UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
OR
[ ] TRANSITION PERIOD PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to ________
Commission file number 0-23970
NETWORK PERIPHERALS INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0216135
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2859 Bayview Drive
Fremont, California 94538
(Address, including zip code, of principal executive offices)
(510) 897-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes /X/ No / /
The number of shares of the Registrant's Common Stock, $0.001 par value,
outstanding as of May 10, 2001 was 13,015,508.
NETWORK PERIPHERALS INC.
FORM 10-Q
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets
as of March 31, 2001 and December 31, 2000 3
Condensed Consolidated Statements of Operations
for the Three Months Ended March 31, 2001 and 2000 4
Condensed Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 2001 and 2000 5
Notes to Condensed Consolidated Financial Statements 6-9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-20
Item 3. Quantitative and Qualitative Disclosures about Market Risk 20
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NETWORK PERIPHERALS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS - UNAUDITED
(in thousands, except share data)
March 31, December 31,
2001 2000
--------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 43,451 $ 33,810
Short-term investments 44,175 62,191
Accounts receivable, net of allowance for doubtful accounts
and returns of $228 and $259 1,359 1,479
Inventories 5,683 10,626
Prepaid expenses and other current assets 1,414 1,776
--------- --------
Total current assets 96,082 109,882
Property and equipment, net 5,423 5,547
Other assets 301 285
--------- --------
$ 101,806 $115,714
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,094 $ 1,902
Accrued liabilities 2,488 2,908
--------- --------
Total current liabilities 3,582 4,810
--------- --------
Stockholders' equity:
Preferred stock, $0.001 par value, 2,000,000 shares
authorized; no shares issued or outstanding - -
Common stock, $0.001 par value, 60,000,000 shares
authorized; 12,847,000 and 12,907,000 shares
issued and outstanding 16 16
Additional paid-in capital 235,032 234,820
Accumulated deficit (82,590) (70,301)
Accumulated other comprehensive income 225 106
--------- --------
152,683 164,641
Treasury stock, 3,595,000 shares of common stock, at cost (54,459) (53,737)
--------- --------
Total stockholders' equity 98,224 110,904
--------- --------
$ 101,806 $115,714
========= ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
NETWORK PERIPHERALS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED
(in thousands, except per share data)
Three Months Ended
March 31,
-----------------------------------
2001 2000
---------------- ---------------
Net sales $ 2,012 $ 3,305
Cost of sales 6,408 2,518
---------------- ---------------
Gross profit (loss) (4,396) 787
---------------- ---------------
Operating expenses:
Research and development 3,776 2,414
Marketing and selling 3,091 1,997
General and administrative 1,283 1,038
Merger related expenses 1,135 -
---------------- ---------------
Total operating expenses 9,285 5,449
---------------- ---------------
Loss from operations (13,681) (4,662)
Interest income 1,392 779
---------------- ---------------
Loss before income taxes (12,289) (3,883)
Income taxes - -
---------------- ---------------
Net loss $(12,289) $(3,883)
================ ===============
Net loss per share:
Basic and diluted $ (0.96) $ (0.28)
================ ===============
Weighted average common shares:
Basic and diluted 12,834 13,682
================ ===============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
NETWORK PERIPHERALS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
Increase (Decrease) in Cash and Cash Equivalents
(in thousands)
Three Months Ended
March 31,
-----------------------------------
2001 2000
--------------- ----------------
Cash flows from operating activities:
Net loss $(12,289) $ (3,883)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 723 541
Changes in assets and liabilities:
Accounts receivable 120 (2,261)
Inventories 4,943 187
Prepaid expenses and other assets 336 247
Accounts payable (808) (124)
Accrued liabilities (420) 356
--------------- ----------------
Net cash used in operating activities (7,395) (4,937)
--------------- ----------------
Cash flows from investing activities:
Proceeds from sales or maturity of short-term investments 18,135 3,997
Proceeds from sale of assets 13 -
Purchases of property and equipment (602) (971)
--------------- ----------------
Net cash provided by investing activities 17,546 3,026
--------------- ----------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of offering costs 212 166,249
Repurchase of common stock (722) -
--------------- ----------------
Net cash provided by (used in) financing activities (510) 166,249
--------------- ----------------
Net increase in cash and cash equivalents 9,641 164,338
Cash and cash equivalents, beginning of period 33,810 4,730
--------------- ----------------
Cash and cash equivalents, end of period $ 43,451 $ 169,068
=============== ================
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
NETWORK PERIPHERALS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
of Network Peripherals Inc. (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not contain all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of
management, the accompanying unaudited condensed consolidated financial
statements reflect all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation of the
Company's financial condition as of March 31, 2001 and December 31,
2000, and the results of its operations and its cash flows for the
three-month periods ended March 31, 2001 and 2000. These financial
statements should be read in conjunction with the audited consolidated
financial statements of the Company as of December 31, 2000 and 1999
and for each of the three years in the period ended December 31, 2000,
including notes thereto, included in the Company's Annual Report on
Form 10-K (Commission File No. 0-23970).
Operating results for the three-month period ended March 31, 2001 are
not necessarily indicative of the results that may be expected for the
year ending December 31, 2001 or for any other future period.
Certain reclassifications have been made to the prior year's amounts in
order to conform to the current year's presentation.
2. INVESTMENT IN AND MERGER WITH FALCONSTOR, INC.
On March 30, 2001, the Company entered into a series of related
agreements with FalconStor, Inc., a privately held company
("FalconStor"), pursuant to which the Company purchased 9,792,401
shares of FalconStor's Series C Preferred Stock for an aggregate price
of $25,000,000, and obtained an exclusive option to merge with
FalconStor. On April 2, 2001, the Company paid FalconStor $25,000,000
in connection with this investment.
FalconStor develops and markets network storage infrastructure software
that enables storage over IP using standard industry components such as
Gigabit Ethernet, Fibre Channel and SCSI, with planned support for
iSCSI and Infiniband. The investment agreements provide that the
Company has the right to designate one member of FalconStor's board of
directors and entitle the Company to liquidation, registration, voting
and preemptive rights customary for venture capital style investments.
On May 4, 2001, the Company exercised the option to merge with
FalconStor and entered into a merger agreement with FalconStor. The
merger agreement provides that, as consideration for all outstanding
shares of FalconStor's stock, the Company will issue a number of newly
issued shares of its common stock determined in accordance with a
formula. The number of shares issuable in the merger depends upon a
number of variable factors, including the trading price per share of
the Company's common stock at the time of the merger, the Company's
assets at the time of the merger and other factors. The actual number
of shares is expected to result in the Company's current stockholders
having a one-third interest in the combined entity. In addition, the
Company would assume all outstanding options to acquire shares of
FalconStor's common stock, which would result in the potential issuance
of approximately 4,500,000 shares if those options vested and were
exercised. The merger is structured as a tax free reorganization and
will be accounted for as a purchase. Completion of the merger would be
subject to the expiration of the applicable Hart-Scott-Rodino waiting
period, stockholder approval and other customary closing conditions. In
the event that the merger is terminated under certain other
circumstances, the Company may be required to pay FalconStor a penalty
of $3,000,000.
6
NETWORK PERIPHERALS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In connection with the merger, the Company engaged an investment bank
to explore strategic alternatives for its Ethernet switching business,
which may include selling the Company's NuWave technology and its
related inventories and equipment, terminating some or all of our
employees, office leases and contracts with certain vendors, including
the Company's contract manufacturer. Although the Company has adopted
and announced a plan to discontinue its NuWave and legacy businesses,
the Company has not yet determined the method of disposal, and the
estimated gain or loss may vary significantly depending on the method
selected. Accordingly, the Company has not presented the NuWave and
legacy businesses as discontinued operations because the plan of
disposal is not sufficiently developed to permit the determination of
the gain or loss with sufficiently reasonable accuracy.
3. CANCELLATION OF PURCHASE ORDERS WITH SOLECTRON
During April 2001, as a result of general business conditions and also
due to the pending merger with FalconStor, the Company canceled
substantially all of its outstanding purchase orders with Solectron,
its contract manufacturer. According to the contract between the
Company and Solectron, the Company may be liable for certain
cancellation changes, and such charges could be significant. The
Company has begun discussions with Solectron to resolve this matter;
however, the Company cannot reasonably estimate its liability at this
time.
4. NET LOSS PER SHARE
Basic earnings per share are computed as net earnings divided by the
weighted-average number of common shares outstanding for the period.
Diluted earnings per share reflects the potential dilution that could
occur from common shares issuable through stock-based compensation
including stock options, restricted stock awards, warrants, and other
convertible securities using the treasury stock method. For the three
months ended March 31, 2001 and 2000, the Company incurred net losses,
such that the inclusion of potential common shares would result in an
antidilutive per share amount. Accordingly, no adjustment is made to
the basic net loss per share to arrive at the diluted net loss per
share.
5. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS (in thousands)
December 31,
March 31, 2001 2000
------------------------------------------ --------------
Unrealized
Amortized Holding Fair Market Fair Market
Cost Gain Value Value
-------------- ----------- --------------- --------------
Cash and cash equivalents:
Cash and money market funds $ 27,418 $ - $ 27,418 $ 14,037
Corporate debt securities 16,033 - 16,033 19,773
-------------- ----------- --------------- --------------
43,451 - 43,451 33,810
-------------- ----------- --------------- --------------
Short-term investments:
Corporate debt securities 31,227 192 31,419 46,777
U.S. government agencies' securities 12,723 33 12,756 13,510
Municipal government securities - - - 1,904
-------------- ----------- --------------- --------------
43,950 225 44,175 62,191
-------------- ----------- --------------- --------------
Total $ 87,401 $ 225 $ 87,626 $ 96,001
============== =========== =============== ==============
7
NETWORK PERIPHERALS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. BALANCE SHEET COMPONENTS (in thousands)
March 31, December 31,
2001 2000
---------------- ----------------
Inventories:
Raw materials $ 2,860 $ 3,764
Work-in-process - 7
Finished goods 2,823 6,855
---------------- ----------------
$ 5,683 $ 10,626
================ ================
Property and equipment:
Computers and equipment $ 9,907 $ 9,408
Leasehold improvements 1,018 993
Furniture and fixtures 774 760
---------------- ----------------
11,747 11,161
Accumulated depreciation (6,276) (5,614)
---------------- ----------------
$ 5,423 $ 5,547
================ ================
Accrued liabilities:
Merger related expenses $ 1,135 $ -
Salaries and benefits 595 583
Consulting expenses 225 1,588
Warranty 208 230
Co-op advertising and market development funds 202 186
Other 123 321
---------------- ----------------
$ 2,488 $ 2,908
================ ================
7. RESTRUCTURING
In August 2000, the Company approved and announced a plan to divest its
manufacturing facility in Taiwan. The objective of the divestiture was
to reduce manufacturing overhead and improve gross margins by taking
advantage of the turnkey manufacturer's economies of scale in materials
procurement and production capacity. The divestiture plan consisted of
terminating 57 employees in the manufacturing and the general and
administrative functions, selling manufacturing equipment and closing
the manufacturing facility. Accordingly, the Company recorded a
restructuring expense of $600,000 during the quarter ended September
30, 2000. The Company completed the divestiture in the first quarter of
2001. The following table summarizes the activities of the accrual for
restructuring expense (in thousands):
Closure of
Severance Facility Total
- ------------------------------------------------------------------------------------------------------
Reserve provided in the third quarter of 2000 $550 $50 $ 600
Reserve utilized in the fourth quarter of 2000 (391) (19) (410)
--------------- ------------- -------------
Balance at December 31, 2000 159 31 190
Reserve utilized in the first quarter of 2001 (110) (53) (163)
Reversal of unused reserve to statement of operations (49) 22 (27)
--------------- ------------- -------------
Balance at March 31, 2001 $ - $ - $ -
=============== ============= =============
8
NETWORK PERIPHERALS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. TREASURY STOCK
In 2000, the Company's Board of Directors approved a common stock
repurchase program, pursuant to which the Company may repurchase up to
five million shares of its common stock in the open market. As of March
31, 2001, the Company has repurchased 3,595,000 shares of its common
stock with a total purchase price of approximately $54.5 million.
9. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative and Hedging
Activities." SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities.
SFAS No. 133 requires an entity to recognize all derivatives as either
assets or liabilities on the balance sheet and measure those
instruments at fair value. In June 2000, SFAS No.133 was amended by
SFAS No. 138, which amended or modified certain issues discussed in
SFAS No. 133. To date, the Company has not engaged in derivative or
hedging activities. The Company adopted SFAS No. 133 and SFAS No. 138
during the quarter ending March 31, 2001, and the adoption of SFAS No.
133 and SFAS No. 138 has no material impact on the Company's results of
operations or financial condition.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
With the exception of historical information, the statements set forth below
include forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
These forward-looking statements include statements regarding potential
strategic collaborations, future capital needs and funding requirements, product
development plans, and market assessments. More specifically, these
forward-looking statements include statements related to expected benefits to be
realized from the FalconStor transactions, express or implied statements
regarding the consummation or success of a potential merger transaction and
strategic alternatives for the hardware business and the potential growth of the
storage industry. These statements are subject to risks and uncertainties that
could cause actual results to differ materially from those in the
forward-looking statements. These risks and uncertainties include:
o risks that the reduction in our liquid assets could limit our ability to
operate independently if the merger is not consummated;
o risks that the closing conditions may not be satisfied;
o the early stage of FalconStor's business;
o our dependence on a small number of OEM and distribution channel customers;
o potential delays in product development;
o rapid technological change in the storage and networking industries;
o potential litigation involving intellectual property and other issues; and
o other risk factors discussed in the company's reports on Forms 10-K, 10-Q
and other reports filed with the Securities and Exchange Commission.
In evaluating these forward-looking statements, consideration should also be
given to the Business Risks discussed in a subsequent section of this interim
report and in our 2000 Annual Report on Form 10-K.
OVERVIEW
We were incorporated in California in March 1989 and were reincorporated in
Delaware in 1994. Our initial business focus was on networking products based on
fiber distributed data interface, or FDDI, technology, and we obtained a
significant share of the market for FDDI adapter products in the early 1990s.
Because the market for FDDI-based products declined significantly beginning in
1995, we developed a new line of Layer 2 Fast Ethernet switching products that
we first shipped in early 1996. By 1998, the market for our FDDI-based products
and our Layer 2 Fast Ethernet products (together, our "legacy products")
declined substantially, and we committed nearly all of our resources to the
development of a new line of Layer 3 Gigabit Ethernet switches (collectively
"NuWave products") founded on our NuWaveArchitecture(TM), which combines our
advanced design and our proprietary application specific integrated circuits, or
ASICs. We commenced limited commercial shipments of our first NuWave product in
December 1999 and volume shipments of all NuWave products in 2000.
Cost of revenue is comprised principally of payments to our materials suppliers
and contract manufacturers, final assembly costs, costs associated with
manufacturing and quality functions, inventory management costs and certain
other product costs. Our gross profit has been affected by many factors,
including:
o declines in the average selling price of our products;
o fluctuations in demand for our products;
o the volume of products sold;
o the mix of products sold;
o the mix of sales channels through which our products are sold;
o new product introductions both by us and our competitors; and
o provision for inventory reserves for potential excess inventories.
10
Generally, we realize higher margins on sales to the reseller channel than on
sales to OEMs. Any change in the mix between the channels or the loss of a major
customer could adversely affect our gross margin, operating results and
financial condition. We experienced significant erosion in the average selling
prices of our legacy products, and the average selling prices of our NuWave
products have also decreased from their levels at introduction.
In transitioning from our legacy business to our NuWave business, we incurred
significant losses in the past four years primarily reflecting declining
revenues of legacy products in conjunction with substantial investments in
research and development to bring NuWave products to market. The losses
continued through the first quarter of 2001 due to a recent slowdown in the
economy, the failure of our NuWave products to achieve significant market
penetration and continuing high levels of research and development expenses.
On March 30, 2001, we entered into a series of related agreements with
FalconStor, Inc. ("FalconStor"), a privately held company, pursuant to which we
purchased 9,792,401 shares of FalconStor's Series C Preferred Stock for an
aggregate price of $25,000,000, and obtained an exclusive option to merge with
FalconStor. On May 4, 2001, we exercised the option to merge with FalconStor and
entered into a merger agreement with FalconStor. See more details of this
transaction in Notes to Condensed Consolidated Financial Statements. In
connection with the merger, we engaged an investment bank to explore strategic
alternatives for our Ethernet switching business, which may include selling our
NuWave technology and its related inventories and equipment, terminating some or
all of our employees, office leases and contracts with certain vendors,
including our contract manufacturer. However, there can be no assurance that we
can complete a sale of our NuWave business. Furthermore, the announcement of the
merger with FalconStor and our exit from the NuWave business may cause delay in
product purchases by our customers and may also adversely affect the average
selling prices of our NuWave products.
Although we have adopted and announced our plan to discontinue our existing
NuWave and legacy businesses, we have not yet determined the method of disposal,
and the estimated gain or loss may vary significantly depending on the ultimate
method selected. Accordingly, we have not presented the NuWave and legacy
businesses as discontinued operations because our plan is not sufficiently
developed to permit the determination of the gain or loss with sufficiently
reasonable accuracy.
RESULTS OF OPERATIONS
Net Sales
Net sales for the three months ended March 31, 2001 ("the quarter") were $2
million, compared to $3.3 million for the three months ended March 31, 2000 (the
"comparable quarter"). The decrease in net sales was primarily attributed to an
overall slowdown in the economy, resulting in delayed spending on communication
infrastructure by most enterprises and a significant build-up of capital
equipment inventories in the marketplace and, consequently, causing our OEM and
reseller customers to postpone their purchases. In addition, the decrease in net
sales was partially due to the winding down of the legacy business.
Net sales to OEM customers were $1.2 million for the quarter, which decreased
from $1.8 million for the comparable quarter. Net sales to the reseller channel
decreased to $779,000 for the quarter from $1.5 million for the comparable
quarter. Following a similar downward trend, net sales to North America and
international customers were $1.4 million and $601,000 for the quarter, compared
to $2.2 million and $1.1 million for the comparable quarter, respectively.
Gross Profit (Loss)
We had a negative gross margin for the quarter, compared to a 24% gross margin
for the comparable quarter. The negative gross margin for the quarter was
primarily attributed to a charge of $4.5 million to provide additional reserves
for potential excess inventories as a result of adverse business conditions
described above.
11
Research and Development
Research and development expenses were $3.8 million for the quarter, compared to
$2.4 million for the comparable quarter. The increase in research and
development expenses was primarily attributed to the hiring of additional
engineers throughout 2000 and increased spending in professional fees related to
enhancing existing NuWave products and developing new ASICs and products.
Marketing and Selling
Marketing and selling expenses were $3.1 million for the quarter, compared to
$2.0 million for the comparable quarter. The increase in marketing and selling
expenses was primarily attributed to the hiring of additional sales personnel
across the U.S. and increased spending in advertising, trade shows and other
marketing activities, in an effort to penetrate the reseller channel and seek
additional OEM customers.
General and Administrative
General and administrative expenses were $1.3 million for the quarter, compared
to $1 million for the comparable quarter. The increase in general and
administrative expenses was primarily attributed to increased spending in
investor relations, recruiting activities and information technology related
services. In addition, we incurred higher insurance expenses as a result of an
overall tightening of the liability insurance market.
Merger Related Expenses
In connection with the investment in and the proposed merger with FalconStor, we
incurred $1.1 million of merger related expenses, primarily related to
investment banking, legal and accounting services specifically provided for this
transaction during the quarter.
Interest Income
Interest income for the quarter was $1.4 million, compared to $779,000 for the
comparable quarter. Such increase in interest income was due to a higher average
balance of cash, cash equivalents and short-term investments throughout the
quarter, compared to the comparable quarter during which the net proceeds of
$165 million from the follow-on public offering were received in early March
2000.
Income Taxes
We did not record a tax benefit associated with the net loss incurred, as the
realization of deferred tax assets is deemed uncertain based on evidence
currently available. Accordingly, a full valuation allowance against deferred
tax assets has been provided.
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative and Hedging Activities." SFAS No.
133 establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. SFAS No. 133 requires an entity to recognize all derivatives
as either assets or liabilities on the balance sheet and measure those
instruments at fair value. In June 2000, SFAS No.133 was amended by SFAS No.
138, which amended or modified certain issues discussed in SFAS No. 133. To
date, we have not engaged in derivative or hedging activities. We adopted SFAS
No. 133 and SFAS No. 138 during the quarter ending March 31, 2001, and the
adoption of SFAS No. 133 and SFAS No. 138 has no material impact on our results
of operations or financial condition.
12
LIQUIDITY AND CAPITAL RESOURCES
The aggregate balance of cash, cash equivalents and short-term investments was
$87.6 million at March 31, 2001, compared to $96 million at December 31, 2000.
The decrease of $8.4 million was primarily due to the use of cash in financing
our operations, capital expenditures and the repurchase of our common stock.
Net cash used in operating activities for the quarter was $7.4 million, which
was primarily attributed to our net loss of $12.3 million and decreases in
accounts payable and accrued liabilities of $1.2 million in total, partially
offset by depreciation and amortization of $723,000 and decreases in accounts
receivable, inventories and other assets of $6.1 million in total. Our capital
expenditures totaled $602,000 for the quarter, primarily related to purchases of
test equipment and related software for research and development activities.
In 2000, our Board of Directors approved a common stock repurchase program,
pursuant to which we are authorized to repurchase up to five million shares of
our common stock. As of March 31, 2001, we have repurchased 3,595,000 shares of
our common stock with a total purchase price of approximately $54.5 million.
On April 2, 2001, we paid FalconStor $25,000,000 to purchase 9,792,401 shares of
FalconStor's Series C Preferred Stock at a price of $2.553 per share, and on May
4, 2001, we entered into a merger agreement with FalconStor. In connection with
the merger, we engaged an investment bank to explore strategic alternatives for
our NuWave and legacy businesses, which may include selling our NuWave
technology and its related inventories and equipment, terminating some or all of
our employees, office leases and contracts with certain vendors, including
Solectron, our contract manufacturer. In April 2001, we canceled substantially
all of our outstanding purchase orders with Solectron. According to our contract
with Solectron, we may be liable for certain cancellation changes, and such
charges could be significant. We have begun discussions with Solectron to
resolve this matter; however, we cannot reasonably estimate its liability at
this time. In addition, we expect to incur additional merger related expenses,
such as legal, accounting, financial advisor and printing fees.
Although we have adopted and announced our plan to discontinue our existing
NuWave and legacy businesses, we have not yet determined the method of disposal,
and the estimated gain or loss may vary significantly depending on the ultimate
method selected. Accordingly, we have not presented the NuWave and legacy
businesses as discontinued operations because our plan is not sufficiently
developed to permit the determination of the gain or loss with sufficiently
reasonable accuracy.
Our principal sources of liquidity are our cash, cash equivalents and short-term
investments that are expected to be used for general corporate purposes,
including expansion of operations and capital expenditures. In addition to our
cash, cash equivalents and short-term investments, we also have a $5 million
revolving bank line of credit, which expires on June 1, 2001, and is renewable
on an annual basis. Borrowings under the line of credit bear interest at the
bank's prime rate. There were no borrowings under the line of credit as of March
31, 2001.
We believe that our current balance of cash, cash equivalents and short-term
investments will be sufficient to satisfy our working capital and capital
expenditure requirements for at least the next 12 months.
BUSINESS RISKS
If any of the following risks actually occurs, our business, financial condition
or operating results could be materially adversely affected. The risks set forth
below are not the only risks facing us. Additional risks and uncertainties not
presently known to us, or that we currently see as immaterial, may also harm our
business.
Failure to complete the merger with FalconStor could cause our stock price to
decline and could harm our business and operating results.
The merger agreement contains conditions which we and/or FalconStor must meet in
order to consummate the merger. In addition, the merger agreement may be
terminated by either FalconStor or us under certain circumstances. If the merger
is not completed for any reason, we may be subject to a number of risks,
including the following:
13
o depending on the reasons for termination, we may be required to pay
$3,000,000 to FalconStor;
o the market price of our common stock may decline to the extent that
the relevant current market price reflects a market assumption that
the merger will be completed;
o many costs related to the merger, such as legal, accounting,
financial advisor and financial printing fees, have to be paid
regardless of whether the merger is completed;
o there may be substantial disruption to our business and distraction
of our workforce and management team; and
o we may hold $25,000,000 worth of unregistered, preferred stock of
FalconStor.
In response to the announcement of the merger, our customers may delay or defer
product purchase or other decisions. Any delay or deferral in product purchase
or other decisions by customers could harm our business, regardless of whether
the merger is completed. Similarly, our current employees may experience
uncertainty about their future roles with our company until the merger is
completed and our strategies with respect to our employees are announced or
executed. As a result, our ability to retain key management, sales, marketing
and technical personnel may suffer.
Further, because the exchange ratio in the merger agreement fluctuates depending
on our assets at closing, we may be required to take actions designed to
preserve the value of our assets that could significantly hinder our ability to
continue our current business. In particular, we have engaged an investment bank
to explore strategic alternatives for our NuWave and legacy businesses, which
may include selling our NuWave technology and its related inventories and
equipment, terminating some or all of our employees, office leases and contracts
with certain vendors, including Solectron, our contract manufacturer. In
addition, there can be no assurance that we can complete a sale of our NuWave
business. If the sale of NuWave business occurred, and if the merger were not
completed, there would be substantial uncertainty about the nature of our future
business.
The merger will result in substantial dilution of the ownership interests of our
current stockholders.
Upon completion of the merger, our current stockholders will own approximately
33% of the outstanding common stock of the combined company. This represents
substantial dilution of the ownership interests of our current stockholders.
However, the number of shares of our common stock that each FalconStor
stockholder will receive will be determined by an exchange ratio. The precise
exchange ratio will be determined at the closing of the merger and will depend,
in part, on the amount of our cash, cash equivalents and short-term investments
minus any cash payments due under certain agreements with our management plus
$25,000,000. This figure will be calculated as of the end of the calendar month
prior to the effective time of the merger without giving effect to expenses we
incur in connection with the merger. To the extent this amount is less than
$90,000,000, the number of merger shares shall be increased by an equivalent
percentage. Any adjustment to the calculation of the exchange ratio will cause
further dilution to our stockholders.
Failure of the merger to achieve potential benefits could harm the business and
operating results of the combined company.
We expect that the merger will result in potential benefits for the combined
company. Achieving these potential benefits will depend on a number of factors,
some of which include:
o retention of key management, marketing and technical personnel
after the merger;
o the ability of the combined company to increase its customer base
and to increase the sales of FalconStor products; and
o competitive conditions in the storage networking infrastructure
software market.
We cannot assure you that the anticipated benefits will be achieved. The failure
to achieve anticipated benefits could harm the business, financial condition and
operating results of the combined company.
The combined company's reported financial results will suffer as a result of
purchase accounting treatment and the impact of amortization of goodwill and
other intangibles relating to the merger.
14
The business combination will be accounted for under the purchase method of
accounting. Although we will be acquiring FalconStor, after the transaction,
FalconStor stockholders will hold a majority of the voting interests in the
combined company. Accordingly, for accounting purposes, the acquisition will be
a "reverse acquisition" and FalconStor will be the "accounting acquiror." As
FalconStor will be the accounting acquiror, its accounts will be recorded at
historical cost and our assets and liabilities will be recorded at their
estimated fair value as of the closing date.
We estimate that intangible assets of approximately $23,500,000 are expected to
be recorded with respect to the business combination and will be amortized over
a period of three years following the closing of the business combination;
however, because the number of shares to be exchanged in the business
combination is subject to change based on an exchange ratio formula, the final
determination of the purchase price will not occur until the closing of the
merger, and will be based upon the fair market value of our stock on that date.
The amount of the purchase price allocated to intangible assets, including
goodwill, may fluctuate significantly as a result.
If goodwill and other intangible assets were amortized in equal quarterly
amounts over three years following completion of the merger, the accounting
charge attributable to these items would be approximately $2,000,000 per fiscal
quarter or $7,800,000 per fiscal year.
The financial results of the combined company could suffer as a result of the
costs of the merger.
We expect to incur significant one-time and other charges, including direct
transaction expenses, in connection with the merger. FalconStor is expected to
allocate the costs it incurs to FalconStor. If the benefits of the merger do not
exceed the costs associated with the merger, including any dilution to our
stockholders resulting from the issuance of shares of our common stock in the
merger, the combined company's financial results, including earnings per share,
could suffer, and the market price of the combined company's common stock could
decline.
Our officers have certain conflicts of interest that may influence them to
support or approve the merger.
Some of our officers participate in arrangements that give them interests in the
merger that are different from the interests of our stockholders. Certain
officers will receive payments in connection with the merger. In addition,
certain officers are entitled to severance benefits if they are terminated as a
result of the merger. Futhermore, Glenn Penisten, the chairman of the board and
an employee, owns 17,500 shares of FalconStor's Series B preferred stock. For
the foregoing reasons, some of our officers could be more likely to vote to
approve the terms of the merger than if they did not have these interests.
If the merger is challenged by governmental authorities, the merger may not
occur or may occur on terms imposed by the governmental authorities, which terms
may not be favorable to the combined company.
Before the merger may be completed, various approvals must be obtained from or
notifications submitted to governmental authorities in the United States. These
governmental entities may attempt to prevent the merger from occurring or
attempt to condition their approval of the merger on the imposition of certain
regulatory conditions that may have the effect of imposing additional costs on
us or of limiting the combined company's revenues. The imposition of regulatory
conditions may make it more difficult for FalconStor to continue developing and
enhancing its storage networking infrastructure software.
A liquidation of our assets, instead of the proposed merger with FalconStor,
might result in increased returns for our stockholders.
We currently have total assets with a book value of approximately $100,000,000.
While our board has determined that it is in the best interests of the company
and our stockholders to enter into the merger, it is possible that, if the
merger is completed, the holders of our common stock immediately prior to the
merger may hold shares of the combined company's common stock worth less than
the dollar amount they would have received if our assets had been distributed
among our stockholders.
15
Failure to consummate the merger could adversely affect our cash position and
attractiveness to acquirors.
On April 2, 2001, we purchased $25,000,000 of FalconStor's Series C preferred
stock. If this merger is not consummated, we will hold $25,000,000 of
unregistered preferred stock of a privately-held company with limited resale
opportunities. This will reduce our operating cash and may reduce our
attractiveness to potential acquirors.
Tax Risks Related to the Merger
A successful IRS challenge to the tax-free reorganization status of the merger
could result in FalconStor stockholders incurring substantial tax liability with
respect to their FalconStor stock exchanged in the merger.
Risks Related to the Combined Company's Business Following the Merger
In addition to the risk factors related to the merger set forth above, after the
merger, the combined company will be subject to the following risks:
We and FalconStor have a history of losses, and the combined company may not
achieve or maintain profitability.
Due to the early stage of FalconStor and its product, FalconStor has limited
visibility into future revenues. FalconStor currently has signed contracts with
resellers and original equipment manufacturers, or OEMs, to begin shipping
products. FalconStor's business model depends upon signing additional OEM
customers, developing a reseller sales channel, and expanding FalconStor's
direct sales force. Any difficulty in obtaining these OEM and reseller customers
or in attracting qualified sales personnel will negatively impact FalconStor's
financial performance.
The market for IP-based storage solutions is new and uncertain, and FalconStor's
business will suffer if it does not develop as FalconStor expects.
The rapid adoption of internet protocol (IP)-based storage solutions is critical
to FalconStor's future success. The market for IP-based solutions is still
unproven, making it difficult to predict its potential size or future growth
rate, and there are currently only a handful of companies with IP-based storage
products that are commercially available. Most potential customers have made
substantial investments in their current storage networking infrastructure, and
they may elect to remain with current network architectures or to adopt new
architectures in limited stages or over extended periods of time. FalconStor
will need to convince these potential customers of the benefits of FalconStor's
IP-based storage products for future storage network infrastructure upgrades or
expansions. FalconStor cannot be certain that a viable market for its products
will develop or be sustainable. If this market does not develop, or develops
more slowly than FalconStor expects, FalconStor's business, financial condition
and results of operations would be seriously harmed.
FalconStor's products may not be accepted by customers or may become obsolete if
FalconStor does not respond rapidly to technological and market changes.
The storage networking infrastructure software market is characterized by rapid
technological change and frequent product and service introductions. The
combined company may be unable to respond quickly or effectively to these
developments. If competitors introduce products, services or technologies that
are better than FalconStor's or that gain greater market acceptance, or if new
industry standards emerge, FalconStor's products and services may become
obsolete, which would materially harm the combined company's business and
results of operations.
If FalconStor's new product introductions are not successful, its operating
results will suffer.
To become a significant supplier within the rapidly evolving storage networking
infrastructure software market, the combined company will need to respond
quickly to develop new products or enhanced features and
16
capabilities in its current product offerings to effectively satisfy customer
expectations. Although FalconStor's current products are designed for one of the
most significant segments of the storage networking infrastructure software
market, demand may shift to other market segments. Accordingly, the combined
company will need to develop and manufacture new products that address
additional storage networking infrastructure software market segments and
emerging technologies to remain competitive in the data storage software
industry. There can be no assurance that the combined company will:
o successfully or timely develop or market any new storage networking
infrastructure software products in response to technological changes or
evolving industry standards;
o not experience technical or other difficulties that could delay or prevent
the successful development, introduction or marketing of new storage
networking infrastructure software products;
o successfully qualify new storage networking infrastructure software
products with its customers by meeting customer performance and quality
specifications;
o quickly achieve high volume production of storage networking infrastructure
software products; or
o achieve market acceptance of its new products.
Any failure of the combined company to develop, introduce and integrate
successfully new products for its existing customers or to address specifically
additional market segments could harm its business, financial condition and
operating results.
FalconStor's complex products may have errors or defects which could result in
reduced demand for its products or costly litigation against the combined
company.
FalconStor's IPStor platform is complex and designed to be deployed in large and
complex networks. Many of the combined company's customers will require that its
products be designed to interface with customers' existing networks, each of
which may have different specifications and utilize multiple protocol standards.
Because FalconStor's products are critical to the networks of its customers, any
significant interruption in their service as a result of defects in the combined
company's product within its customers' networks could result in lost profits or
damage to its customers. These problems could cause the combined company to
incur significant service and warranty costs, divert engineering personnel from
product development efforts and significantly impair the combined company's
ability to maintain existing customer relationships and attract new customers.
In addition, a product liability claim, whether successful or not, would likely
be time consuming and expensive to resolve and would divert management time and
attention. Further, if FalconStor is unable to fix the errors or other problems
that may be identified in full deployment, it would likely experience loss of or
delay in revenues and loss of market share and its business and prospects would
suffer.
The loss of one or more of FalconStor's significant customers would harm its
business and operating results.
FalconStor expects to sell most of its products to a limited number of
customers. FalconStor's management expects that a relatively small number of
customers will account for a significant portion of the 21 combined company's
revenue after the merger, and the proportion of its revenue from these customers
could continue to increase in the future. These customers have a wide variety of
suppliers to choose from and therefore could make substantial demands on the
combined company. Even if the combined company successfully qualifies a product
for a given customer, that customer generally will not be obligated to purchase
any minimum volume of products from it and generally will be able to terminate
its relationship with the combined company at any time. The combined company's
ability to maintain strong relationships with its principal customers is
essential to its future performance. If it loses a key customer or if any of its
key customers reduce their orders of the combined company's products or require
it to reduce its prices before it is able to reduce costs, the combined
company's business, financial condition and operating results would suffer.
FalconStor's business would be adversely affected if it fails to manage its
growth properly.
The combined company plans to expand its operations rapidly to execute
FalconStor's business plan. This growth will place a significant strain on the
combined company's management, systems and resources and will
17
force the combined company to incur increased operating expenses. In order to
grow and achieve future success, the combined company must:
o retain existing personnel;
o hire, train, manage and retain additional qualified personnel; and
o effectively manage relationships with its customers, suppliers and
other third parties.
Because FalconStor will need to continue to expand, train and manage its
workforce worldwide, the combined company will incur increased operating
expenses. If the combined company does not manage this growth, or if
Falconstor's revenues do not grow as fast as planned, the combined company's
results would be adversely affected.
The combined company's quarterly results may fluctuate significantly which could
cause its stock price to decline.
Our quarterly operating results have fluctuated significantly in the past and
the combined company's quarterly operating results may fluctuate significantly
in the future. The combined company's future performance will depend on many
factors, including:
o the average unit selling price of its products;
o changes in product or customer mix;
o existing competitors introducing better products at competitive
prices before it does;
o new competitors entering its market;
o its ability to manage successfully the complex and difficult process
of qualifying its products with its customers;
o its customers canceling, rescheduling or deferring significant
orders for the combined company's products, particularly in
anticipation of new products or enhancements from it or its
competitors;
o import or export restrictions on its proprietary technology;
o the availability of adequate capital resources;
o increases in research and development expenditures, particularly as
a percentage of revenue, required to maintain its competitive
position;
o changes in the combined company's strategy;
o personnel changes; and
o other general economic and competitive factors.
Many of our and FalconStor's expenses are relatively fixed and difficult to
reduce or modify. As a result, the fixed nature of the combined company's
operating expenses will magnify any adverse effect of a decrease in revenue on
its operating results. As a result of these and other factors, we believe that
period to period comparisons of its historical results of operations and
FalconStor's operations are not a good predictor of the combined company's
future performance. If the combined company's future operating results are below
the expectations of stock market analysts, its stock price may decline.
The storage networking infrastructure software market is highly competitive and
intense competition could negatively impact FalconStor's business.
The storage networking infrastructure software market is intensely competitive
even during periods when demand is stable. FalconStor's management believes that
it competes primarily with:
o DataCore; and
o StorageApps.
Many of FalconStor's potential competitors have a number of significant
advantages, including:
o preferred vendor status with customers;
o extensive name recognition and marketing power; and
o significantly greater financial, technical and manufacturing
resources.
18
As a result, those competitors may be able to establish rapidly or expand
storage networking infrastructure software offerings more quickly, adapt to new
technologies and customer requirements faster, and take advantage of acquisition
and other opportunities more readily.
FalconStor's competitors also may:
o consolidate or establish strategic relationships among themselves to
lower their product costs or to otherwise compete more effectively
against it;
o lower their product prices to gain market share; or
o bundle their products with other products to increase demand for
their products.
In addition, new competitors could emerge and rapidly capture market share
including some OEMs with whom FalconStor does business, or hopes to do business,
that may enter the market directly. If the combined company fails to compete
successfully against current or future competitors, its business, financial
condition and operating results may suffer.
The loss of any of FalconStor's key personnel could harm the combined company's
business.
The combined company's success depends upon the continued contributions of
FalconStor's key employees, many of whom would be extremely difficult to
replace. FalconStor does not have key person life insurance on any of its
personnel. Many of FalconStor's senior management and a significant number of
its other employees have been with FalconStor for a short period of time.
Worldwide competition for skilled employees in the storage networking
infrastructure software industry is extremely intense. If the combined company
is unable to retain existing employees of FalconStor or to hire and integrate
new employees, the combined company's business, financial condition and
operating results could suffer. In addition, companies whose employees accept
positions with competitors often claim that the competitors have engaged in
unfair hiring practices. The combined company may be the subject of such claims
in the future as it seeks to hire qualified personnel and could incur
substantial costs defending itself against those claims.
If FalconStor is unable to raise more capital in the future, its business,
financial condition and operating results may suffer.
FalconStor's business is capital intensive and the combined company may need
more capital in the future. The combined company's future capital requirements
will depend on many factors, including:
o the rate of its sales growth;
o the level of its profits or losses;
o the timing and extent of its spending to support facilities upgrades
and product development efforts;
o the timing and size of business or technology acquisitions; and
o the timing of introductions of new products and enhancements to its
existing products.
Any future equity financing will decrease the combined company's stockholders'
percentage equity ownership and may, depending on the price at which the equity
is sold, result in significant economic dilution to the combined company's
stockholders.
If the combined company is not able to raise sufficient capital through equity
financings, the combined company may be required to borrow money to meet its
capital requirements. However, we and FalconStor believe that current market
conditions for credit facilities are not as favorable as they have been at
certain times in the past and that the terms on which the remaining potential
lenders are willing to offer such facilities, in many cases, are restrictive
and/or costly. Consequently, the terms and conditions under which the combined
company might obtain such a facility are uncertain. Any failure to obtain
adequate credit facilities on acceptable terms could harm the combined company's
business, financial condition and results of operations.
19
If FalconStor is unable to protect its intellectual property, its business will
suffer.
FalconStor has applied for patent protection on some of its proprietary
technologies. After the merger, the combined company may not receive patents for
its pending or future patent applications, and any patents that it owns or that
are issued to it may be invalidated, circumvented or challenged. Moreover, the
rights granted under any such patent may not provide the combined company with
any competitive advantages. Finally, the combined company's competitors may
develop or otherwise acquire equivalent or superior technology.
We and FalconStor also rely on trade secret, copyright and trademark laws, as
well as the confidentiality and other restrictions contained in their respective
sales contracts and confidentiality agreements to protect their proprietary
rights. These legal protections afford only limited protection. The combined
company may have to litigate to enforce patents issued or licensed to it, to
protect trade secrets or know-how owned by it or to determine the
enforceability, scope and validity of its proprietary rights and the proprietary
rights of others. Enforcing or defending the combined company's proprietary
rights could be expensive and might not bring it timely and effective relief.
The combined company may have to obtain licenses of other parties' intellectual
property and pay royalties. If the combined company is unable to obtain such
licenses, it may have to stop production of its products or alter its products.
In addition, the laws of certain countries in which it sells and manufactures
its products, including various countries in Asia, may not protect the combined
company's products and intellectual property rights to the same extent as the
laws of the United States. The combined company's protective measures in these
countries may be inadequate to protect its proprietary rights. Any failure to
enforce and protect the combined company's intellectual property rights could
harm its business, financial condition and operating results.
FalconStor's technology may be subject to infringement claims which could harm
its business.
The combined company may become subject to litigation regarding infringement
claims alleged by third parties. Even if the combined company has valid defenses
to such claims, the results of any litigation are inherently uncertain. Neither
we nor FalconStor can assure you that the combined company will be able to
defend itself successfully against any such lawsuit. A favorable outcome by a
third party could result in the issuance of an injunction against the combined
company and its products and/or the payment of monetary damages equal to a
royalty, the third party's lost profits or statutory damages. In the case of a
finding of a willful infringement, the combined company also could be required
to pay treble damages and the third party's attorneys' fees. Accordingly, a
litigation outcome favorable to a third party could harm the combined company's
business, financial condition and operating results.
FalconStor has received correspondence from a third party claiming that some of
FalconStor's employees formerly employed by that third party may have disclosed
proprietary information of the third party in violation of certain agreements or
other obligations to that third party. This third party has also asserted that
FalconStor's intellectual property may be based on or utilizes its intellectual
property. As of the date of this joint proxy statement/prospectus, no formal
action has been taken by the third party. FalconStor believes these claims are
without merit. However, if an action is commenced against FalconStor, its
management may have to devote substantial attention and resources to defend
these claims. An unfavorable result for FalconStor could have a material adverse
effect on the combined company's business, financial condition and operating
results and could limit its ability to use its intellectual property.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no changes in financial market risk as originally discussed in
the Company's Annual Report on Form 10-K for the year ended December 31, 2000.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Description of Document
2.1 Agreement and Plan of Merger and Reorganization
3.1 (1) Amended and Restated Certificate of Incorporation.
3.2 (2) Certificate of Amendment of the Certificate of
Incorporation.
3.3 (1) By-Laws.
(1) Incorporated by reference to the corresponding
exhibit in the Registrant's Registration Statement
on Form S-1.
(2) Incorporated by reference to the corresponding
exhibit in the Registrant's Quarterly Report on
Form 10-Q for the period ended June 30, 2000.
(b) Reports on Form 8-K
None.
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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.
NETWORK PERIPHERALS INC.
Date: May 15, 2001 By: /s/ JAMES WILLIAMS
-----------------------------------
James Williams
Senior Vice President of Finance and
Administration, Secretary, Treasurer
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
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