 OpenROUTE Networks, Inc. Form 10-Q Quarterly Report September 25, 1999 Table of Contents Part I. Financial Information Item 1. Financial Statements Consolidated Balance Sheets as of September 25, 1999 (unaudited) and December 31, 1998. Consolidated Statements of Operations for the three months and nine months ended September 25, 1999 and September 26, 1998 (unaudited). Consolidated Statement of Shareholders' Equity for the nine months ended September 25, 1999 (unaudited). Consolidated Statements of Cash Flows for the nine months ended September 25, 1999 and September 26, 1998 (unaudited). Notes to the Consolidated Financial Statements, unaudited. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Item 3. Quantitative and Qualitative Disclosures about Market Risk. Part II. Other Information Item 1. Legal Proceedings. Item 2. Changes in Securities. Item 3. Defaults upon Senior Securities. Item 4. Submission of Matters to a Vote of Security Holders. Item 5. Other Information. Item 6. Exhibits and Reports on Form 8-K. 3 PART I - FINANCIAL INFORMATION Item 1. Financial Statements OpenROUTE Networks, Inc. Consolidated Balance Sheets (in thousands) September 25, December 31, ASSETS 1999 1998 ------------- ------------ (unaudited) Current assets: Cash and cash equivalents $ 2,804 $ 2,024 Marketable securities 0 3,128 Accounts receivable, net 3,450 3,356 Inventories 5,563 8,546 Prepaids and other assets 343 509 ------- ------- Total current assets 12,160 17,563 Trademarks,licenses 41 0 Property and equipment, net 2,239 2,715 ------- ------- Total assets $14,440 $20,278 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,226 $ 1,449 Accrued compensation 88 353 Accrued expenses 1,417 2,743 Accrued warranty 582 582 ------- ------- Total current liabilities 3,313 5,127 ------- ------- Stockholders' equity Preferred stock -- -- Common stock 160 157 Capital in excess of par value 49,689 49,418 Accumulated deficit (37,835) (33,526) Cumulative translation adjustments 123 112 Less Treasury stock, at cost (1,010) (1,010) ------- ------- Total stockholders' equity 11,127 15,151 ------- ------- Total liabilities and stockholders' equity $14,440 $20,278 ======= ======= The accompanying notes are an integral part of these consolidated financial statements. 4 OpenROUTE Networks, Inc. Consolidated Statements of Operations (in thousands, except per share data) (unaudited) For the three months ended For the nine months ended September 25, September 26, September 25, September 26, 1999 1998 1999 1998 ------------ ------------ ------------ ------------ Sales: Product $ 2,534 $ 1,714 $ 8,425 $ 7,733 Software licensing 84 -- 785 1,663 Service and other 415 454 1,401 1,785 ------- ------- ------- ------- Net sales 3,033 2,168 10,611 11,181 Cost of sales: Product 1,717 1,017 5,058 5,281 Software licensing -- -- -- -- Service and other 223 411 1,187 1,452 ------- ------- ------- ------- Cost of sales 1,940 1,428 6,245 6,733 ------- ------- ------- ------- Gross profit 1,093 740 4,366 4,448 ------- ------- ------- ------- Operating expenses: Research and development 987 1,142 2,935 3,532 Selling and marketing 1,174 1,714 3,181 6,653 General and administrative 684 1,598 2,418 4,561 Restructure costs -- -- 243 -- ------- ------- ------- ------- Total operating expenses 2,845 4,454 8,777 14,746 ------- ------- ------- ------- Loss from operations (1,752) (3,714) (4,411) (10,298) Interest income, net 22 145 112 498 ------- ------- ------- ------- Loss before income taxes (1,730) (3,569) (4,229) (9,800) Provision for income taxes 8 4 10 162 ------- ------- ------- ------- Net loss $(1,738) $(3,573) $(4,309) $(9,962) ======= ======= ======= ======= Loss per share -- Basic and Diluted $ (0.11) $ (0.23) $ (0.28) $ (0.65) ======= ======= ======= ======= Weighted average number of common shares outstanding -- Basic and Diluted 15,460 15,323 15,461 15,302 ======= ======= ======= ======= The accompanying notes are an integral part of these consolidated financial statements. 5 OpenROUTE Networks, Inc Consolidated Statement of Stockholders' Equity (in thousands) (unaudited) Accumulated Capital in Other Common Stock Excess of Accumulated Comprehensive Shares Amount Par Value Deficit Income ------------------------------------------------------------------ BALANCE, December 31, 1998 15,740 $157 $49,418 $(33,526) $112 Issuance of common stock 176 3 271 -- -- Comprehensive income (loss) Foreign currency translation -- -- -- -- 11 Net Loss -- -- -- (4,309) ================================================================================================================== Total comprehensive loss -- -- -- -- -- - ------------------------------------------------------------------------------------------------------------------ BALANCE, September 25, 1999 15,916 $160 $49,689 $(37,835) $123 - ------------------------------------------------------------------------------------------------------------------ Total Treasury Stock Stockholders' Shares Amount Equity - -------------------------------------------------------------------------------- BALANCE, December 31, 1998 390 $(1,010) $ 15,151 Issuance of common stock -- -- 274 Comprehensive income (loss) Foreign currency translation -- -- 11 Net loss -- -- (4,309) - -------------------------------------------------------------------------------- Total comprehensive loss (4,024) - -------------------------------------------------------------------------------- BALANCE, September 25, 1999 390 $(1,010) $11,127 - -------------------------------------------------------------------------------- 6 OpenROUTE Networks, Inc. Consolidated Statements of Cash Flows for the nine months ended (in thousands) (unaudited) September 25, September 26, 1999 1998 ------------- ------------- Cash flows provided by operating activities: Net loss ($4,309) ($ 9,962) Adjustments to reconcile net loss to cash flows used by operating activities: Bad debt provision 210 470 Depreciation and amortization 565 890 Loss on disposition of fixed assets 8 4 Changes in operating assets and liabilities: (Increase ) decrease in accounts receivable (304) 3,511 (Increase) decrease in inventories 2,983 (2,795) Decrease in deposits and other assets 125 6 Decrease in accounts payable and accrued expenses (1,814) (1,054) ------ ------- Net cash used by operating activities (2,536) (8,930) ------ ------- Cash flows provided by investing activities: Sale of equipment and fixed asset proceeds 153 1 Capital expenditures (250) (616) Marketable securities sales and maturities 3,128 14,070 Marketable securities purchases -- (7,640) ------ ------- Net cash provided by investing activities 3,031 5,815 ------ ------- Cash flows provided by financing activities: Proceeds from the issuance of common stock 274 70 ------ ------- Net cash provided by financing activities 274 70 ------ ------- Effect of exchange rate changes on cash 11 23 ------ ------- Net increase (decrease) in cash and cash equivalents 780 (3,022) Cash and cash equivalents at beginning of period 2,024 5,317 ------ ------- Cash and cash equivalents at end of period $2,804 $ 2,295 ====== ======= The accompanying notes are an integral part of these consolidated financial statements. 7 OpenROUTE Networks, Inc. Notes to Consolidated Financial Statements, unaudited BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of OpenROUTE Network, Inc. and its subsidiaries (collectively, "the Company" or "OpenROUTE"). The consolidated financial statements for the Company for the interim periods ended September 25, 1999 and September 26, 1998 have been prepared without an audit pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in the Company's annual financial statements have been condensed or omitted. The interim financial statements, in the opinion of management, reflect all adjustments (including normal recurring accruals) necessary for a fair statement of the results for the interim periods ended September 25, 1999 and September 26, 1998. Operating results for the interim periods ended September 25, 1999 are not necessarily indicative of the results that may be expected for the full year ending December 31, 1999. These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 1998, which are contained in the Company's 1998 Annual Report to its shareholders and in its Form 10-K filed with the SEC. PROPOSED MERGER On September 30, 1999, OpenROUTE signed a definitive merger agreement with Netrix Corporation (Netrix) whereby OpenROUTE will merge with and into Netrix and Netrix will be the surviving corporation. As consideration for the merger, each holder of OpenROUTE common stock will receive one share of Netrix common stock for each share of OpenROUTE common stock that it holds. The agreement has been approved by the boards of directors of both companies and is subject to the approval of the stockholders of each company. For a complete description of this proposed transaction and to review the agreement and plan of merger, see the Current Report on Form 8-K filed by the Company on October 13, 1999 MANAGEMENT'S ESTIMATES AND ASSUMPTIONS The accompanying financial statements were prepared by the Company in conformity with generally accepted accounting principles which require 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 reported period. The Company reviews all significant estimates affecting the financial statements on a recurring basis and records the effect of any necessary adjustments prior to their issuance. Actual results could differ from those estimates. The Articles of Organization of the Company were amended on June 10, 1998 to change the Company's name to OpenROUTE Networks, Inc. from its former name of Proteon, Inc. INVENTORIES Inventories are stated at the lower of cost or market, with cost determined under the first-in, first-out method. - -------------------------------------------------------------------------------- (in thousands) September 25, 1999 December 31, 1998 - -------------------------------------------------------------------------------- Raw Materials $1,056 $2,270 Work In Process 27 15 Finished goods 4,480 6,261 - -------------------------------------------------------------------------------- Total Inventories $5,563 $8,546 - -------------------------------------------------------------------------------- NET LOSS PER SHARE OF COMMON AND COMMON EQUIVALENT STOCK The Company follows SFAS No. 128 "Earnings 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 holders of Common Stock by the weighted average number of shares of Common Stock 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 holders of Common Stock by the sum of the weighted average number of shares of Common Stock and Common Stock equivalents computed using the average market price for the period under the treasury stock method. 8 NET LOSS PER SHARE OF COMMON AND COMMON EQUIVALENT STOCK (CONTINUED) The following table presents the numerator and the denominator of the basic and diluted EPS computations shown on the consolidated statements of operations: 3 Months ended September 25, 1999 September 26, 1998 - -------------------------------------------------------------------------------- Basic and diluted EPS (in thousands, except per share data) computation: Numerator: Net loss $(1,738) $(3,573) Denominator: Weighted average common shares outstanding 15,460 15,323 - -------------------------------------------------------------------------------- Basic and diluted EPS $ (0.11) $ (0.23) - -------------------------------------------------------------------------------- Outstanding stock options of 2,185,776 with an average exercise price of $1.69 as of September 25, 1999 and outstanding stock options of 2,078,263 with an average exercise price of $1.72 as of September 26, 1998 were not included in the diluted EPS computation because their effect would be anti-dilutive. COMPREHENSIVE INCOME The Company has adopted SFAS No. 130, "Reporting Comprehensive Income", which requires that all components of comprehensive income and total comprehensive income be reported and that changes be shown in a financial statement displayed with the same prominence as other financial statements. The Company has elected to disclose this information in its statement of stockholders' equity. NEWLY ISSUED ACCOUNTING STANDARDS The FASB issued Statement No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information". This Statement, which supersedes Statement No. 14, "Financial Reporting for Segments of a Business Enterprise," changes the way public companies report information about segments. SFAS 131, which is based on the management approach to segment reporting, includes requirements to report segment information quarterly and entity-wide disclosures about products and services, major customers and the material countries in which the entity holds assets and reports revenues. The Company is engaged principally in one business segment having two lines of business: (i) Internet access and (ii) local area network access. During the three months ended September 25, 1999 and September 26, 1998, net sales to one customer accounted for approximately 17% and 20% of the Company's total net sales, respectively. A second significant customer accounted for approximately 8% of total net sales during the three months ended September 25, 1999 and September 26, 1998. During the nine months ended September 25, 1999 and September 26, 1998, net sales to one customer accounted for approximately 10% and 13% of the Company's total net sales, respectively. A second significant customer accounted for approximately 9% of total net sales during the nine months ended September 25, 1999 and 10% during the nine months ended September 26, 1998. 9 The geographic distribution of the Company's operating data is summarized as follows: United Asia Europe States Pacific And Other Total ---------------------------------------- (In thousands) Quarter ended September 25, 1999 Net sales 2,196 137 700 3,033 Loss from operations (1,303) (218) (231) (1,752) Long-lived assets 2,212 10 17 2,239 Capital expenditures 140 0 0 140 Depreciation and amortization 174 3 2 179 Quarter ended September 26, 1998 Net sales 1,805 100 263 2,168 Loss from operations (2,900) (315) (499) (3,714) Long-lived assets 2,859 105 29 2,993 Capital expenditures 401 0 4 405 Depreciation and amortization 272 10 3 285 Nine Months ended September 25, 1999 Net sales 7,728 656 2,227 10,611 Loss from operations (3,275) (561) (575) (4,411) Long-lived assets 2,212 10 17 2,239 Capital expenditures 250 0 0 250 Depreciation and amortization 543 14 8 565 Nine Month ended September 26, 1998 Net sales 8,544 1,039 1,598 11,181 Loss from operations (9,082) (693) (523) (10,298) Long-lived assets 2,859 105 29 2,993 Capital expenditures 604 2 10 616 Depreciation and amortization 837 34 19 890 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This quarterly report on Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "estimates," "will," "should," "plans" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. These forward-looking statements are based on numerous assumptions about future conditions that could prove not to be accurate. Actual events, transactions and results may materially differ from the anticipated events, transactions or results described in such statements. Investors are cautioned that forward-looking statements involve risks and uncertainties 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 product introductions; acceptance of products in the marketplace; increased competition; changes in manufacturing costs; changes in the mix of product sales; the Company's proposed merger with Netrix Corporation and their ability to integrate their operations; availability of financing; and changes in world economic conditions. No assurance can be given that these are all of the factors that could cause actual results to vary materially from the forward-looking statements. The following discussion of the financial condition and performance of the Company should be read in conjunction with the consolidated financial statements and related notes and other detailed information regarding the Company included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 and other reports filed by the Company with the SEC. SUMMARY OpenROUTE is a pioneer in the data communications industry. OpenROUTE has distinguished itself as a leader in networking and in particular, in developing networking connectivity solutions that focus exclusively on the Internet's edge. For more than 18 years OpenROUTE has shipped network connectivity products that have helped companies grow and prosper through deploying network-centric computing. Historically, the Company's local area networking ("LAN") products have provided connectivity solutions in more than 70 percent of the Fortune 100 companies. Leveraging this expertise in mission-critical network solutions, OpenROUTE aggressively delivers this same quality of product and service for Internet connectivity. OpenROUTE is committed to providing solutions that make the Internet a more cost-effective, secure and comfortable place to grow a business. The Company's comprehensive line of products and solutions is designed to meet the needs of Internet service providers ("ISPs") and corporate enterprises. OpenROUTE's data networking products and services combine cost effectiveness with ease of operation, interoperability, network security, reliability and performance. The Company's customers include Global 1000 multinationals, ISPs as well as corporations looking to the Internet to grow their businesses. Specifically, OpenROUTE provides solutions that complement and optimize the edge of the network. RESULTS OF OPERATIONS NET SALES Net sales for the quarter ended September 25, 1999 were $3,033,000 as compared with $2,168,000 for the quarter ended September 26, 1998, an increase of $865,000, or 39.9%. This increase was primarily due to the sale of Internet access products. For the first nine months of 1999, net sales were $10,611,000, as compared with $11,181,000 for the same period in 1998, a decrease of $570,000, or 5.1%. Although sales of Internet access products increased 42.6% for the first nine months of 1999 as compared to the first nine months of 1998, a decrease in product revenue from the Company's LAN products, combined with decreases in licensing and service revenue, accounted for the overall net decrease in sales for the period. Product sales for the quarter ended September 25, 1999 were $2,534,000, as compared with $1,714,000 for the quarter ended September 26,1998, an increase of $820,000, or 47.8%. For the first nine months of 1999, product sales were $8,425,000, as compared to $7,733,000 for the same period in 1998, an increase of $692,000, or 8.9%. Internet access product revenue increased by $1,079,000, or 90% for the quarter ended September 25, 1999 as compared to the same period in 1998. For the first nine months of 1999, Internet access product revenue increased by $2,261,000, or 42.6%. Internet access product revenue contributed 90% of the total product sales for the quarter ended September 25, 1999 and 89.8% for the nine months ended September 25, 1999. This reflects the Company's transition from LAN to internet access products. The total number of units of Internet access products sold increased by 71.2% for the quarter ended September 25, 1999 and 93.2% for the nine months ended September 25, 1999, as compared to the same periods in 1998. This reflects the Company's selling strategy to focus its efforts on the ISP and telecommunications company marketplace and the growth in demand for 11 Internet access products within this market place. Software licensing revenue for the three and nine months ended September 25, 1999 was $84,000 and $785,000, respectively. There was no software license revenue for the quarter ended September 26, 1998; nine month's software license revenue for the period ended September 26, 1998 was $1,663,000. This represents a decrease in software licensing revenue for 1999 of $878,000, or 52.8%. The Company expects future software licensing revenue to be at varying and uncertain levels. Software licensing revenue is an ancillary component of the Company's core revenue stream but is strategic in its promotion of the OpenROUTE routing technology in its markets. For the quarter ended September 25, 1999 service and other revenues decreased by $39,000, or 8.6%, to $415,000, as compared to $454,000 for the same period in 1998. For the first nine months of 1999, service and other revenues were $1,401,000, as compared with $1,785,000 for the same period in 1998, a decrease of $384,000, or 21.5%. This decrease was primarily due to the reduction in service contracts worldwide resulting from the Company's decision to focus on Internet access products, which require fewer support services. GROSS PROFIT The total gross profit margin as a percentage of net sales increased to 36.0% for the quarter ended September 25, 1999, from 34.1% for the same period in 1998. The Company's product gross profit for the quarter ended September 25, 1999 was 41.1% compared to the 40.7% for the quarter ended September 26, 1998. Total gross profit increased as a percentage of net sales to 41.1% for the first nine months of 1999 from 39.8% for the nine months ended September 26, 1998. The margin improvement is primarily due to the sale of certain higher margin products and purchasing efficiencies. RESEARCH AND DEVELOPMENT Research and development expenses were $987,000, or 32.5% of net sales for the quarter ended September 25, 1999, compared to $1,142,000, or 52.7% of net sales for the same period in the prior year. The decrease in expenses of $155,000 was primarily due a reduction in depreciation and occupancy related costs. For the first nine months of 1999, research and development costs were $2,935,000, or 27.7% of net sales compared to $3,532,000, or 31.6% of net sales for the same period in 1998. The decrease of $597,000, or 16.9%, was due primarily to the same factors stated above. The Company considers investments in research and development to be critical to future revenues and intends to focus these expenditures on Internet access products. SELLING AND MARKETING Selling and marketing expenses were $1,174,000, or 38.7% of net sales for the quarter ended September 25, 1999, compared to $1,714,000, or 79.1% of net sales for the quarter ended September 25, 1998, a decrease of $540,000, or 31.5%. This decrease was the result of lower fixed personnel related costs, and cost containment measures in line with the Company's selling strategy. For the first nine months of 1999, selling and marketing expenses were $3,181,000, or 30.0% of net sales, as compared to $6,653,000, or 59.5% of net sales for the same period in the prior year. This decrease in expenses of $3,472,000, or 52.2% was due primarily to the same factors stated above. GENERAL AND ADMINISTRATIVE General and administrative expenses were $684,000,or 22.6% of net sales for the quarter ended September 25, 1999, compared to $1,598,000, or 73.7% of net sales for the quarter ended September 26, 1998, a decrease of $914,000, or 57.2%. For the first nine months of 1999, general and administrative expenses were $2,418,000, or 22.8% of net sales as compared to $4,561,000, or 40.8% of net sales for the same period in the prior year. The decrease of $2,143,000, or 47.0% was primarily due to cost containment measures implemented and lower personnel related costs after restructuring in the same period last year. RESTRUCTURING OF OPERATIONS The Company's management continually reviews methods to reduce its expense base to keep in line with the Company's current and projected revenue stream. As a result, the Company has implemented a series of restructurings; the most recent of which was in connection with the consolidation of Asian operations. This restructuring of operations was necessary to reestablish the strategic direction of the Company and better align its operating expenses and anticipated revenues. In the second quarter of 1999, the Company recorded a $243,000 restructuring charge. This charge included approximately $60,000 of severance costs, $93,000 of office rental liability, $43,000 of provision for bad debts, $23,000 for legal, audit and professional fees, $11,000 for inventory write down and $13,000 of other expenses. During the quarter ended September 25, 1999 the Company incurred cash expenditures of approximately $37,000 relating to the restructuring reserve. PROVISION FOR INCOME TAXES For the quarter ended September 25, 1999, the Company booked an income tax adjustment of $8,000 bringing the 1999-year to date total to $10,000. This is a result of foreign taxes withheld from software licensing fees received from a foreign 12 corporation. SUBSEQUENT EVENTS On September 30, 1999, OpenROUTE signed a definitive merger agreement with Netrix Corporation (Netrix) whereby OpenROUTE will merge with and into Netrix and Netrix will be the surviving corporation. As consideration for the merger, each holder of OpenROUTE common stock will receive one share of Netrix common stock for each share of OpenROUTE common stock that it holds. The agreement has been approved by the boards of directors of both companies and is subject to the approval of the stockholders of each company. For a complete description of this proposed transaction and to review the agreement and plan of merger, see the Current Report on Form 8-K filed by the Company on October 13, 1999. LIQUIDITY AND CAPITAL RESOURCES As of September 25, 1999, the Company's ratio of current assets to current liabilities was 3.67:1, compared to 3.43:1 at December 31, 1998. As of September 25, 1999, the Company's quick assets ratio of cash, cash equivalents, marketable securities and accounts receivable to current liabilities was 1.89:1, compared to 1.66:1 at December 31, 1998. During the first nine months of 1999, the net increase in cash and cash equivalents was $780,000, as compared to a net decrease of $3,022,000 for the same period in 1998. During the first nine months of 1999, the Company consumed $2,536,000 of cash for operating activities as compared to $8,930,000 used for the same period in 1998. This was due primarily to the net operating loss of $4,309,000 and a decrease in accounts payable and accrued expenses of $1,814,000, offset by a decrease in inventories of $2,983,000,and depreciation and amortization of $565,000. Investing activities for the first nine months of 1999 provided net proceeds of $3,031,000 principally from the sales of marketable securities. Net cash provided by financing activities provided $274,000, all of which resulted from the issuance of common stock. As of September 25, 1999, the Company's principal sources of liquidity consisted of $2,804,000 of cash and cash equivalents, and a $5,000,000 working capital line of credit from Silicon Valley Bank. The $5,000,000 line was established to provide short-term working capital financing on an "as needed" basis and also to fund planned growth. The line is based on eligible accounts receivable and approximately $1,150,000 was available at September 25, 1999. The interest rate on outstanding borrowings is at a variable rate; there were no outstanding borrowings at September 25, 1999. The Company's management believes that if it achieves its twelve month operating plan, then the Company's current levels of cash, cash equivalents, and marketable securities, as well as its borrowing capability, will be sufficient to satisfy its expected working capital and capital expenditure requirements through the next twelve months. TRENDS AND UNCERTAINTIES The Company continues to face many risks and uncertainties in addition to those set forth below, including without limitation, risks that apply to most businesses, such as risks arising from competition and general and specific market and economic risks. TECHNOLOGICAL CHANGE, NEW PRODUCTS AND INDUSTRY STANDARDS OpenROUTE is positioning itself as a company focused on the edge of the Internet. OpenROUTE views the network access market as having two lines of business - Internet access and local access. Its current strategy is based upon concentration on the Internet access market segment. The market for the Company's products is characterized by rapidly changing technology, new product introductions and multiplicity of current and evolving industry standards. Accordingly, the Company believes that its future success will depend on its continuing ability to enhance and expand its existing products and to develop or private label other manufacturer's technology and introduce in a timely fashion new products which incorporate new technologies, conform to standards and achieve market acceptance. There can be no assurance that the Company's strategy is the correct one under the circumstances; that the Company has correctly assessed trends in the marketplace; that the Company will be able to develop, market, support or secure external supplies of such products successfully; or that the Company will be able to respond effectively to technological changes, new product announcements by others or new industry standards. 13 MANUFACTURING AND SUPPLY; DEPENDENCE ON SUPPLIERS The Company's manufacturing operations consist of systems level integration and testing. The Company has strategic relationships with U.S. Assemblies of Taunton, Massachusetts, a major subcontract manufacturer with access to cost-effective, high volume manufacturing, distribution and repair capability worldwide, and since October 1998 with Venture Manufacturing (Venture). U.S. Assemblies manufactures the Company's board assemblies for its router, hub and adapter card product lines and specific, turnkey manufacturing assignments for a number of OpenROUTE products. As of June 1999, Venture began turnkey manufacturing for some of the Company's adapter card and remote access router product lines. Venture conducts complete in-circuit and functional testing of all units. Venture is certified by ISO9002, British Approval Board for Telecommunications (BABT), Underwriters Laboratory (UL), TUV and Canadian Standards Association (CSA). The Company believes that in the event of an interruption in manufacturing by either of its subcontractors (U.S. Assemblies or Venture) it will be able to shift its production needs to the unaffected facility as necessary and continue to meet its expected demand. Both U.S. Assemblies and Venture operate a number of other plants within the United States and Asia. OpenROUTE performs some final assembly and testing of its intelligent hubs and routers at its Westborough, Massachusetts facility. A repair depot and logistics operation is also located at its Westborough facility, coordinating global service requirements for all products. The token ring chip sets used in the Company's 4 and 16 million bits per seconds (Mbps) adapters are currently manufactured by Texas Instruments Inc. (Texas Instruments). The Company has an agreement with Texas Instruments under which it believes it will be able to obtain adequate supplies of these chipsets in a timely manner to meet customer demand. However, the reduction or interruption in supply or a significant price increase could adversely affect the Company's operating results. The reduced instruction set chip ("RISC") processor presently used in the Company's CNX 600 and CNX 500 bridging routers is available solely from Advanced Micro Devices Inc. ("AMD"). The Company believes, however, that other available RISC processors could be substituted for the AMD chip, if necessary, with some product modifications. Certain logic semiconductors, signal processors and subassembly components used in the Company's products are also available only from limited sources. The Company has not experienced any significant problems in obtaining required supplies of such limited source components and believes that alternative sources could be developed quickly. However, such shortages could result in production delays that might adversely affect the Company's business. The Company's line of GTX and GT business series products incorporates microprocessors supplied by Motorola Inc. ("Motorola"). The Company is not aware of any shortages of chips from Motorola, and believes that supplies will be adequate for the coming year. OpenROUTE continues to have OEM arrangements with manufacturers for some of its token ring product offerings. The Company does not feel these arrangements jeopardize the quality of the products the Company is shipping. In most cases, if supply from one vendor was interrupted or made scarce, the Company believes it could find a comparable source for the affected product with limited delays in shipment. The inability to obtain sufficient sole or limited source components as required, or to develop alternative sources if and as required in the future, could result in delays or reductions in product shipments which would adversely affect the Company's operating results. There can be no assurance that, in the event of interruptions in contract manufacturing, supplies of components from sole or limited sources or supplies of units from original equipment manufacturer ("OEM") vendors or similar occurrences, the Company could find and engage suitable alternatives in a timely manner. Such interruptions or the inability of OpenROUTE to counteract them successfully could have an adverse effect on the Company's business, operations and finances. INTELLECTUAL PROPERTY Currently, OpenROUTE relies principally upon a combination of contractual rights, trade secrets and copyright laws to establish and protect proprietary aspects of its products. The Company believes that, because of the rapid pace of technological change in the data communications and computer industries, legal protection for its products is a less significant factor in the Company's success than the knowledge, ability and experience of the Company's employees, the frequency of product enhancements and the timeliness and quality of support services provided by the Company. However, should a successful challenge be mounted against the rights of OpenROUTE in and to its intellectual property, by allegations of infringement on the rights of others or for any other reason, the Company's business, operations and finances could be adversely affected. Certain technology used in the Company's products is licensed by the Company from third parties. The termination of certain of these licenses would have a material adverse effect on the Company's operations. 14 PRODUCT COMPATIBILITY AND COMPETITION INTERNET ACCESS (ROUTERS) OpenROUTE expects to participate significantly in the market segment of Internet access routing by focusing exclusively on the Internet's edge. Specifically, the Company provides best-of-class edge solutions that complement with the core and maximize the edge. The Company has enhanced its Internet access capabilities with the introduction of new products that and expanded its presence in the Integrated Services Digital Network ("ISDN") marketplace. INTERNETWORKING SOFTWARE OpenROUTE(TM), OpenROUTE's inter-networking software suite, is the foundation of the Company's high performance Internet access products. All of OpenROUTE's internetworking products ship with this software technology installed. Also, OpenROUTE licenses this software to other providers of internetworking products. As routing technology progresses, the Company may be required to modify its routing and bridging software to maintain compatibility of its products with various standards and interoperability with other manufacturers' router products. Failure by the Company to maintain such compatibility, interoperability and technical competencies could adversely affect the Company's business, operations and finances. NETWORK INTERFACE CARD PRODUCTS The market for token ring network interface card products is dominated by IBM, MADGE and Olicom. While token ring networking is an industry standard, OpenROUTE believes that its ability to address successfully the market for token ring network products is dependent upon the compatibility and interoperability of the Company's products with products offered by these vendors and upon maintaining compatibility with the token ring standard as it continues to evolve. LAN ACCESS The Company continues to sell token ring switches; intelligent hubs that provide connectivity and management of different network cabling schemes and local area network ("LAN") topologies; Ethernet hubs, the pronto/E series, for the workgroup market segment; token ring hubs, the Serial 75 Stackable Hub family for building networked and extended workgroups; token ring adapters for physical connectivity and token ring signaling between a personal computer or workstation and cabling; and multi port cards intended to provide a full range of solution for the client/server marketplace. The Company also seeks opportunities to leverage technology through licensing arrangements. COMPETITION The data communications, networking and computer industries are highly competitive and characterized by rapidly changing technology and evolving industry standards. These advances result in frequent new product introductions, increased capabilities and improvements in the relative price/performance of networking products. As a competitor in the networking industry, OpenROUTE believes one of the keys to success will be making networks more accessible to a broader base of customers. OpenROUTE is committed to open, standards based products, innovative solutions to customer requirements for reliable and high performance networks, a favorable price/performance ratio, ease of installation and ease of use. The Company competes with several companies having greater research and development, marketing and financial resources, manufacturing capability, customer support organizations, and name recognition than those of the Company. There can be no assurance that the Company will be able to compete successfully in the future or those competitive pressures will not adversely affect the Company's business. RESEARCH AND PRODUCT DEVELOPMENT Management believes the Company's future success depends in large part upon timely enhancement of existing products and the development of new products that not only maintain technological excellence, but also improve the capabilities, efficiency and cost effectiveness of the end users' data communication networks. The Company is developing new products to improve price/performance ratios, enhance its network management capabilities, simplify ease of use and ensure interoperability with other vendors' standards based products. VARIABILITY OF QUARTERLY OPERATING RESULTS The Company's quarterly operating results may vary significantly depending upon factors such as the timing of new product announcements and releases by the Company and its competitors, the timing of significant orders, the mix of products sold and the mix of distribution channels through which the products are sold. In addition, substantially all of the Company's sales in each quarter result from orders booked in that quarter. Consequently, if sales do not close in any quarter as anticipated, the Company's results of operations for that quarter would be adversely affected. Further, the Company's expense levels are based, in part, on its expectations of future sales. If sales levels are below expectations, operating results may be adversely affected. Also, quarterly results can be materially affected by the existence and/or the timing of software licensing revenues. 15 METHOD OF DISTRIBUTION The Company sells its products to end users worldwide primarily through an indirect sales channel comprised of ISPs, OEMs, and value added resellers. These resellers also represent other lines of products which are, in some cases, identical or complementary to, or which compete with, those of the Company. While the Company attempts to encourage these resellers to focus on its products through marketing and support programs, there is a risk that these resellers may give higher priority to products of other suppliers, thereby reducing their efforts devoted to selling the Company's products. One reseller accounted for approximately 12%, 11% and 14%, of the Company's total net sales in 1998, 1997 and 1996, respectively, and a second reseller accounted for approximately 10%, 8%, and 14% of the Company's total net sales in 1998, 1997, and 1996, respectively. There can be no assurance that the Company has selected appropriate channels of distribution for its products or that existing resellers will dedicate adequate resources to sales of the Company's products. Failure to do so could result in an adverse impact on the Company's business, operations and finances. LIQUIDITY Failure of the Company to create and maintain adequate working capital and liquidity, by sales of equity, obtaining lines of credit or otherwise, could adversely impact the Company's business, operations and finances. INTERNATIONAL SALES, REGULATORY STANDARDS AND CURRENCY EXCHANGE International sales accounted for 30.9%, 35.4% and 38.3% of the Company's net sales in 1998, 1997 and 1996, respectively. The decrease in the international sales as a percentage of the Company's net sales was primarily the result of the economic crisis in the Asia Pacific region. The Company expects that international sales to continue to be a significant portion of the Company's business. Foreign regulatory bodies continue to establish standards different from those in the United States, and the Company's products are designed generally to meet those standards. The inability of the Company to design products in compliance with such foreign standards could have an adverse effect on the Company's operating results. The Company's international business may be affected by changes in demand resulting from fluctuation in currency exchange rates and tariffs and difficulties in obtaining export licenses. SHARES ELIGIBLE FOR FUTURE SALE Approximately 15,525,801 outstanding shares of Common Stock as of September 25, 1999 are now freely tradable or eligible for sale on the open market. In addition, options to acquire an aggregate of 571,118 shares of Common Stock were vested as of September 25, 1999, and the shares issuable upon exercise of any such option will be freely tradable or eligible for sale in the public market. Additional shares will become eligible for resale in the public market at subsequent dates. Sales of substantial numbers of such shares in the public market could adversely affect the market price of the Common Stock. POSSIBLE VOLATILITY OF STOCK PRICE The Company believes factors such as announcements of new products by the Company or its competitors and quarterly variations in financial results could cause the market price of the Company's Common Stock to fluctuate substantially. In addition, the stock market has experienced volatility which has particularly affected the market prices the stocks of many high technology companies' and which often has been unrelated to the operating performance of such companies. These market fluctuations may adversely affect the price of the Company's Common Stock. CERTAIN CHARTER AND BY LAW PROVISIONS The Company's Amended and Restated Articles of Organization and By-Laws contain certain provisions that could have the effect of making it more difficult for a third party to acquire, or could discourage a third party from attempting to acquire, control of the Company. Such provisions could limit the price that certain investors might be willing to pay in the future for shares of the Company's Common Stock. Certain of such provisions allow the Company to issue preferred stock with rights senior to those of the Common Stock and impose various procedural and other requirements which could make it more difficult for stockholders to effect certain corporate actions. 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. 16 The Company has initiated a program to review the Year 2000 readiness of its internal systems, product line and third party suppliers and vendors. The program consists of: (i) preparing an inventory of the Company's products and suppliers to determine which systems, if any, may encounter date processing problems; (ii) assessing 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) 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, 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 successfully completed the installation of these systems in January 1999. The Company has a one year limited warranty on these systems commencing from the date of delivery, which warranty would expire before January 1, 2000. The Company also has installed a new telephone system under a long-term lease, which the Company believes to be 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, financial condition 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 expended $72,000 for the first nine months of 1999 and expects to incur additional expenditures of $35,000 in the fourth quarter of 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 ISPs 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 ("MRP") efforts. 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 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Currently, the Company is not exposed to any market risks arising from changes in interest rates, foreign currency rates or other market risk sensitive instruments. Under its current policy, the Company places its investments in highly rated financial institutions and, by policy, limits the amount of credit exposure to any one financial institution. Financial instruments, which 17 potentially subject the Company to concentration of credit risk, are principally cash and cash equivalents, marketable securities and accounts receivable. 18 Part II - Other Information Item 1. Legal Proceedings: OpenROUTE filed a civil complaint against Digital Equipment Corporation ("Digital") and Cabletron Systems, Inc. ("Cabletron") (the Defendants) on April 1, 1998 in the Middlesex Superior Court located in Cambridge, Massachusetts. Docket # 98-01533-F is assigned to this matter. In its complaint (as amended), OpenROUTE alleges that Digital breached two separate existing agreements by and between OpenROUTE and Digital, namely the Source Code Licensing Agreement and the Hardware and Software Development and Software Distribution Agreement for Networks Brouters, by assigning its rights under both agreements to Cabletron without the required consent of OpenROUTE. In addition, OpenROUTE alleges unfair and deceptive practices in violation of Massachusetts Law and, as against Cabletron, OpenRoute alleges unjust enrichment for unauthorized receipt and use of OpenROUTE technology. OpenROUTE seeks monetary damages against Digital. Digital counter-claimed that it had the right to assign its rights without OpenROUTE's consent, and therefore, the suit should be dismissed. Cabletron answered the Company's complaint by asserting that it was a good faith purchaser for value, and as such, the claim against it should also be dismissed. Court hearings have been held to narrow the issues in the case. To date, the court has found a breach of contract by Digital to exist as a matter of law. The court has also found that Cabletron was a good faith purchaser for value and dismissed the claim against Cabletron. However, the court specifically reserved the right for OpenROUTE to amend its complaint if it discovers any unlawful transfer of intellectual property apart from the issue of improper assignment of rights under the two agreements. The case has now proceeded to discovery along with Motions for Reconsideration being filed by both sides. Reconsideration of the court has resulted in the case against Cabletron being reinstated. Digital had requested dismissal of the case but the court has denied the request(s). Discovery in this matter will continue over the next several months. Neither the Company nor any of its subsidiaries is a party to any other material legal proceedings nor is any property of the Company the subject of any material legal proceedings. Item 2. Changes in Securities: Not applicable. Item 3. Defaults upon senior Securities: Not applicable. Item 4. Submission of Matters to a Vote of Security Holders: Not applicable. Item 5. Other Information: Not applicable. Item 6. Exhibits and Reports on Form 8 - K: (a) Exhibits: See Exhibits Index (b) Reports on Form 8 - K: Registrant filed a Current Report on Form 8-K on August 30, 1999. This Form 8-K was filed to report that on August 27, 1999, the Registrant and Netrix Corporation filed a joint press release announcing that they had signed a non-binding letter of intent providing for the merger of the two corporations 19 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. OpenROUTE Networks, Inc. November 9, 1999 By: /s/ Bryan R. Holley ------------------- Bryan R. Holley President & Chief Executive Officer (principal executive officer) By: /s/ Henry Barber ------------------- Henry Barber Chief Financial Officer, Vice President Treasurer and Clerk (principal financial officer) 20 Exhibit Index Exhibit Number Description - ------ (2.1) Amendment No. 1 To Agreement and Plan of Merger (filed herewith) (3.1) Restated Articles of Organization as Amended * (a) (filed as Exhibit 3.1) (3.3) By-Laws, as amended and restated, of the Registrant * (b) (filed as Exhibit 3.3) (4.1) Article 4 of the Restated Article of Organization, (See 3.1 above) (4.2) Form of Common Stock Certificate * (c) (filed as Exhibit 4.2) (27) Financial Data Schedule (filed herewith) All exhibit descriptions followed by an asterisk and a letter in parentheses were previously filed with the Securities and Exchange Commission as Exhibits to, and are hereby incorporated by reference from, the document to which the letter in parentheses corresponds, as set forth below: (a) Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991. (b) Registrant's Registration Statement on Form S-1 Registration No. 33-40073. (c) Amendment No. 1 on Form 8 to the Registrant's Registration Statement on Form 8-A, File No. 0-19175. Where documents are incorporated by reference from previous filings, the Exhibit number of the document in that previous filing is indicated in parentheses after the incorporation by reference code.