ITEM 2. PROPERTIES
We sublease an approximately 66,000 square foot facility in San Jose, California, which we use for executive offices and for administrative, engineering, product development, manufacturing and sales and marketing purposes. The sublease for this facility expires in September 2001.
EMPLOYEES
As of December 31, 1999, we employed approximately 169 full-time employees and 37 contract personnel. Our full-time employees include 53 people in operations and manufacturing, 69 in engineering, 30 in sales, marketing and customer advocacy, and 17 in finance and administration. None of our employees is represented by collective bargaining agreements, and we consider relations with our employees to be good.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Netro is not currently a party to any material legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None. PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER INFORMATION
(a) Market Information
The following table shows the high and low bid prices of the Company's Common Stock for the fiscal year ended December 31, 1999 as reported on The Nasdaq Stock Market:
The Closing price of the Company's Common Stock on The Nasdaq Stock Market on March 24, 2000 was $83.00.
Future stock prices may be subject to volatility, particularly on a quarterly basis. Any shortfall in revenues or net income from amounts expected by securities analysts could have an immediate and significant adverse effect on the trading price of the Company's stock.
(b) Holders
The Company's Common Stock is traded on the Stock Market under the
symbol NTRO. As of March 24, 2000, the Company had approximately 294 shareholders of record.
(c) Dividends
The Company has not paid dividends on its Common Stock at any time and has no present plans to do so in the future.
(d) Report of offering securities and use of proceeds therefrom
On August 18, 1999, in connection with the Company's initial public offering, a Registration Statement on Form S-1 (No. 333-81325) was declared effective by the Securities and Exchange Commission, pursuant to which 5,750,000 shares of the Company's Common Stock were offered and sold for the account of the Company at a price of $8.00 per share, generating gross offering proceeds of $46.0 million. The managing underwriters were Merrill Lynch, Pierce, Fenner & Smith Incorporated, BancBoston Robertson Stephens Inc. and Dain Rauscher Wessels, a division of Dain Rauscher Incorporated.
The Company incurred the following expenses in connection with the offering:
All of such expenses were direct or indirect payments to others.
The net offering proceeds to the Company after deducting the total expenses above were approximately $41,605,000. From August 18, 1999 to December 31, 1999, the Company used such net offering proceeds, in direct or indirect payments to others, as follows:
Each of such amounts is a reasonable estimate of the application of the net offering proceeds. This use of proceeds does not represent a material change in the use of proceeds described in the prospectus of the Registration Statement.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
You should read the following selected consolidated financial data in conjunction with our consolidated financial statements and the related notes and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Form 10-K. The statement of operations data for the years ended December 31, 1997, 1998 and 1999, and the balance sheet data as of December 31, 1998 and 1999, are derived from our audited consolidated financial statements included elsewhere in this Form 10-K. The statement of operations data for the period from November 14, 1994 (inception) to December 31, 1995 and for the year ended December 31, 1996 and the balance sheet data as of December 31, 1995, 1996 and 1997 are derived from our audited consolidated financial statements not included in this Form 10-K. The historical results presented below are not necessarily indicative of the results to be expected for any future fiscal year. See "Management's Discussion and Analysis of Financial Condition and Results of Operations".
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following selected consolidated financial data in conjunction with our consolidated financial statements and the related notes contained elsewhere in this report. We urge you also to read our Form 10-K before deciding to invest in our company or to maintain or increase your investment.
This report contains forward-looking statements which include, but are not limited to, statements concerning projected revenues, expenses and gross profit, need for additional capital, Year 2000 compliance and market acceptance of our products. The forward-looking statements are based on our current expectations, estimates and projections about our industry, management's beliefs and certain assumptions made by us. Words such as "anticipates," "expects," "intends," "plans," "believes," or similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ substantially from those anticipated in these forward-looking statements as a result of many factors. Our Form 10-K and other Securities Exchange Commission filings discuss some of the important risk factors that may affect our business, results of operations and financial condition. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.
OVERVIEW
We are a leading provider of wireless broadband access equipment used by telecommunications service providers to provide businesses with high-speed internet access. We were incorporated in 1994 and introduced our first product, the AirMAN system, in 1996. Recognizing the competitiveness of the market for AirMAN products, we decided to devote substantially all of our product development efforts to the AirStar product from 1996 onward. The AirMAN system was designed to provide a dedicated link to connect two high traffic nodes in a network. Unlike the AirMAN system, the AirStar system allows multiple subscribers to communicate with a single base station radio in a point-to-multipoint architecture using packet based technology. We began initial sales of an early 26 GHz AirStar system in Europe in early 1998. With the successful trial shipments of the AirStar system, we discontinued AirMAN in September 1998. We shipped the first trial AirStar systems for 26 GHz in the third quarter of 1998. We then shipped a trial version of a 10 GHz AirStar product in November 1998. Based on our success in field trials and the receipt of limited quantities of AirStar subsystems from our contract manufacturers, we made the 26 GHz AirStar product commercially available in January 1999 and the 10 GHz AirStar product commercially available in October 1999. However, the products were, and continue to be, available only in limited quantities due to manufacturing and capacity constraints. Additionally, we shipped a trial version of a 38 GHz product in September 1999. We also expect to begin customer testing of a preliminary version of a 28 GHz AirStar product in the first quarter of 2000.
All of our 1997 revenues, approximately 47% of our 1998 revenues and 2% of our 1999 revenues were derived from sales of the AirMAN system. Due to the product transition, revenues declined slightly to $5.4 million in 1998 from $5.6 million in 1997. We had negative gross margins in each quarter of 1997 and 1998 as a result of declining average selling prices in the market for the AirMAN system; however, our 1999 gross margins were positive due primarily to the advent of AirStar product sales.
Currently, all of our revenues are generated from sales of AirStar systems through system integrators, local resellers and our direct sales force. In the first quarter of 1998, we entered into a product supply agreement with Siemens. In the third quarter of 1998, we signed a product supply and joint development agreement with Lucent. For 1998 and 1999, international revenues represented approximately 76% and 43% of total revenues. In addition, substantially all of our domestic revenues are derived from systems intended for installation in international locations.
Sales to our four largest customers represented approximately 77% of our total revenue
in 1999, 68% of our total revenue in 1998 and 92% of our total revenue in 1997. We expect that our key customers will continue to account for a significant portion of our total revenue for 2000 and in the future.
Although we have historically assembled our products in-house, we are currently in the process of outsourcing manufacturing and assembly to contract manufacturers. Solectron began providing us with AirStar subsystems in the first quarter of 1999. In January 1999, we also signed a manufacturing agreement with Microelectronic Technology Inc. of Taiwan, to obtain a second source for the AirStar radios and to increase our manufacturing capacity. In August 1999, we received our first AirStar subsystems from this manufacturer. We expect these contract manufacturers to be responsible for most of our volume production in the future. In January 2000, we signed a manufacturing agreement with NEC America to obtain a second source for AirStar digital system components. In December 1999, we received and qualified initial subsystems from this manufacturer.
System integrators and service providers typically perform numerous tests and extensively evaluate products before incorporating them into networks. The time required for testing, evaluation and design of our products into the service provider's network typically ranges from six to twelve months. If a service provider decides to supply commercial service with our products, it can take an additional six to twelve months before a service provider commences deployment of our products. During the trial period, we sell to service providers a limited number base stations and corresponding subscriber equipment The successful completion of this trial phase often results in another sale of additional hubs and subscriber equipment intended for commercial service.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998 AND 1999
REVENUES. Current revenues primarily consist of product revenues from the sale of the AirStar system. Revenues increased from $5.4 million in 1998 to $18.2 million in 1999, due principally to increased AirStar system sales, which were slightly offset by the final phase-out of AirMAN sales. Substantially all of the revenues for these years were generated from installations in international locations. Sales to major customers were as follows:
* Sales less than 10%.
GROSS PROFIT (LOSS). Gross profit represents total revenue less the cost revenue. Cost of revenues consists of contract manufacturing costs, material costs, compensation costs, manufacturing overhead, warranty reserves and other direct product costs. Gross profit increased from a loss of $4.2 million in 1998 to a profit of $3.3 million in 1999, principally due to increased AirStar system sales, which typically have a higher margin than predecessor products.
RESEARCH AND DEVELOPMENT. Research and development expenses consist of compensation costs, the cost of some software development tools, consultant fees and prototype expenses
related to the design, development and testing of our products. Research and development expenses increased from $16.1 million in 1998 to $19.3 million in 1999, primarily due to increases in personnel and related compensation costs, prototype material expenses, third-party engineering charges and expenses related to the release of new product features for the AirStar system. Gross research and development expenses increased from $17.0 million in 1998 to $19.9 million in 1999. We expect that continued substantial investment in research and development will be critical to attaining our strategic product and cost reduction objectives.
SALES AND MARKETING. Sales and marketing expenses consist primarily of compensation costs, commissions, travel and related expenses for marketing, sales, customer advocacy and field service support personnel, as well as product management, trade show and promotional expenses. Sales and marketing expenses increased from $4.8 million in 1998 to $5.8 million in 1999. The increase was primarily due to the significant expansion in sales, technical assistance and field support personnel necessary to support both the pre-sale and post-sale activities associated with the AirStar system. We expect these expenses to continue to increase on an absolute basis as we invest in expanding our sales and customer advocacy organizations.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of compensation costs and related expenses for executive, finance, management information systems, human resources and administrative personnel. These expenses also include professional fees, facilities and other general corporate expenses. General and administrative expenses increased from $4.0 million in 1998 to $7.4 million in 1999. The increase was primarily due to deferred compensation charges, increased rent and overhead expenses associated with additional facilities, as well as the increased cost associated with being a public company. We expect that the growth of our operations as a public company will continue to require additional personnel and costs.
AMORTIZATION OF DEFERRED STOCK COMPENSATION. Amortization of deferred stock compensation results from the granting of stock options to employees with exercise prices per share determined to be below the estimated fair values per share of our common stock at dates of grant. The deferred compensation that results is being amortized to expense over the vesting periods of the individual options, generally four years. We have recorded total deferred stock compensation of $4.8 million through December 31, 1999.
OTHER INCOME, NET. Other income (expense), net consists primarily of interest income earned on low-risk, short-term investments and interest paid on outstanding debt. Other income, net increased from $304,000 in 1998 to $353,000 in 1999 primarily due to higher interest income from higher average cash balances partially offset by increased interest expense resulting from greater utilization of secured equipment loans and lease and bank financing for working capital.
NET LOSS. Net loss was relatively constant at $28.8 million from 1998 to 1999 principally due to higher gross profit, offset by increased operating expenses.
YEARS ENDED DECEMBER 31, 1997 AND 1998
REVENUES. Revenues decreased from $5.6 million in 1997 to $5.4 million in 1998. This decrease was primarily due to the discontinuation of the AirMAN system, which resulted in declining revenues that more than offset the revenues generated from the launch of the AirStar system. Substantially all of the revenues for these years were generated from installations in international locations. Sales to major customers were as follows:
* Sales less than 10%.
GROSS LOSS. Gross loss increased from $2.7 million in 1997 to $4.2 million in 1998. This increase was primarily due to pricing pressures and increased warranty reserves for the AirMAN system.
RESEARCH AND DEVELOPMENT. Research and development expenses increased from $15.3 million in 1997 to $16.1 million in 1998. The increase was primarily due to increases in personnel and related compensation costs, prototype material expenses, third-party engineering charges and expenses related to the trial release of the initial AirStar system. Gross research and development expenses increased from $15.3 million in 1997 to $17.0 million in 1998.
SALES AND MARKETING. Sales and marketing expenses increased from $3.8 million in 1997 to $4.8 million in 1998. The increase was primarily due to the significant expansion in sales, technical assistance and field support personnel necessary to support both the pre-sale and post-sale activities associated with the AirStar system.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased from $3.5 million in 1997 to $4.0 million in 1998. The increase was primarily due to increased rent expense due to relocation to larger facilities, as well as an increase in personnel from 8 to 15.
OTHER INCOME, NET. Other income, net decreased from $703,000 in 1997 to $304,000 in 1998, primarily due to greater utilization of secured equipment loans and lease and bank financing for working capital.
NET LOSS. Net loss increased from $24.5 million in 1997 to $28.8 million in 1998 primarily due to increases in operating expenses and negative gross profit.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1999, cash and cash equivalents were $7.5 million and short-term investments were $37.9 million. We have a $6.0 million bank line of credit. As of December 31, 1999, borrowings outstanding were $4.3 million and amounts utilized for outstanding letters of credit were $300,000 under this agreement. The line of credit is secured by eligible outstanding accounts receivable and inventory. The borrowings under the line are due in January 2001 and accrue interest at the 30-day LIBOR plus 2.25% or the bank's prime rate, at our option. In addition, we have secured equipment financing which allows a maximum borrowing of $3.0 million of which $1.1 million was available as of December 31, 1999. See note 6 of notes to consolidated financial statements.
Cash used in operating activities was $25.9 million for the year ended December 31, 1998 and $29.1 million for the same period in 1999. Cash used for operations for both periods was primarily due to the net loss, partially offset by non-cash charges.
Cash used in investing activities was $2.2 million for the year ended December 31, 1998, primarily due to excess cash invested in short-term investments and capital equipment purchases. Cash used in investing activities was $30.6 million for the year ended December 31, 1999, primarily due to excess cash invested in short-term investments.
Cash provided by financing activities was $18.5 million and $61.0 million for the years ended December 31, 1998 and 1999, respectively. Cash provided by financing activities for both periods was primarily due to issuances of stock and, to a lesser extent, capital lease and bank financing. Cash provided by financing activities in 1999 includes net
proceeds of $41.6 million related to our initial public offering in August 1999.
We completed our initial public offering of common stock in August 1999. We sold 5,750,000 shares at a price of $8.00 per share. We received net aggregate proceeds from the initial public offering of $41.6 million, net of underwriting discounts and commissions and offering costs.
In March 2000 the Company completed a follow-on public offering. Of the 6 million shares of common stock offered , the Company sold 4,504,111 shares and selling shareholders sold 1,495,889, at a price of $82.5 per share. We received net aggregate proceeds of approximately $352.3 million after deducting underwriting discounts and commission and estimated offering costs.
We have no material commitments other than obligations under our credit facilities and operating and capital leases. See notes 6 and 7 of notes to consolidated financial statements. Our future capital requirements will depend upon many factors, including the timing of research and product development efforts and expansion of our marketing efforts. We expect to continue to expend significant but smaller amounts on property and equipment related to the expansion of our facilities, and on research and development laboratory and test equipment.
The capital required for volume manufacturing is being committed by our contract manufacturers. We provide six or twelve month forecasts to our contract manufacturers. We generally commit to purchase products to be delivered within the most recent 60 days covered by these forecasts with cancellation fees. As of December 31, 1999, we had committed to make purchases totaling $4.6 million from these manufacturers in the next 60 days. In addition, in specific instances we may agree to assume liability for limited quantities of specialized components with lead times beyond this 60-day period.
In future periods, we generally anticipate significant increases in our working capital needs on a period-to-period basis primarily as a result of planned increased product revenues. In conjunction with the expected increases in revenues, we expect higher levels of inventory and trade accounts receivable. While we also expect an increase in trade accounts payable and other liabilities, we do not expect that they will offset the increases in inventory and trade accounts receivable.
We believe that our current cash and cash equivalents balances, short-term investments and funds available under our existing line of credit will be sufficient to satisfy our cash requirements for at least the next twelve months. Our management intends to invest our cash in excess of current operating requirements in short-term, interest-bearing, investment-grade securities.
YEAR 2000 IMPACT
We have not experienced any problems with our computer systems relating to their inability to recognize appropriate dates related to the year 2000. We are also not aware of any material problems with our clients or vendors. Accordingly, we do not anticipate incurring material expenses or experiencing any material operational disruptions as a result of any Year 2000 issues.
RISK FACTORS
In addition to the other information in this Report, the following factors should be considered carefully in evaluating the Company's business and prospects:
WE HAVE A HISTORY OF LOSSES, EXPECT FUTURE LOSSES AND MAY NEVER ACHIEVE PROFITABILITY
As of December 31, 1999, we had an accumulated deficit of $96.4 million, and we expect to continue to incur net losses. We anticipate continuing to incur significant sales and marketing, research and development and general and administrative expenses and, as a
result, we will need to generate significantly higher revenues to achieve and sustain profitability. Our financial results prior to 1999 were largely based on sales of AirMAN, a predecessor product, which we discontinued in September 1998. For 1999, our financial results were largely based on customer trials and commercial pilots of our AirStar product line. Although our AirStar revenues have grown in recent quarters, our past results should not be relied on as indications of future performance. We cannot be certain that we will realize sufficient revenues to achieve and sustain profitability. We incurred net losses of approximately $24.5 million, $28.8 million and $28.8 million in 1997, 1998 and 1999.
WE HAVE NOT MANUFACTURED OUR PRODUCTS IN SUBSTANTIAL VOLUMES. IF WE ARE UNABLE TO DO SO IN A COST-EFFICIENT WAY, OUR BUSINESS WILL BE ADVERSELY AFFECTED
Our products are commercially available only in limited quantities. We began low-volume manufacturing runs in January 1999 with our first contract manufacturer and in August 1999 with our second contract manufacturer. We are currently in the process of initiating manufacturing runs with a third contract manufacturer. If we or our manufacturers are unable to develop processes by which we can manufacture substantial volumes of our products at the required quality and expected costs in relatively short periods of time, our financial results will suffer. Manufacturing our products, particularly the radio elements of our products, is complex and difficult. One of our contract manufacturers does not have a history of producing radio elements on a large scale. In addition, many of our contracts with distributors and system integrators provide for financial penalties in the event of a delay in delivery of products.
DUE TO OUR LIMITED OPERATING HISTORY IT IS DIFFICULT TO PREDICT FUTURE OPERATING RESULTS OR OUR STOCK PRICE
We have generated only limited revenues to date, and revenues from our current AirStar product have been significant only in the past year. Prior to 1999, most of our revenues came from sales of a discontinued product line. Due to our limited operating history with our current product line, it is difficult for us to predict future results of operations. Investors in our common stock must consider our business and prospects in light of our historical dependence on a discontinued product line.
IF WE CANNOT REDUCE OUR PRODUCT COSTS, POTENTIAL CUSTOMERS WILL NOT PURCHASE OUR PRODUCTS AND OUR RESULTS OF OPERATIONS WILL SUFFER
Market acceptance of our products will depend in part on reductions in the unit cost of our products. If we cannot reduce the cost of our products, our product sales, and consequently our results of operations, will suffer. If prices for alternative high-speed telecommunications services continue to decline, we may not become profitable. We believe that the price for high-speed wireless telecommunications equipment is driven by the prevailing price for other high-speed connection technologies, especially the cost of leasing a high-speed wire from the traditional telecommunications service provider in a given locale. Recently, the price of these leased connections has declined significantly in many countries. In addition, if this trend continues, service providers might be more likely to use this kind of leased connection than to introduce new technology such as our products, which would adversely affect our market share and pricing. Our cost reduction efforts may not allow us to keep pace with competitive pricing pressures or may not lead to improved gross margins.
OUR FUTURE OPERATING RESULTS ARE DEPENDENT ON THE SALES OF A SINGLE PRODUCT LINE. IF THERE ARE UNEXPECTED CHANGES IN REVENUES FROM THIS PRODUCT, WE WILL NOT HAVE OTHER PRODUCTS TO OFFSET THE NEGATIVE IMPACT ON OUR OPERATING RESULTS
We currently derive substantially all of our revenues from our AirStar product line and expect that this will continue for the foreseeable future. If there are unexpected changes in revenues from this product, we will not have other products to offset the negative impact on our operating results. Many of the risk factors listed in this section could negatively affect sales of our product line.
OUR BUSINESS IS SUBJECT TO MANY FACTORS THAT COULD CAUSE OUR QUARTERLY OPERATING RESULTS TO FLUCTUATE AND OUR STOCK PRICE TO BE VOLATILE
Our quarterly and annual operating results have fluctuated in the past and are likely to fluctuate significantly in the future due to the risk factors described in this section. It is likely that in some future quarter our operating results will fall below the expectations of securities analysts and investors. In this event, the market price of our common stock could significantly decline.
IF WE ARE UNABLE TO DEPLOY OUR PRODUCTS ON A LARGE SCALE OR INTEGRATE THEM INTO A LARGE-SCALE NETWORK ENVIRONMENT, WE COULD LOSE SALES OPPORTUNITIES, SUFFER INJURY TO OUR REPUTATION, OR EXPERIENCE WARRANTY CLAIMS
To date, we have launched our products only in customer trials and commercial pilots. If our products fail, or do not function adequately, in a large-scale deployment or in a network environment, we could experience:
- delays in or losses of sales opportunities;
- diversion of development resources;
- injury to our reputation; and
- increased service, warranty and replacement costs.
In addition, our products may contain undetected or unresolved errors when they are first introduced or as a result of changes we make to reduce manufacturing costs. Our products are integrated with other network elements. There may be incompatibilities between these elements and our products that adversely affect the service provider or its subscribers.
WE DEPEND ON TWO CONTRACT MANUFACTURERS AND WE ARE IN THE PROCESS OF INITIATING MANUFACTURING RUNS WITH A THIRD. IF THESE MANUFACTURERS ARE UNABLE TO FILL OUR ORDERS ON A TIMELY BASIS, AND WE ARE UNABLE TO FIND ALTERNATIVE SOURCES, WE MAY BE UNABLE TO DELIVER PRODUCTS TO MEET CUSTOMER ORDERS
We currently have relationships with three contract manufacturers of our products. Two of these provided products to us in 1999, and we expect the third will begin to provide products to us in the first quarter of 2000. We only manufacture pilot runs of our products and perform testing and staging at our own facilities. If our manufacturers are unable or unwilling to continue manufacturing our products in required volumes, we would have to identify and train acceptable alternative manufacturers, which could take as long as six months and cause our results of operations to suffer.
Our experience with these manufacturers provides us with no basis to project their delivery schedules, yields or costs. In addition, few manufacturers produce radios like ours on a large scale. It is possible that a source may not be available to us when needed, and we may not be able to satisfy our production requirements at acceptable prices and on a timely basis, if at all. Any significant interruption in supply would affect the allocation of products to customers, which in turn could have an adverse effect on our business.
BECAUSE SOME OF OUR KEY COMPONENTS ARE FROM SOLE SOURCE SUPPLIERS OR REQUIRE LONG LEAD TIMES, OUR BUSINESS IS SUBJECT TO UNEXPECTED INTERRUPTIONS, WHICH COULD CAUSE OUR OPERATING RESULTS TO SUFFER
Many of our key components have long lead times, are purchased from sole source vendors for which alternative sources are not currently available, and are complex to manufacture. In the event of a reduction or interruption of supply, or a degradation in quality, as many as six months could be required before we would begin receiving adequate supplies from alternative suppliers, if any. As a result, product shipments could be delayed and our revenues and results of operations would suffer.
For example, we purchase our base station shelf from Cisco Systems, Inc. under an agreement that terminates in September 2000. Cisco has recently acquired interests in companies with high-speed wireless technology, and we cannot be certain that Cisco will continue to supply us after the termination of the current agreement. In addition, we purchase most of our electronic boards for base station equipment from Solectron, one of our
contract manufacturers, and other components from other sole source and long lead time vendors.
IF WE DO NOT DEVELOP NEW PRODUCTS AND PRODUCT FEATURES IN RESPONSE TO CUSTOMER REQUIREMENTS OR IN A TIMELY WAY, CUSTOMERS WILL NOT BUY OUR PRODUCTS
Our inability to develop new products or product features on a timely basis, or the failure of new products or product features to achieve market acceptance, could adversely affect our business. We may experience design or manufacturing difficulties that could delay or prevent our development, introduction or marketing of new products and enhancements, any of which could cause us to incur unexpected expenses or lose revenues. For example, the first trial shipments of AirStar were delayed for almost one year due to technical problems. In addition, some of our customers have conditioned their future purchases of our products on the addition of product features. In the past we have experienced delays in introducing new features. For example, we intended to introduce base radio units that supported smaller sectors and a new release of our network management software in 1999, but the release of both of these features has been delayed until later in 2000. Furthermore, in order to compete in many markets, we will have to develop different versions of our existing products that operate at different frequencies and comply with diverse, new or varying governmental regulations in each market.
WE DEPEND ON TWO SYSTEM INTEGRATORS FOR MOST OF OUR REVENUES. IF THESE SYSTEM INTEGRATORS DO NOT PROMOTE OR PURCHASE OUR PRODUCTS, OUR BUSINESS WILL BE ADVERSELY AFFECTED
We sell most of our products through two system integrators, Lucent and Siemens. The loss of either of these system integrators or the delay of significant orders from these system integrators, even if only temporary, could, among other things:
- reduce or delay our revenues;
- harm our reputation in the industry; or
- reduce our ability to predict our cash flow accurately.
Aggregate sales through these two system integrators accounted for approximately 31% and 64% of our revenues for 1998 and 1999, respectively. Accordingly, unless and until we diversify and expand our customer base, our future success will significantly depend on the timing and size of future purchase orders, if any, from these two system integrators. There are a limited number of system integrators that have the financial resources or technical expertise to sell, or to integrate, our products globally. If one or both of our system integrators will not sell, service or integrate our products, and we cannot identify other system integrators as replacements, we would be limited in our ability to sell our products.
Our relationships with our system integrators are non-exclusive and do not contain minimum purchase commitments. Should either of our system integrators cease to emphasize systems that include our products, choose to emphasize alternative technologies or promote products of our competitors, our revenues and consequently results of operations would be adversely affected. For example, Siemens has an equity interest in, and a commercial relationship with, one of our competitors, which may motivate Siemens to select this competitor's solutions over our own in the future.
IF WE ARE UNSUCCESSFUL IN ESTABLISHING LARGER DIRECT SALES AND CUSTOMER ADVOCACY ORGANIZATIONS, WE MAY NOT BE ABLE TO GROW OUR BUSINESS
We intend to grow our direct sales force and customer advocacy organization. We believe that the efforts of our direct sales force and customer advocacy organization are important in enabling both ourselves and our system integrators to acquire customers. We believe that qualified personnel are difficult to find and, once found, take substantial lead time to become productive. To the extent that we are unable to expand our direct sales force and customer advocacy organization, we may be unable to grow our business.
IF HIGH-SPEED WIRELESS TELECOMMUNICATIONS TECHNOLOGY OR OUR IMPLEMENTATION OF THIS TECHNOLOGY IS NOT ACCEPTED BY SERVICE PROVIDERS, WE WILL NOT BE ABLE TO SUSTAIN OR GROW OUR BUSINESS
Our future success is substantially dependent on whether high-speed wireless telecommunications equipment gains market acceptance as a means to provide telecommunications voice and data services. All of our products are based on this technology. In the event that service providers adopt technologies other than the high-speed wireless technology that we offer, we may not be able to sustain or grow our business. Service providers continuously evaluate alternative high-speed access technologies, including wire-based technologies such as digital subscriber lines, cable modems, fiber optic cable and high-speed wires leased from the traditional service providers in a given locale, as well as different wireless technologies. In addition, widespread acceptance of our technology may be hindered by inherent technological limitations, such as a need for a clear line-of-sight for transmissions and a reduction in coverage radius in areas that experience heavy rain.
THE MAJORITY OF SERVICE PROVIDERS USING OUR PRODUCTS ARE EMERGING COMPANIES WITH UNPROVEN BUSINESS MODELS. IF THESE SERVICE PROVIDERS DO NOT SUCCEED, THERE WILL BE NO MARKET FOR OUR PRODUCTS
Most telecommunications service providers using our products are emerging companies with unproven business models. If these new service providers do not succeed, there will be no market for our products. Neither they nor we have experience in integrating a complete telecommunications network that includes our products. The inability of emerging service providers to acquire and keep customers, acquire radio frequency licenses, successfully raise needed funds or respond to any trends such as price reductions for their services or diminished demand for telecommunications services generally, could cause them to reduce their capital spending on network buildouts. If service providers defer or curtail their capital spending programs, sales of our products might be impacted, which would have an adverse effect on our business.
WE HAVE A LONG SALES CYCLE, WHICH COULD CAUSE OUR RESULTS OF OPERATIONS AND STOCK PRICE TO FLUCTUATE
We believe our sales cycles are long and unpredictable. As a result, our revenues may fluctuate from quarter to quarter and fail to correspond with our expenses. This would cause our operating results and stock price to fluctuate. System integrators and service providers typically perform numerous tests and extensively evaluate products before incorporating them into networks. The time required for testing, evaluation and design of our products into the service provider's network typically ranges from six to twelve months. If a service provider decides to supply commercial service with our products, it can take an additional six to twelve months before a service provider commences deployment of our products. Some additional factors that affect the length of our sales cycle include:
- testing and evaluation;
- acquisition of roof rights;
- deployment and planning of network infrastructure;
- complexity of a given network;
- scope of a given project;
- availability of radio frequency; and
- regulatory issues.
In addition, the delays inherent in our sales cycle raise additional risks of service provider decisions to cancel or change their product plans. Our business could be adversely affected if a significant customer reduces or delays orders during our sales cycle or chooses not to deploy networks incorporating our products.
INTENSE COMPETITION IN THE MARKET FOR COMMUNICATIONS EQUIPMENT COULD PREVENT US FROM INCREASING OR SUSTAINING REVENUES OR ACHIEVING OR SUSTAINING PROFITABILITY
The market for high-speed, wireless, point-to-multipoint telecommunications equipment is rapidly evolving and highly competitive. Increased competition is likely to result in price reductions, shorter product life cycles, reduced gross margins, longer sales cycles and
loss of market share, any of which would adversely affect our business. As a provider of high-speed wireless telecommunications equipment, we compete with a number of large telecommunications equipment suppliers, including Alcatel, Ericsson, Hughes, Marconi, Newbridge, Nortel and Spectrapoint, a joint venture between Cisco and Motorola, as well as with smaller start-up companies. In addition, well capitalized companies such as Nokia are potential entrants into the market. As a technology for providing high-speed telecommunications services, high-speed, wireless solutions compete with other high-speed, wire-based solutions, such as digital subscriber lines, fiber optic cable, cable modems and high-speed wires leased from traditional telecommunications service providers and satellite technologies.
We expect our competitors to continue to improve the performance of their current products and to introduce new products or new technologies that may supplant or provide lower cost alternatives to our products. Our competitors may also attempt to influence the adoption of standards that are not compatible with our current architecture. Our larger, more established competitors may have more influence with standards setting bodies than we do. In addition, if standards other than ours are adopted, this may require us to incur additional development and integration costs and may delay our sales efforts. To be competitive, we must continue to invest significant resources in research and development, sales and marketing and customer support. We cannot be sure that we will have sufficient resources to make these investments or that we will be able to make the technological advances necessary to be competitive. As a result, we may not be able to compete effectively against our competitors.
BECAUSE WE MUST SELL OUR PRODUCTS IN MANY COUNTRIES THAT HAVE DIFFERENT REGULATORY SCHEMES, IF WE CANNOT DEVELOP PRODUCTS THAT WORK WITH DIFFERENT STANDARDS, WE WILL BE UNABLE TO SELL OUR PRODUCTS
If our sales are to grow, we must sell our products in many different countries. Many countries require communications equipment used in their country to comply with unique regulations, including safety regulations, radio frequency allocation schemes and standards. If we cannot develop products that work with different standards, we will be unable to sell our products. If compliance proves to be more expensive or time consuming than we anticipate, our business would be adversely affected. Some countries have not completed their radio frequency allocation process and therefore we do not know the standards with which we would be forced to comply. We have not completed all activities necessary to comply with existing regulations and requirements in most of the countries in which we intend to sell our products. Furthermore, standards and regulatory requirements are subject to change. For example, standards for antenna design expected to be established by the European Telecommunications Standards Institute are currently in flux.
IF WE ARE UNABLE TO MANAGE OUR INTERNATIONAL OPERATIONS EFFECTIVELY, OUR BUSINESS WOULD BE ADVERSELY AFFECTED
Sales in foreign countries accounted for 76% and 43% of our revenues in 1998 and 1999, respectively. In addition, most equipment purchased by domestic customers has been shipped to international service providers. Our international operations are subject to a number of risks and uncertainties, including:
- the difficulties and costs of obtaining regulatory approvals for our products;
- unexpected changes in regulatory requirements; and
- legal uncertainties regarding liability, tariffs and other trade barriers.
Any of these factors could have an adverse impact on our existing international operations and business or impair our ability to expand into international markets.
WE DEPEND ON A SMALL NUMBER OF CUSTOMERS. CHANGES IN TIMING AND SIZE OF THESE CUSTOMERS' ORDERS MAY CAUSE OUR OPERATING RESULTS AND STOCK PRICE TO FLUCTUATE
We sell our products to a small number of customers. Unless and until we diversify and expand our customer base, our future success will significantly depend on:
- the timing and size of future purchase orders, if any, from our largest customers;
- the product requirements of these customers;
- the financial and operational success of these customers; and
- the success of service providers that have deployed our products.
Sales to our largest customers have in the past fluctuated and may in the future fluctuate significantly from quarter to quarter and year to year.
MANY PROJECTS THAT INCLUDE OUR PRODUCTS REQUIRE SYSTEM INTEGRATION EXPERTISE AND THIRD-PARTY FINANCING, WHICH WE ARE UNABLE TO PROVIDE. IF SOURCES FOR SYSTEM INTEGRATION OR FINANCING CANNOT BE OBTAINED AS NEEDED, SERVICE PROVIDERS MAY NOT SELECT OUR PRODUCTS
Some service providers using our products purchase them as a part of a larger network deployment program that can require capital expenditures in the hundreds of millions of dollars. In some circumstances, these service providers require their equipment vendors to integrate equipment into these larger networks and finance deployment. We will be unable to provide this integration or financing and therefore will have to rely on the ability of our system integrators or third parties to integrate or finance these transactions. In the event that we are unable to identify distributors and system integrators that are able to provide this integration or financing on our behalf, we would be unable to compete for the business of some service provider accounts and our business might be adversely affected.
IF WE ARE UNABLE TO HIRE OR RETAIN OUR PERSONNEL, WE MIGHT NOT BE ABLE TO OPERATE OUR BUSINESS SUCCESSFULLY
Given our early stage of development, we are dependent on our ability to attract, retain and motivate high caliber personnel. The loss of the services of any key personnel or our inability to hire new personnel could restrict our ability to compete effectively. Competition for qualified personnel in our industry and in the Silicon Valley is intense, and we may not be successful in attracting and retaining these personnel. There are only a limited number of people with the requisite skills, particularly people with millimeter wave radio expertise. We are also dependent on the continued contributions of our principal sales, engineering and management personnel, many of whom would be difficult to replace. We currently do not maintain key person life insurance on any of our key executives.
CLAIMS THAT WE INFRINGE THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS COULD RESULT IN SIGNIFICANT EXPENSES OR RESTRICTIONS ON OUR ABILITY TO SELL OUR PRODUCTS IN PARTICULAR MARKETS
From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies and in various jurisdictions that are important to our business. Any claims could be time-consuming, result in costly litigation, divert the efforts of our technical and management personnel, cause product shipment delays or require us to enter into royalty or licensing agreements, any of which could have an adverse effect on our operating results. Royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. In addition, in our sales agreements, we agree to indemnify our customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties.
CONTROL BY OUR EXISTING SHAREHOLDERS COULD DISCOURAGE POTENTIAL ACQUISITIONS OF OUR BUSINESS THAT OTHER SHAREHOLDERS MAY CONSIDER FAVORABLE
Our executive officers, directors and 5% or greater shareholders and their affiliates own 16,492,453 shares or approximately 33.5% of the outstanding shares of common stock. Acting together, these shareholders would be able to exert substantial influence on matters requiring approval by shareholders, including the election of directors. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could have an adverse effect on the market price of our common stock or prevent our shareholders from realizing a premium over the market price for their shares of common stock.
OUR ARTICLES OF INCORPORATION AND BYLAWS MAY DISCOURAGE POTENTIAL ACQUISITIONS OF OUR BUSINESS BY THIRD PARTIES THAT SHAREHOLDERS MAY CONSIDER FAVORABLE
Some provisions of our articles of incorporation and bylaws and of California law may discourage, delay or prevent a merger or acquisition that shareholders may consider favorable. This may reduce the market price of our common stock. A summary of these provisions in our articles and bylaws is included in "Description of Capital Stock - Anti-Takeover Provisions".
OUR STOCK PRICE MAY BE VOLATILE
Since our initial public offering in August 1999, our stock price has experienced significant volatility. We expect that the market price of our common stock also will fluctuate in the future in response to many of the risk factors listed in this section. These fluctuations may be exaggerated if the trading volume of our common stock is low.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCY HEDGING INSTRUMENTS. We transact business in various foreign currencies and, accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. To date, the effect of changes in foreign currency exchange rates on revenues and operating expenses have not been material. Basically, all of our revenues are earned in U.S. dollars. Operating expenses incurred by our German subsidiary are denominated primarily in European currencies. We currently do not use financial instruments to hedge these operating expenses. We intend to assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.
We do not use derivative financial instruments for speculative trading purposes.
FIXED INCOME INVESTMENTS. Our exposure to market risks from changes in interest rates relates primarily to corporate debt securities. We place our investments with high credit quality issuers and, by policy, limit the amount of the credit exposure to any one issuer.
Our general policy is to limit the risk of principal loss and ensure the safety of invested funds by limiting market and credit risk. All highly liquid investments with a maturity of less than three months at the date of purchase are considered to be cash equivalents; all investments with maturities of three months or greater are classified as held-to-maturity and considered to be short-term investments.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Netro Corporation:
We have audited the accompanying consolidated balance sheets of Netro Corporation (a California corporation) and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations and comprehensive loss, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Netro Corporation and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Jose, California January 24, 2000
NETRO CORPORATION
CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
The accompanying notes are an integral part of these consolidated financial statements.
NETRO CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (IN THOUSANDS, EXCEPT PER SHARE DATA)
The accompanying notes are an integral part of these consolidated financial statements.
NETRO CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
The accompanying notes are an integral part of these consolidated financial statements.
NETRO CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
The accompanying notes are an integral part of these consolidated financial statements.
NETRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS:
Netro Corporation (collectively, with its subsidiaries, the "Company") was incorporated in California on November 14, 1994. Netro is a leading provider of broadband wireless access equipment to competitive communications service providers worldwide. Netro's AirStar broadband access system derives its price-performance benefits from dynamic bandwidth allocation and a point-to-multipoint architecture that provides integrated voice and high-speed packet data services. The Company operates in one business segment.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries in Germany, France and a dormant subsidiary in Israel.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Company's subsidiaries is the local currency. Gains and losses resulting from the translation of the financial statements have not been material to date.
Foreign exchange gains and losses resulting from foreign currency transactions were not material in any of the periods presented.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of short-term, highly liquid investments with original maturities of less than three months.
SHORT-TERM INVESTMENTS
The Company classifies its investments in debt securities as "held-to-maturity." Accordingly, these investments, which mature at various dates through February 2000, are valued using the amortized cost method. The fair value of the investments approximates amortized cost and, as such, the gross unrealized holding gains and losses at December 31, 1999 and 1998, were not material.
The carrying value of the Company's investments by major security type consisted of the following (in thousands):
Approximately none and $4,971,000 of the total investments in debt securities as of December 31, 1999 and 1998, respectively, were included in cash and cash
equivalents. The remaining balances were classified as short-term investments. There were no investments included in cash and cash equivalents as of December 31, 1999.
INVENTORY
Inventory includes materials and labor, is stated at the lower of cost (first-in, first-out) or market and consisted of the following (in thousands):
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment is recorded at cost and depreciated using the straight-line method based upon the estimated useful lives of the assets, which range from three to five years. Leasehold improvements are recorded at cost and are amortized over the estimated lives of the improvements or the term of the lease, whichever is shorter. Maintenance and repairs that do not improve or extend the life of assets are expensed as incurred.
SOFTWARE DEVELOPMENT COSTS
Under the criteria set forth in Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," capitalization of software development costs begins upon the establishment of technological feasibility of the product. The establishment of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, anticipated future gross product revenues, estimated economic life and changes in software and hardware technology. Amounts that could have been capitalized under this statement after consideration of the above factors were immaterial and, therefore, no software development costs have been capitalized by the Company to date.
REVENUE RECOGNITION
Revenues from product sales are generally recognized when all of the following conditions are met: the product has shipped, an arrangement exits with the customer and the Company has the right to invoice the customer, collection of the receivable is probable and the Company has fulfilled all of its material contractual obligations to the customer. Provisions are made at the time of revenue recognition for estimated warranty costs.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred and consist primarily of payroll costs, other direct expenses and overhead. The Company received third-party research and development funding of $625,000 and $900,000 in 1999 and 1998, respectively. The Company offset research and development expenses with the funding when agreed-upon milestones were met.
COMPUTATION OF HISTORICAL NET LOSS PER SHARE AND PRO FORMA NET LOSS PER SHARE
Historical net loss per share was calculated under SFAS No. 128, "Earnings per Share." Basic and diluted net loss per share on a historical basis is computed using the weighted average number of shares of common stock outstanding. Potential common shares from the conversion of convertible preferred stock and exercise of stock options and warrants are excluded from diluted net loss per share because they would be antidilutive. The total number of shares excluded from diluted net loss per share relating to these securities was 4,408,949, 32,453,093 and 29,777,846 shares for 1999, 1998 and 1997, respectively.
Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 98, convertible preferred stock and common stock issued or granted for nominal consideration prior to the anticipated effective date of an initial public offering must be included in the calculation of basic and diluted net loss per share as if they had been outstanding for all periods presented. To date, the Company has not had any issuances or grants for nominal consideration.
Pro forma basic and diluted net loss per share is calculated assuming the conversion of convertible preferred stock into an equivalent number of shares of common stock, as if the shares had converted on the dates of their issuance.
The following table presents the calculation of historical and pro forma net loss per share (in thousands, except per share data):
COMPREHENSIVE LOSS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income," which the Company adopted beginning on January 1, 1998. SFAS No. 130 establishes standards for the reporting and display of comprehensive income (loss) and its components in a full set of general purpose financial statements. The objective of SFAS No. 130 is to report a measure of all changes in equity of an enterprise that result from transactions and other economic events of the period other than transactions with shareholders. Comprehensive income (loss) is the total of net income (loss) and all other non-owner changes in equity. For each of the periods presented, the Company had no such transactions, therefore the comprehensive loss was equal to net loss.
STOCK-BASED COMPENSATION PLANS
Effective January 1, 1996, the Company adopted the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." In accordance with the provisions of SFAS No. 123, the Company applies Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for stock options.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires companies to value derivative financial instruments, including those used for
hedging foreign currency exposures, at current market value with the impact of any change in market value being charged against earnings in each period. In June 1999, the Financial Accounting Standards Board issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of SFAS No. 133" to defer the effective date of SFAS No. 133 until fiscal years beginning after June 15, 2000. To date, the Company has not entered into any derivative financial instrument contracts. Thus, the Company anticipates that SFAS No. 133 will not have a material impact on its consolidated financial statements.
3. CONCENTRATIONS OF CREDIT RISK:
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade receivables, cash equivalents and short-term investments. As of December 31, 1999 and 1998, approximately 85% and 71%, respectively, of the Company's trade accounts receivable balance was represented by three customers and one customer, respectively. Although the Company does not require collateral on accounts receivable, because the majority of the Company's customers are large, well-established companies, it requires stand by letters of credits or prepayments on certain sales to foreign and smaller companies. The Company provides reserves for credit losses and such losses have been insignificant in all periods presented in the accompanying consolidated financial statements. With respect to cash equivalents and short-term investments, the Company has cash investment policies that limit the amount of credit exposure to any one issuer and restrict placement of these investments to issuers evaluated as creditworthy.
4. EQUIPMENT AND LEASEHOLD IMPROVEMENTS:
Equipment and leasehold improvements consisted of the following (in thousands):
5. ACCRUED LIABILITIES:
Accrued liabilities consisted of the following (in thousands):
6. DEBT AND CAPITAL LEASES:
The following table summarizes obligations under long-term debt and capital leases (in thousands):
In January 1998, the Company entered into a new bank line of credit under which up to $6,000,000 is available for borrowings and letters of credit. This arrangement was renewed in September 1999 and expires in January 2001. Borrowings are limited to an aggregate amount equaling approximately 80% and 90% of domestic and foreign eligible trade accounts receivables, respectively, and 50% of eligible foreign inventories. The line of credit is secured by the Company's outstanding trade accounts receivable and inventory. The borrowings under the line are due in January 2001 and accrued interest at the 30-day LIBOR rate plus 2.25% or the bank's prime rate, at the Company's option. Under the agreement, the Company must comply with certain financial and other covenants.
As of December 31, 1999, borrowings outstanding under this agreement were $4,338,000 and amounts utilized for outstanding letters of credit were $300,000.
In 1997, the Company borrowed $3,750,000 from a lender to finance purchases of fixed assets. The loan accrues interest at 12.5% per annum from the date of borrowing, and is secured by a purchase money lien on the equipment financed. Principal payments due under the loan at December 31, 1999, are as follows (in thousands):
A significant portion of the Company's machinery and equipment is leased under agreements accounted for as capital leases. The cost of equipment under capital leases included in property and equipment at December 31, 1999 and 1998 was approximately $6,590,000, and $5,754,000 respectively.
In March 1999, the Company entered into a new equipment lease agreement, under which the Company can finance equipment purchases of up to $3,000,000. As of December 31, 1999, the Company had borrowed approximately $1,936,000 against this agreement. See Note 9 for information regarding warrants issued as part of this agreement.
Future minimum lease payments under all noncancelable capital lease agreements as of December 31, 1999, are summarized as follows (in thousands):
7. COMMITMENTS AND CONTINGENCIES:
COMMITMENTS
The Company leases its facilities and certain equipment under noncancelable operating lease agreements expiring at various dates through 2002. Future minimum lease payments under all noncancelable operating lease agreements as of December 31, 1999, are summarized as follows (in thousands):
Rent expense for the operating leases was approximately $1,361,000, $922,000, $538,000 in 1999, 1998, and 1997, respectively.
The Company had outstanding a standby letter of credit of $400,000 to secure the Company's warranty obligations to one customer relating to discontinued product. The letter of credit is secured by a certificate of deposit for $125,000. The letter of credit is subject to draw if the Company fails to meet its obligation for liquidated damages to the customer for downtime.
In January 1999, the Company entered into an engineering service agreement with one of its vendor's for $728,000, which is payable in cash or stock at the option of the Company. As of December 31,1999, the Company had paid 41,588 shares of Common Stock with a value of $328,000. In November 1999, the Company agreed to pay the remaining future obligations under this agreement in cash.
CONTINGENCIES
In 1999, the Company reached a settlement agreement and mutual release with a former contract manufacturer. Under the settlement the Company will purchase certain component inventory for cash. This settlement is within amounts previously reserved for this purpose in the Company's financial statements.
8. EMPLOYEE BENEFIT PLAN:
The Company maintains an employee savings plan for all of its full-time employees. This plan qualifies under Section 401(k) of the Internal Revenue Code (the "Code"). The plan allows employees to make pre-tax contributions in specified percentages up to the maximum dollar limitations prescribed by the Code. The Company has the option to contribute to the plan, but has not made contributions to date.
9. CAPITAL STOCK:
INITIAL PUBLIC OFFERING
On August 24, 1999, the Company completed its initial public offering of 5,750,000 shares of common stock at a public offering price of $8 per share. The offering resulted in net proceeds to the Company of $42,780,000 after payment of the underwriters commission but before deduction of offering expenses. Simultaneously with the closing of the initial public offering, all of the Company's then outstanding convertible preferred stock was automatically converted into an aggregate of 29,902,283 shares of common stock.
CAPITAL STOCK
The Company's capital stock is divided into two classes: Common Stock and Convertible Preferred Stock. Convertible Preferred Stock consisted of Series A Convertible Preferred Stock, Series B Convertible Preferred Stock, Series C Convertible Preferred Stock and Series D Convertible Preferred Stock.
At December 31, 1999, 7,907,469 shares of Common Stock were reserved, including 7,850,441 shares for issuance under the Company's stock option plans, and 57,028 for warrants to purchase Common Stock.
During 1998, the Company issued 400,000 shares of Common Stock in exchange for a full recourse note in the amount of $800,000. The note bears interest at 5.44% per annum and is due in April 2002.
STOCK OPTION PLANS
1999 Executive Stock Plan
The 1999 Executive Stock Plan was adopted by the board of directors in April 1999 and approved by the shareholders in May 1999. A total of 1,195,000 shares of
common stock has been reserved for issuance under the 1999 Executive Stock Plan. As of December 31, 1999, options to purchase 1,175,000 shares of common stock with a weighted average exercise price of $3.50 had been issued, and 20,000 shares remained available for future option grants. Unless terminated earlier, the 1999 Executive Stock Plan will terminate in April 2009. The 1999 Executive Stock Plan does not impose an annual limitation on the number of shares subject to options that may be issued to any individual employee.
The terms of options issued under the 1999 Executive Stock Plan are generally the same as those that may be issued under the 1996 Stock Option Plan. However, all options granted under the 1999 Executive Stock Plan may be exercised immediately after the grant date, subject to the Company's right to repurchase at cost any shares that remain unvested at the time of the optionee's termination of employment. Options granted under the 1999 Executive Stock Plan generally vest at the rate of 1/4th of the total number of shares subject to the options twelve months after the date of grant and 1/48th of the total number of shares subject to the options each month thereafter.
1997 Directors' Stock Option Plan
The 1997 Directors' Stock Option Plan (the "Directors' Plan") was adopted by the Board of Directors in December 1997 and amended in June 1999. A total of 300,000 shares of common stock has been reserved for issuance under the Directors' Plan, of which options to purchase 125,000 shares of common stock had been granted. Under the Directors' Plan, as amended, each individual who first becomes a non-employee director after the effective date of the amendment will receive an automatic initial grant of an option to purchase 10,000 shares of common stock upon appointment or election. Initial grants to non-employee directors will be vested and exercisable in full as of the date of grant. The Directors' Plan also provides for annual grants of options to purchase 10,000 shares of common stock on the first day of each fiscal year to each non-employee director who has served on the Board of Directors for at least six months, provided that a non-employee director who received a 20,000 share initial grant under the original version of the Directors' Plan will be eligible to receive an annual grant of an option to purchase 5,000 shares of common stock until the first day of the fiscal year following the date on which the initial option has fully vested under the terms of that option, after which date each director will be eligible to receive an annual grant of an option to purchase 10,000 shares of common stock. The annual grants to non-employee directors will be vested and exercisable in full as of the date of grant. The per share exercise price of all stock options granted under the Directors' Plan must be equal to the fair market value of a share of the Company's common stock on the date of grant of the option. Options granted under the Directors' Plan have a term of ten years. However, unvested options will terminate when the optionee ceases to serve as a director and vested options will terminate if they are not exercised within 12 months after the director's death or disability or within 90 days after the director ceases to serve as a director for any other reason.
1995 and 1996 Stock Option Plans
During 1996, the Company established the 1996 Stock Option Plan (the "1996 Plan"). All shares previously available for issuance under the Company's 1995 Stock Option Plan are reserved for issuance under the 1996 Plan. As of December 31, 1999, 8,800,000 shares of Common Stock had been authorized for issuance under the 1995 and 1996 Plan, of which 810,981 shares remained available for future option grants. Under the 1996 Plan, the Company may grant incentive stock options or nonstatutory stock options to employees, officers, directors and consultants at an exercise price of not less than 100% of the fair market value of the Common Stock on the date of grant, except that nonstatutory stock options may be granted at 85% of such fair market value. Options granted generally become exercisable at a rate of one-fourth of the shares subject to the option at the end of the first year and 1/48 of the shares subject to the option at the end of each calendar month thereafter. However, at the discretion of management, the optionee may have the immediate right to exercise the option subject to a restricted stock agreement that gives the Company the right to repurchase unvested shares at the original issuance price in the event of termination of employment. The maximum term of a stock option under the plans is ten years, but if the optionee at the
time of grant has voting power of more than 10% of the Company's outstanding capital stock, the maximum term is five years. The number of shares reserved for issuance under the 1996 stock option plan will be subject to an automatic annual increase on the first day of each year beginning from 2001 through 2005 equal to the least of: 1) 750,000 shares, 2) 3% of our outstanding common stock on the last day of the immediately preceding fiscal year or 3) a number of shares determined by the administrator.
The following table summarizes option activity under all option plans including the 1997 Director Stock Option Plan, the 1999 Executive Stock Option Plan and the 1995 and 1996 Stock Option Plans:
Shares of common stock issued pursuant to options granted under the 1995 and 1996 stock option plans that had not vested at the date of employee termination were repurchased by the Company at cost, as reflected in the table above as "unvested shares repurchased." The repurchased shares were cancelled and returned to the pool of options available for grant.
The following table summarizes information about stock options outstanding at December 31, 1999:
In January 1996, the Company adopted the provisions of SFAS No. 123, which calls for companies to measure employee stock compensation expense based on the fair value method of accounting. As allowed by SFAS No. 123, the Company elected the continued use of APB Opinion No. 25, with pro forma disclosure of net loss determined as if the fair value method had been applied in measuring compensation cost. Had compensation cost for the Company's stock based compensation awards been determined under the fair value method consistent with SFAS No. 123, the Company's net loss would have resulted in the following pro forma amounts:
The fair value of each option grant for the six month period ended June 30, 1999, 1998, and 1997 was estimated on the date of grant using the Black-Scholes option valuation model with the following assumptions:
The fair value of each option grant for the six month period ended December 31, 1999, was estimated on the date of the grant using the Black-Scholes option valuation model with the following assumptions:
To comply with the pro forma reporting requirements of SFAS No. 123 compensation cost is also estimated for the fair value of future employee stock purchase plan issuances. Therefore, the Company has estimated the compensation cost for our first employee stock purchase plan issuance, which will be in January 2000. The fair value of purchase rights granted under the Purchase Plan is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
1999 EMPLOYEE STOCK PURCHASE PLAN
In June 1999, the Board of Directors adopted the 1999 Employee Stock Purchase Plan (the "Purchase Plan"). The Purchase Plan is intended to qualify under Section 423 of the Internal Revenue Code. A total of 1,000,000 shares of common stock have been reserved for issuance under the Purchase Plan. The number of shares reserved for issuance under the Purchase Plan will be subject to an automatic annual increase on the first day of each of 2001 through 2005 equal to the least of: (1) 250,000 shares, (2) 1% of the outstanding common stock on the last day of the immediately preceding fiscal year, or (3) a number of shares determined by the administrator. The price of shares purchased under the plan will be equal to 85% of the fair market value of the Common Stock on the first or last day of the offering period, whichever is lower.
DEFERRED STOCK COMPENSATION
In connection with the grant of stock options to purchase 2,338,550 shares of common stock with a weighted average exercise price of $2.84 per share to employees during 1998 and 1999, the Company recorded deferred compensation of $4,834,000, representing the difference between the estimated fair value of the common stock and the aggregate option exercise price of such options at the date of grant. This amount is presented as a reduction of shareholders' equity and amortized ratably over the vesting period of the applicable options (generally four years). Amortization expense related to deferred stock compensation was immaterial in 1998. Amortization expense related to deferred stock compensation was $1,104,000 in 1999. Compensation expense is decreased in the period of forfeiture for any accrued but unvested compensation arising from the early termination of an option holder's services.
PREFERRED STOCK
Netro is authorized to issue 5,000,000 shares of undesignated preferred stock. The board of directors will have the authority, without any further vote or action by the shareholders:
- to issue the undesignated preferred stock in one or more series.
- to determine the powers, preferences and rights and the qualifications, limitations or restrictions granted to or imposed upon any wholly unissued series of undesignated preferred stock; and
- to fix the number of shares constituting any series and the designation of that series.
The rights of the holders of the common stock are subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future.
CONVERTIBLE PREFERRED STOCK
The Company's outstanding Convertible Preferred Stock consists of:
WARRANTS
In connection with the Company's capital lease financing arrangements, the Company issued warrants to its lessors as follows:
Warrants to purchase 23,750 shares at $7.00 per share will expire in June 2002. Warrants to purchase 5,000 shares at $7.00 per share will expire in September 2002. Warrants to purchase 8,997 shares at $7.78 per share will expire in February 2003. Warrants to purchase 19,281 shares at $7.78 per share will expire in March 2006. The fair value of the warrants was estimated at the date of grant using the Black-Scholes model and the value was determined to be immaterial.
All of the outstanding warrants to purchase Preferred Stock were converted upon completion of the Company's initial public offering into warrants to purchase shares of Common Stock on a one for one basis.
10. INCOME TAXES:
The Company provides for income taxes under the provisions of SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 requires an asset and liability based approach in accounting for income taxes. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences of revenue and expense items for financial statement and income tax purposes. Valuation allowances are provided against assets that are not likely to be realized.
The provision for income taxes differs from the expected tax benefit amount computed by applying the statutory federal income tax rate of 35% to loss before income taxes as follows:
The major components of the net deferred tax asset were as follows (in thousands):
The Company has established a valuation allowance for the total deferred tax asset because, given the Company's limited operating history and accumulated deficit, it is uncertain that the deferred tax asset will be realized.
As of December 31, 1999, the Company had Federal and State net operating loss carryforwards of approximately $87,479,278 and $24,208,734, respectively. The Company's net operating loss carryforwards expire at various dates through 2019. Under current tax law, the net operating loss and tax credit carryforwards available for use in any given year may be limited upon the occurrence of certain events, including significant changes in ownership interest.
11. SEGMENT REPORTING:
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." The Company adopted SFAS No. 131 in fiscal 1998. SFAS No. 131 establishes standards for disclosures about operating segments, products and services, geographic areas and significant customers. The Company is organized and operates as one operating segment: the design, development, manufacturing, marketing and selling of broadband wireless point-to-multipoint access systems.
The Company markets its products in the United States and in other foreign countries through worldwide system integrators, its direct sales force and local resellers. Revenue by country based on sales to those customers before distribution to the end customer was as follows:
The following customers accounted for 10% or more of revenues in the periods indicated:
---------- * Customer below 10% in 1998 or 1999
12. SUBSEQUENT EVENT (UNAUDITED)
2000 Non-Executive Stock Option Plan
The 2000 non-executive stock option plan was adopted by the Board of Directors in February 2000 and, unless terminated earlier by the Board of Directors, will terminate in February 2010. It does not require shareholder approval. The 2000 non-executive stock option plan provides for the grant of nonstatutory stock options to non-executive employees of and consultants to the Company. The purposes of the 2000 non-executive stock option plan are: to attract and retain the best available personnel; to provide additional incentives to our non-executive employees and consultants; and to promote the success of the Company. The Company has reserved 2,000,000 shares for issuance under the 2000 non-executive stock option plan.
The compensation committee currently administers the 2000 non-executive stock option plan. The administrator of the plan determines: the number of shares subject to options, provided that no individual employee may receive option grants for more than 1,000,000 shares; vesting schedules, which are typically 1/4(th) after one year and 1/48(th) per month thereafter; exercise prices, which must be at least 85% of the fair market value of our common stock; the term of the options, which may not exceed ten years; and the transferability of the options, which are generally non-transferable other than by will or the laws of descent or distribution, unless otherwise determined by the administrator.
Options granted under the 2000 non-executive stock option plan are also subject to the following restrictions: options granted under the 2000 non-executive stock option plan are only nonstatutory stock options; and executive officers of the Company may not receive grants under the plan.
In the event of a change of control of the Company, outstanding options will be assumed or substituted by the successor corporation. If the successor corporation does not agree to this assumption or substitution, the options will terminate upon the closing of the transaction. The Company's board of directors may amend, modify or terminate the 2000 non-executive stock option plan if the amendment, modification or termination does not impair vesting rights of the plan participants.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
Not applicable.
PART III
The Company's Proxy Statement for its 2000 Annual Meeting of Shareholders, which when filed pursuant to Regulation 14 A under the Securities Exchange Act of 1934, will be incorporated by reference in this Annual Report on Form 10-K pursuant to General Instruction G(3) of Form 10-K and will provide the information required under Part III (Items 10, 11, 12 and 13).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Netro Corporation
Date: March 30, 1999 By: /s/ Michael T. Everett ------------------------------------- Michael T. Everett Executive Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements The financial statements (including the Notes thereto listed in the Index to Consolidated Financial Statements are included in Item 8 of Part II of this Form 10-K
(2) Financial Statement Schedules The following financial statement schedule is included herein: Schedule II--Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
(3) EXHIBITS
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* Incorporated by reference to our registration statement on Form S-1 (File No. 333-81325) initially filed with the SEC on June 22, 1999.
** Incorporated by reference to our registration statement on Form S-1 (File No. 333-30738) initially filed with the SEC on February 18, 2000.
+ Confidential treatment granted with respect to certain portions of this Exhibit.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
To the Board of Directors and Shareholders of Netro Corporation:
We have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Netro Corporation (a California corporation) and subsidiaries included in this registration statement and have issued our report thereon dated January 24, 2000. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the exhibit index above is the responsibility of the Company's management, is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements, and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP -----------------------------
San Jose, California January 24, 2000
NETRO CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)
EXHIBIT INDEX
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* Incorporated by reference to our registration statement on Form S-1 (File No. 333-81325) initially filed with the SEC on June 22, 1999.
** Incorporated by reference to our registration statement on Form S-1 (File No. 333-30738) initially filed with the SEC on February 18, 2000.
+ Confidential treatment granted with respect to certain portions of this Exhibit.