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SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
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FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-19640
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VERTEL CORPORATION
(Exact name of Registrant as specified in its charter)
California 95-3948704
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
21300 Victory Boulevard, Suite 700, Woodland Hills, California 91367
(Address of principal executive offices) (zip code)
(818) 227-1400
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 Par Value
(Title of Class)
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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 as the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past ninety days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this form 10-K or any
amendment to this Form 10-K. [_]
As of March 20, 2001 there were 28,369,892 shares of the Registrant's
Common Stock outstanding, and the aggregate market value of the stock held on
that date by non-affiliates was approximately $43,422,563, based on the
closing price of $1.56 per share as reported by The Nasdaq Stock Market.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the definitive proxy
statement for the Registrant's Annual Meeting of Shareholders to be held on
May 17, 2001 (the "Annual Meeting"), to be filed with the Commission not later
than 120 days after the end of the fiscal year 2000.
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INTRODUCTORY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Except for the historical information presented, the matters discussed in
this document are forward looking statements (as defined in Section 21E of the
Securities Exchange Act of 1934) and are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. These
statements--including, without limitation, statements regarding future revenue
streams and operating results, sales of our new products, our long-term
customer base, and run-time royalties related to the e*ORB product--should be
evaluated together with the many risks and uncertainties that affect our
business and may cause results to differ materially from those set forth in
the statements. These include timely and successful development of products
and technologies and deployment of our products by our customers; successful
introduction and customer acceptance of new and enhanced products and
technologies in existing and new markets; the possibility that delays or
difficulties will arise in implementing complex products and technologies and
enabling them to work successfully with other complex products and
technologies; the uncertainty regarding the future acceptance of the TMN
standard and TMN-based products; the possible development and introduction of
competitive products and new and alternative technologies; pricing, currency
and exchange risks; governmental and regulatory developments affecting Vertel
Corporation and its customers; loss of key customers; the ability to identify,
conclude, and integrate acquisitions on a timely basis; the ability to retain
and attract key technical and other personnel; the length of our sales cycle;
size and timing of license fees closed in a quarter; the likely continued
significant percentage of quarterly revenues recorded in the last month of a
quarter, making forecasting difficult and subject to wide variations from
actual results; economic uncertainties associated with conducting business
worldwide; our ability to control and manage expenses; and other risks and
uncertainties detailed from time to time in Vertel's periodic and other
reports filed with the U.S. Securities and Exchange Commission (SEC). Readers
are cautioned not to place undue reliance on our forward-looking statements,
which only reflect management's beliefs or opinions as of a specific point in
time. Copies of such filings are available upon request from Vertel's Investor
Relations Department.
PART I
ITEM 1. BUSINESS
General
Vertel Corporation, a California corporation, was founded as Retix in 1985,
and was originally concentrated in the internetworking market. In 1995, we
released our first telecommunications management network (TMN) software
products and services. In 1996, our operating divisions were split into three
business units, each with its own management structure. These three units
focused on internetworking (Sonoma Systems, Inc.), network management software
(Vertel Corporation I), and wireless applications software (Wireless
Solutions). In 1997, we merged Wireless Solutions into Vertel I. Additionally,
in 1997, Sonoma Systems, Inc., restructured to focus solely on broadband
access equipment for the telecommunications marketplace. In January 1998, we
discontinued investing in Sonoma Systems and our voting ownership was
subsequently reduced to 19.9% as Sonoma Systems raised additional capital from
outside investors. In December 1998, we sold our holdings of Series B and
Series C preferred stock in Sonoma Systems to a party related to Newbridge
Networks Corporation. In October 2000, Sonoma Systems was acquired by Nortel
Networks Corporation and we exchanged our remaining investment in Sonoma
Systems (primarily consisting of $1.0 million of non-convertible, non-voting
Series A preferred stock) to common stock of Nortel Networks Corporation as
part of such acquisition. Our results of operations for 1997 and prior years
have been reclassified to present the operating results of Sonoma Systems as a
discontinued operation. In 1998, Vertel Corporation I merged into Retix and we
changed our name to Vertel Corporation. We are now focused on network
management software for the telecommunications industry. Further references to
"we", "our", "Vertel" and "the Company" refer solely to our continuing
operations unless specifically identified otherwise.
In March 1999, we acquired Expersoft Corporation (Expersoft), a developer,
and marketer of standards-based, high performance Common Object Request Broker
Architecture (CORBA) software technology. The
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acquisition price was approximately $3,225,000 and consisted of cash of
$3,000,000 and acquisition costs of $225,000. The acquisition was accounted
for as a purchase. Expersoft Corporation was merged into Vertel Corporation in
December 1999.
We are a telecommunications software, solutions, and services company. We
have two lines of business--license revenue from software products and
services revenue from software solutions and a service bureau. We have three
software product lines; 1) e*ORB--software for developing telecom hardware,
systems and applications based on the CORBA industry standard, 2) Vertel
Mediation Framework (Mediation Framework)--software for integration of network
management applications and telecom hardware, and 3) TMN--software based on an
international standard for developing telecom management systems and
applications. Additionally, as part of our services business, we offer telecom
network management solutions, and WebResolve, a business to business (B2B)
exchange service for telephone companies of all types.
Our offerings are all targeted at the wireless and broadband market
segments within the large telecommunications market.
Our software products provide connectivity for a variety of
telecommunications hardware and software within those segments. Namely:
1. Connectivity for the management of telecommunications equipment,
systems and applications in the form of:
a. system interfaces used for the management and communication
between numerous combinations of equipment and management systems, and
b. an integration framework that connects devices, management
systems and applications that are either standards-based or
proprietary, using either old or new technology, that were not designed
to naturally connect.
2. Infrastructure and communications "glue" for distributed telecom
applications that require a small form factor, fault tolerance and
exceptionally high throughput. This is typical of software running within a
multi-card/processor device, and/or software running across devices in
networks with bandwidth management and quality of service requirements.
We focus our services business on network management. Namely:
1. Solutions and turnkey projects that utilize the two software areas
described above.
2. Network management design and applications development for equipment
manufacturers and telecommunications providers. These include fault,
configuration, performance and security management solutions.
3. A B2B exchange bureau that interconnects information and applications
that are used to assure the operation of telecommunications type services
in the supply chain of incumbent and emerging service providers.
We sell products and services primarily through a direct sales force in the
United States and abroad and, in certain territories, through third party
agents. Our customers include telecommunications service providers and their
customers, network equipment manufacturers, independent software developers
and software platform vendors.
We derive revenue primarily from software binary and source license fees,
royalties and services, including professional services, technical support and
maintenance. License fees consist primarily of licenses of our software
solutions and development platforms. We recognize revenue in accordance with
the American Institute of Certified Public Accountants Statement of Position
("SOP") No. 97-2, "Software Revenue Recognition," as amended by SOP No. 98-4,
"Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue
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Recognition" and SOP No. 98-9, "Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions". Effective January 1, 2000,
we adopted SOP No. 98-9 which requires us to use the residual method for
revenue recognition when arrangements include multiple software products or
other elements, such as maintenance and professional services, and vendor
specific objective evidence exists for the fair value of undelivered elements
and does not exist for one or more of the delivered elements. To date,
substantially all source license fees have been recognized upon delivery to
our customer. Source license agreements generally do not provide for a right
of return.
Pursuant to binary and source code license agreements, licensees may
distribute binary or embedded versions of our software in our licensees'
products. Royalties or runtime revenues become due upon shipment of products
containing the binary or embedded code. Generally, software license royalty
revenue is recognized upon notification by our licensee that products
incorporating our software have been shipped by our licensee or, for customers
for which we have sufficient historical information, upon estimated amounts
which we expect the customer to report. Because of the development times
required for licensees to design and ship products containing binary or
embedded software, we generally do not receive royalties from shipments of
such products for at least three quarters from the date we initially ship
source code.
We separately offer professional services, including system design and
engineering, custom application development, source code portation,
conformance testing and certification and application development. Many of our
customers contract for professional services. These services are typically
based on a detailed statement of work. Professional services revenue varies
according to the size, timing and complexity of the project and is typically
billed based on satisfaction of certain milestones or on a per day fee.
Revenue from professional services is recognized using the percentage of
completion method, or on a time and materials basis. In certain cases,
customers reimburse us for non-recurring engineering efforts. Such
reimbursements are recognized as revenue and associated costs are reflected as
cost of revenues.
Our technical support services consist of product support and maintenance,
training and on-site consulting. Product support and maintenance fees have
constituted the majority of technical support and service revenue. Product
support and maintenance fees are recognized on a straight-line basis over the
term of the contract, which is generally twelve months. Other revenue from
training and on-site consulting is recognized as performed.
While more than 50% of our license revenue in 2000 was derived from
products complying with the TMN standard, the TMN standard has not been widely
adopted in USA or Europe. Therefore, we are expanding our products and
technologies to reduce our dependence on TMN. In addition, our markets are new
and rapidly evolving which heightens these risks and uncertainties. To address
these risks, we must, among other things, successfully implement our marketing
strategy, respond to competitive developments, continue to develop and upgrade
our products and technologies more rapidly than our competitors and
commercialize our products and services incorporating these enhanced
technologies. There can be no assurance that we will succeed in addressing any
or all of these risks. See Item 1: Risk Factors; "The TMN Standard has not
Been Widely Adopted in the U.S. or Europe."
Our principal offices are located at 21300 Victory Boulevard, Suite 700,
Woodland Hills, California 91367 and our telephone number at that location is
(818) 227-1400. Our website address is www.vertel.com.
Highlights of 2000
In 2000, we continued our transformation from a pure TMN company to a
telecommunications software and service solutions company by introducing three
new product lines. We believe that these new products, e*ORB, Mediation
Framework and WebResolve represent exciting opportunities for future revenue
growth in the face of declining revenue from our TMN products.
In the first full year of product availability, our e*ORB software was
adopted by three of the top eight network equipment manufacturers, Lucent,
Motorola and Alcatel, among others. Acceptance of our
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software by companies of this caliber is a key milestone for Vertel and
validates our belief in e*ORB's market potential. e*ORB is being utilized in
the third generation (3G) wireless infrastructure by Lucent and has potential
for other 3G applications.
Mediation Framework was released as a product in the spring of 2000.
Mediation Framework, which utilizes our e*ORB software platform, had a
similarly successful adoption rate in its first year of product introduction,
including contracts with Alcatel and Nokia and the U.S. Department of Defense.
Customer projects utilizing Mediation Framework included enhancement of the
open architecture of a Global Systems Mobile (GSM) wireless network and
integration of network management systems supporting an asynchronous transfer
mode (ATM) network.
Another significant milestone for us in 2000 was the announcement in
September of a new service, WebResolve, which utilizes Mediation Framework.
WebResolve is a service assurance bureau that provides an automated,
electronic interconnection service for service assurance information. The
first offering is a trouble ticket exchange service. Two customers signed
Letters of Intent to start trials with WebResolve within the first six months
of availability.
Industry Background
Economic Trends
For the first time in many years, the telecommunications sector did not
experience rapid growth. Even though the overall U.S. economy experienced a
slowdown in 2000, the impact on the telecommunications industry was more
severe than in most other segments. A number of service providers were forced
to cease operations and many others reported earnings that were far below
analyst's expectations.
We were not immune to these conditions. Several transactions that had been
in progress during the fourth quarter were either cancelled or postponed. The
current business climate is resulting in many of our customers reevaluating
their strategies. This has elongated our already lengthy and unpredictable
sales process.
Industry analysts predict that the softness within the telecommunications
industry will continue through much of 2001. While we expect that some
projects we would typically be awarded might get cancelled, new opportunities
may surface as downsizing at other customer organizations may result in more
outsourcing of projects. In addition, the cost savings and "pay as you go"
aspects of our WebResolve service allow our customers to reduce costs and make
a minimal up-front infrastructure investment for a fully operational trouble
ticketing service bureau. This may have more appeal as companies try to
conserve cash.
We believe that the worldwide telecommunications industry continues to
undergo significant transformation. The Internet and corporate intranets have
created a new networked economy with online versions of every conceivable
product and service. New market entrants as well as traditional companies are
moving their business online through e-commerce initiatives. Innovative
business models are capitalizing on the unique economics of the Internet. We
expect that the telecom industry will continue to grow as companies in this
industry attempt to meet the increased demand for network bandwidth,
reliability, data integrity and security.
Technology trends
Until late in the 1990's, most telecommunications service providers managed
their voice networks exclusively with proprietary systems developed and
supported by internal development organizations. By design, these proprietary
management systems did not interconnect with one another. Even those third
party products provided by equipment manufacturers and application vendors
keep the interfaces that bind management applications together among
themselves. This was a way to keep the network within their control by owning
the management systems and their external communications pipes (called
management interfaces). While these proprietary systems are tightly integrated
and can provide operating efficiencies within a single network, they are
expensive to develop, operate and maintain, and often require a large,
specialized and expensive technical organization.
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Because these systems are not based on a common standard, management among
telecommunications service providers and the provisioning of end-to-end
services is more difficult, and the equipment choices of service providers are
limited to vendors who conform to the provider's standard. Furthermore,
because these systems are a mixture of proprietary and standards-based
technologies and are based on older software technologies, they generally do
not scale easily, usually require substantial development effort for new
functionality and services, and are often incompatible with the additional
software and hardware service providers require to upgrade networks. Service
providers can no longer afford to sustain these systems in this hyper-
competitive environment and have been looking at commercial off-the-shelf
software to manage their networks.
Service providers have augmented their proprietary systems by incorporating
the Simple Network Management Protocol (SNMP) to manage their data networks.
SNMP has been widely accepted as a standard in private enterprise data
networks. SNMP-based systems interoperate, permitting the addition of
incremental functionality, hardware and software without substantial
additional development effort and are generally adequate to manage equipment
in enterprise data networks. A major drawback of SNMP-based systems, however,
is in bandwidth-constrained public networks, where their architecture requires
continuous communication among equipment and management platforms; this
communication can consume substantial bandwidth and limit network scalability.
In addition, SNMP provides for limited data integrity, does not identify a
security protocol and does not effectively manage the flow of data on
networks. While SNMP has permitted service providers to begin their transition
away from proprietary systems, it has also created the need for a new family
of systems that are highly scalable, cost-effective and offer high bandwidth.
In response to the shortcomings of available network management solutions,
the International Telecommunications Union (ITU), an organization of
telecommunications companies and governments, identified the need for a
standard that permitted interoperability among network management solutions.
The ITU recognized the need for this standard to provide a framework within
which network management systems could more cost-effectively be designed,
developed and deployed and at the same time provide functionality beyond that
enabled by proprietary and SNMP-based systems. The standard established by the
ITU in 1994 is known as the telecommunication management network or TMN
standard. This standard attacks the problem in two ways, the first by way of
an architecture of an out of band network for managing telecom networks and
the second is in how these networks should be managed by specifying protocols
and management interfaces.
. For the architectural aspect, the specifications comprising the TMN
standard divide the telecommunications management infrastructure into a
framework of five logical layers: Network Element (NEL) Element
Management (EML), Network Management (NML), Service Management (SML) and
Business Management (BML). The TMN standard includes a set of interface
specifications for communicating within and among layers to enable
interoperability between and among network operating systems, network
management systems and network equipment.
. For the protocols and management interfaces, TMN prescribed Common
Management Information Protocol (CMIP) as its first management protocol
and specified specific management interfaces for different types of
equipment, networks and telecom services.
So, TMN is both a management network architecture and a management network
implementation.
The TMN protocol and interface standards are used predominantly in Asia and
the Pacific Rim and globally in a number of network types such as GSM
networks, Synchronous Optical networks (SONET) and Synchronous Digital
Hierarchy (SDH) networks. The adoption of TMN protocols has slowed
significantly as service providers and network equipment manufacturers begin
to look to general computing technologies, in particular CORBA, for the next
phase of integrated management solutions.
As architecture for telecom management, TMN is widely used today. While
there is a blending of the management layers occurring, the concepts are still
at the heart of telecommunications devices, management systems, and
applications. Additionally, while the majority of the industry still uses
proprietary in-house
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developed solutions, the telecommunications market is still predominantly
using third party products for the development of management systems, third
party management applications, and third party integration platforms.
Technologies such as CORBA, Java, SNMP, Extensible Markup Language (XML), and
other new and proprietary technologies are all being developed and deployed in
equipment and applications.
CORBA middleware technology is supported by a wider market base than is the
telecom specific TMN technology. The telecom industry hopes to reduce
implementation cost and increase the pace of technology innovation by using
CORBA. CORBA benefits from its use in a wide number of information-based
industries, greater availability of knowledgeable software engineers, and ease
of interoperability. Today, many telecom Operations Support Systems (OSS)
companies have added CORBA interfaces to their OSS products and major network
equipment suppliers have started building CORBA interfaces into their network
elements.
Our Solutions
Our software products, solutions and services offerings allow
telecommunications equipment manufacturers, service providers, and their
customers to:
Improve Time to Market. Our products and services enable our customers to
produce proprietary and standards compliant network management solutions for
their products faster, with fewer developers. Our products provide off-the-
shelf software based on international standards that our customers can embed
into their products and OSS systems. Instead of developing the protocols,
connectivity software, and management functions from scratch, our customers
can integrate our off-the-shelf products to their systems thereby potentially
reducing the overall development effort dramatically and improving the quality
of the end product. We also offer turnkey services that solve critical service
assurance functions and require minimal, if any, development on the part of
our customers. Our WebResolve service bureau provides a faster way to acquire
a B2B service for telecom providers and their trading partners.
Reduce Costs. Our software solutions enable telecommunications service
providers to reduce costs by efficiently managing diverse networks and network
equipment with a single, integrated management system. Unlike many proprietary
systems, our solutions adhere to an object-oriented architecture and do not
require large, expensive technical organizations for additional development
and maintenance. Because our solutions use standard interfaces and the latest
state of the art technology, they allow multiple systems to connect to each
other across applications, networks, vendors and systems. This
interoperability allows service providers to purchase the most cost-effective
equipment from a broad range of vendors. In addition, by utilizing our
professional services, customers can reduce the cost of in-house development.
Finally, our WebResolve service enables new entrants to exchange information
with all of their trading partners for a fraction of the cost of developing
one-to-one gateways with each partner in the supply chain.
Derive Incremental Revenue. Our network management solutions also enable
telecommunications service providers to bring new functionality and services
to market more rapidly by providing an integrated, standards-based suite of
tools that facilitate the rapid development and deployment of new applications
across heterogeneous networks. For example, our products have been used by
telecommunications switch equipment manufacturers, operation support system
vendors and telecommunications service providers to provide data collection
information to support billing, trouble ticketing and inter-service provider
exchange of management information.
Implement Complete Solutions. Successful implementation requires seamless
vertical integration of network management and back office systems that are
often based on disparate protocols. We believe that we provide the only
commercially available suite of products and services that offers complete
end-to-end solutions for vertical integration.
Preserve Existing Investments. Our solutions enable telecommunications
service providers to continue to use and integrate their existing legacy
systems with newer systems based on more modern architectures. Our
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technology and solutions manage CORBA, TL1 (Bellcore's Transaction Language
1), SNMP and other legacy equipment and systems within our solution framework.
Enhance Communications Across Service Providers and with Customers. Our
products enable the deployment of systems that allow telecommunications
service providers and network operators to manage new and existing services
and equipment across multiple service provider domains. The products also
enable enterprise network operators to deploy systems that manage services of
multiple service providers. Our WebResolve service will also provide
transaction-based turnkey solutions that enable communications between and
among partners in a supply chain with no development required on the part of
the customer.
Strategy
Our goal is to position Vertel as a leading provider of (1) critical object
oriented middleware solutions and software to telecommunications service
providers, equipment manufacturers, platform vendors and independent software
developers; and (2) a telecommunications B2B exchange bureau of critical
service assurance information to service providers. We are focused on next
generation communication services and software solutions that support multiple
management technologies. These solutions are targeted to provide public and
Internet Protocol (IP) network and back office operation support systems, the
key components required for end-to-end network and service management with
carrier-grade quality of service. Key elements of our strategy include:
Superior Products and Services. We continue to develop and look for
innovative and superior technology. Technological leadership is a key strategy
and differentiator for the company. We believe our e*ORB product line offers
the best embeddable telecom-based, commercially available CORBA products in
the market today.
Market Penetration. The development and utilization of leading technology
requires focus on the adoption of the technology in the marketplace. Our
strategy during the first year of introduction of our new technology and the
several years following that is to seed the market by focusing on market share
as a primary objective.
Business Diversification for Leading Edge Technologically Advanced
Products. Innovative and technologically advanced products and services
require market adoption and deployment. As such, we are not investing in just
one such technology. We are also identifying and developing areas of
utilization where the technology provides a competitive differentiation for
our services and solutions.
Extend Vertical Solutions. Our strategy is to provide complete suites of
software and services that enable businesses to implement telecommunications
management solutions efficiently. We intend to provide management applications
that leverage our experience in TMN and CORBA. To date we have demonstrated
that e*ORB is dynamic in its own right and at the core of other solutions such
as our own Mediation Framework. Additionally, Mediation Framework has
applications as a stand-alone solution and is at the core of solutions such as
our WebResolve service product.
Leverage Existing Relationships with Equipment Manufacturers. Historically,
we have derived a significant portion of our revenues from the sale of
software to be embedded by telecommunications equipment manufacturers. We
believe that the availability of our products in telecommunications equipment
will facilitate the adoption of our solutions in the marketplace by service
providers. The company is selling its new product and service offerings to the
same customers and divisions that acquired our legacy products.
Expand Global Sales and Distribution Capability. We currently sell our
products primarily through a direct sales force in the United States and
internationally. We plan to leverage our direct sales efforts by pursuing
sales prospects generated by partners and by selling through select systems
integrators and other indirect sales channels. In addition, we plan to
continue to license our software to service providers, network equipment
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manufacturers and independent software developers. Our customers have the
right to distribute products, services and applications developed using our
software in exchange for royalty payments. We believe that our distribution
strategy will help to establish our solutions as the premier object oriented
middleware products for network management.
Promote the Deployment of CORBA. We believe that the broad adoption and
deployment of CORBA will be key to our success. Correspondingly, we commit
substantial resources to the promotion of the CORBA standard for
telecommunications network management. We are working with leading industry
experts, forums and working groups to define, refine and develop
specifications for CORBA solutions. We use trade shows, seminars and industry
conferences to advance our market strategy.
Develop Strategic Relationships. We believe that we can expand our
visibility, improve our product offerings and broaden our potential market
through the development of relationships with other companies within the
telecommunications network market. In 1999, we added Atlantech Technologies, a
leading supplier of element management framework software, as a strategic
partner for supplying turnkey element management solutions through our
professional service organization. In 2000, we announced partnerships with
Eternal Systems for Fault Tolerance capabilities and Tri-Pacific for real time
design tools. Both of these relationships are consistent with our strategy to
seek out the best technological partners in the marketplace to augment and add
more value into our product offerings.
Expand Professional Services Unit (PSU) Customer Base. We believe that
there is a large market for customized network management solutions. Our PSU
provides customized software design and engineering, including designing,
developing, deploying and maintaining turnkey telecommunications management
solutions. By utilizing or enhancing our existing products, our PSU is capable
of customizing and delivering carrier-grade quality solutions that enable
businesses to efficiently implement network management solutions quickly and
cost-effectively.
Products
We have two lines of business--license revenue from software products and
services revenue from software solutions and a service bureau. We have three
software product lines; 1) e*ORB--software for developing telecom hardware,
systems and applications based on the CORBA industry standard, 2) Mediation
Framework--software for integration of network management applications and
telecom hardware, and 3) TMN--software based on an international standard for
developing telecom management systems and applications. Additionally, we offer
network management solutions, and WebResolve, a B2B exchange service for
telephone companies of all types.
We generally license our binary and source code to customers who may either
sublicense the code in binary form or integrate it into additional products.
Revenue is derived from license fees received upon the shipment of binary and
source code and from royalties relating to the distribution by the customer of
binary or integrated versions of the software. On occasion, royalties may be
prepaid at the request of the customer.
e*ORB, Mediation Framework and WebResolve were our three primary new
product/service offerings in 2000. We made significant strides toward industry
acceptance of e*ORB, our CORBA-based software solution that was launched in
late 1999, and our Mediation Framework solution which became commercially
available in the second quarter of 2000.
WebResolve was announced in September 2000. It is our first transaction-
based service that provides an immediate and continuous revenue stream based
on usage. WebResolve is a business-to-business exchange service for service
assurance information. WebResolve has been well-received by potential
customers since its introduction and we have already received Letters of
Intent with two customers who are entering into trials of the service.
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New Product Offerings:
WebResolve
WebResolve provides an automated, electronic interconnection service for
service assurance information. Service assurance functions report information
and carry out actions that ensure the vital ongoing operation of a
telecommunications network. Functions include management of network faults,
management of service levels and their agreements, network throughput and
problem reports that are referred to as trouble tickets.
With an increasing number of trading partners and players providing
businesses and consumers with telecommunications services, the B2B exchange of
service assurance information is becoming ever more important and more
difficult to execute. WebResolve allows service providers to have a single
interface to our hosted application that can interconnect and pass information
to all of the service provider's suppliers. Trouble ticket exchange is the
first service WebResolve is offering.
WebResolve is a telecommunications service bureau offering 24 hours a day,
seven days a week availability with carrier-grade reliability. It is an
application built on our Mediation Framework software solution. Service
bureaus for the telecommunications industry have been in existence for many
years, but WebResolve is the first to offer service assurance solutions that
require a single interface from the service provider's site with distribution
capabilities to many trading partners. This solution is a hub and spoke
concept versus the more traditional point-to-point solution of developing
separate software gateways for each trading partner. This provides a simple
solution utilizing one gateway instead of multiple gateways and can
dramatically reduce costs for telecommunications providers.
WebResolve allows a service provider to "pay as you go" instead of making a
substantial up-front investment to develop point-to-point interconnections
with each of their trading partners. The target markets for this product are
interexchange carriers and their access providers; local service providers;
and data center providers and their content providers on the Internet side.
e*ORB
e*ORB provides a "carrier-grade" embeddable CORBA ORB (both C++ and Java)
targeted at the telecom OSS and network management infrastructure market.
Unlike other CORBA products on the market, it focuses on delivering high
performance and high scalability in a small form factor and supports a set of
features applicable to our targeted telecom customers.
In addition to Unix servers, Windows NT servers and other standard OSS and
management platforms, e*ORB has applications within mobile devices such as
hand-held devices and wireless phones, as well as on high-end network elements
such as optical switches. This is because e*ORB is small enough to fit within
the memory and CPU constraints of mobile devices, and fast enough to meet the
performance requirements of high-end switching products.
e*ORB conforms to the Object Management Group's (OMG's) "minimum CORBA"
specification and supports product enhancements that make it more adaptable to
the telecom market. The e*ORB software architecture supports the TCP/IP
transport protocol as well as ATM and broadcast wireless protocols.
Our focus for e*ORB falls into two areas:
1. Connectivity for the management of telecommunications equipment,
systems and applications in the form of system interfaces used for the
management and communication between numerous combinations of equipment and
management systems, and
2. Infrastructure and communications "glue" for distributed telecom
applications that require a small form factor, fault tolerance and
exceptionally high throughput which is typical of software running within a
multi-card/processor device, and/or software running across devices in
networks with bandwidth management and quality of service requirements.
9
e*ORB technology is not only being used by our customers but it is also
used in our own application level products. e*ORB is used in our Mediation
Framework to provide internal software distribution across our mediation
software components.
During 2000, Linux and PalmOS versions of the software were introduced as
was a Java Edition. The Java Edition can interoperate with the C++ Edition of
e*ORB. The core technology was expanded for CORBA service relevant to the
telecommunications industry and fault tolerance capabilities and design tools
were added through our relationships with partners.
Mediation Framework
Our Mediation Framework software solution is used to simplify and
accelerate the integration of a network infrastructure within a telecom OSS
infrastructure. Our professional services unit uses Mediation Framework as a
building block to integrate network managers, element managers and/or devices
with other OSS systems without requiring changes on the part of the devices,
managers or the OSS.
As noted in the Industry Background section, telecom operators are
increasingly faced with integrating and combining multiple networks and their
associated components. In many cases, these components, or network elements,
were not designed to operate, or be managed, together. A variety of
incompatible protocols connect the network elements to their element
management systems, and their element management systems to their network
management systems. These disparate protocols must coexist and can be made to
do so through the use of a mediation solution.
There are too many combinations of transport and communications protocols
and target OSS systems to feasibly provide interfaces for each operator's
unique needs. Equipment vendors for network equipment and OSS systems have the
choice of re-coding the interface for each customer, or utilizing a mediation
framework that can provide the requisite "protocol-bridge" from their protocol
of choice to the one demanded by their customers.
Mediation Framework is being employed in these situations. In simple terms,
the framework is composed of a series of modules. These modules convert the
protocol used by the equipment manufacturer and the service providers to a
normalized format. By using a normalized format, any protocol (standard or
proprietary) can be translated to another. As the number of formats increase,
the turn-around time for mediation solutions will naturally decrease, reducing
service providers' network integration time, and equipment vendors' time to
market.
Mediation solutions built with our Mediation Framework can be quickly
updated to adapt to changes in the protocol standards, to add additional
network element types, and to add other protocols to the solution. This "life-
cycle-management" of network mediation solutions helps our customers to better
maintain their networks and improve the quality of service to their end users.
Legacy TMN Products:
Our legacy TMN business is in its declining phase but is still utilized by
a significant number of incumbent equipment manufacturers that provide GSM
wireless transmission and SONET/SDH optical networking. The product line is
very robust, even though it is no longer being upgraded. See "Risk Factors--
The TMN Standard has not Been Widely Accepted in the U.S. or Europe."
TMN Telecore Products
TMN Telecore Development Environment products provide tools and components
to automate the development of CMIP Management Applications for telecom
service management, telecom network management and equipment management
applications. TMN Development Environment product interfaces are object-
oriented and consistent with the TMF-defined TMN/C++ API. They are available
on Solaris, HP-UX,
10
Windows NT and Windows 2000 and AIX. The products include both client (known
as managers) and server (known as agents) design, development and testing
tools.
The TMN Telecore product line offers an agent development environment, a
manager development environment, TMN Simulators for both the agent and manager
development environments and a TMN OpenStore application.
TMN Agent Development Environment
The TMN Agent Development Environment (ADE) enables developers to easily
build customizable, dynamically configurable TMN-conformant agents. The
resulting, fully functional TMN Agent provides the value-added, agent role
process for network elements, Q-adapters, and mediation devices at the NEL,
EML, NML, and SML layers of the TMN model. ADE automates most of the tasks
associated with building an agent application.
TMN Manager Development Environment
The Manager Development Environment (MDE) enables developers to easily
build customizable, dynamically configurable, and scalable TMN-conformant
manager applications. The MDE automates most of the tasks associated with
building a manager application.
TMN Simulators
The TMN Agent Simulator and TMN Manager Simulator may be used with the ADE
or MDE products or with any TMN-conformant agent or manager. The Simulators
use standard TCL scripts to emulate the behavior of a TMN-conformant agent or
manager. Simulators have graphical user interfaces, are dynamically
configurable at run-time, and provide script-generation tools to produce test
cases for a particular information model (MIB).
TMN OpenStore
TMN OpenStore offers an application interface for the storage of management
information organized in a containment tree. It stores both the management
information and the containment tree structure that organizes it.
Other TMN Products
Other TMN Products include TMN Embedded Telecommunications Solutions (ETS)
products that include networking stacks and tools to create embedded agents
for telecom hardware, TMN Unix/NT Telecommunications Solutions (UTS) products
which are communications networking stacks for clients and servers, UTS file
transfer, access and management (FTAM) products for the reliable transfer of
billing information, files and network data and UTS-NetLink products.
ATN Router Software Products
In June 1998, we granted a semi-exclusive license for our Aeronautical
Telecommunications Network (ATN) Router Software product line to Airtel ATN
plc, an independent supplier of communications software products and services
for the aeronautical industry. ATN router products are specifically designed
for routing end systems and intermediate systems in air-to-ground and ground
communication. The products provide complete ATN-compliant design,
implementation, test and deployment capabilities based on ATN standards. We
retain intellectual property rights in these products.
11
Customer Service and Support:
Professional Services
We believe that the adoption of our products will depend, in part, upon the
ability of service providers, network operators, network hardware and software
vendors, and systems integrators to implement TMN and CORBA solutions quickly
and cost-effectively. Our professional services unit works with systems
integrators, application developers and in-house customer engineers to enable
customers to deploy a complete solution. Professional services include system
analysis and design, source code portation, conformance testing and
certification and custom application development. Many of our software
customers contract for professional services. We generally provide
professional services based on a detailed statement of work.
We focus our services business on network management. Namely:
1. Solutions and turnkey projects that utilize the two connectivity
software product families, e*ORB and Mediation Framework, described above.
2. Network management design and applications development for equipment
manufacturers and telecommunications providers. These include fault,
configuration, performance and security management solutions.
3. A B2B exchange bureau that interconnects information and applications
that are used to assure the operation of telecommunications type services
in the supply chain of incumbent and emerging service providers.
Turnkey solutions for e*ORB and Mediation Framework provide our customers
with turnkey projects for e*ORB based applications and for mediators that
integrate management systems. The e*ORB based projects can range from
equipment infrastructure development, to network management interfaces, to
distributed application development. Mediation based projects are typically
mediators for equipment, equipment management systems, network management
systems or service management systems. Other possible projects include
customization in the form of platforms or proprietary interfaces.
The network management practice includes consulting for architecture and
design of networks, management systems, technological assessment and
usability/productivity analysis of customer's current systems, and the actual
development and integration of the network management applications. These
projects and services are used by both equipment manufacturers and
telecommunications service providers. We have focused on and have expertise in
the development of these systems for the fiber optic and wireless market
segments.
The network management practice also includes the design, development and
deployment of embedded network management agents and communications stacks.
These solutions are used by equipment manufacturers as part of their network
management strategies and implementations. We are targeting not only the top
ten equipment manufacturers, but have also started going after smaller start-
up companies to provide them with a turnkey network management solution for
their equipment as they typically do not have the expertise on staff.
As part of our network management application soliution, the development of
network management applications are carried out on the AccessVision Network
Management Framework. In 1999, we partnered with Scotland-based Atlantech
Technologies to offer a flexible framework to deliver management solutions for
the network element layer (NEL) and the network management layer (NML) of the
TMN architecture. Atlantech Technologies, purchased by Cisco Systems in 2000,
continues to support the AccessVision product family.
The AccessVision product family provides an open, standards-based set of
management building blocks that allow development, configuration and
deployment of specific management solutions for use within these domains. Our
professional services unit uses the AccessVision building blocks to construct
customized network managers and element managers for our customers.
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As part of the WebResolve service bureau, there is an initiation fee that
covers the secure integration of the customers service assurance system into
the WebResolve service.
Technical Support
In order to assist customers in fully designing and operating integrated
solutions, we believe that it is important to offer a broad range of technical
support services for our customers. Technical support consists of the
following services:
Training. We provide training to our customers on a per-product basis.
Training services range from detailed technical tutorials on technology
products to product configuration, management and administration training on
end user products.
Product Support and Maintenance. We can provide global coverage 24 hours
per day, seven days per week with direct access to technicians and product
support engineers on demand. In response to a high demand for expert-level,
on-site product support, we offer an on-demand service staffed by highly
competent product experts. Personnel primarily located in our California,
Korea and Germany facilities provide product support. Customers subscribing
for product support also receive software updates and maintenance releases. We
typically issue software updates every six to twelve months.
On-site Consulting. Our engineers travel to customer sites for an initially
specified period and provide expert level consultation including additional
system design, training, customization and development support.
We typically warrant our products for 30 days. To date, we have not
encountered any significant product warranty problems. See "Risk Factors--We
Need to Develop New Products to be Successful" and "Our Software is Complex
and Therefore is Prone to Bugs."
Competition
We compete on the basis of product features and characteristics, including
quality, performance, ease of use, functionality, interoperability,
reliability, scalability and extensibility and speed of implementation, price,
implementation and development services, technical support, and training and
maintenance.
Competition in this market is intense and is characterized by rapidly
changing technologies, evolving industry standards, in-house or proprietary
solutions, frequent new product introductions and rapid changes in customer
requirements. Moreover, it is expected that this market will continue to
experience several new entrants in the foreseeable future. To maintain and
improve our competitive position, we believe that we must continue to develop
and introduce or acquire, in a timely and cost-effective manner, new services,
products and product features that keep pace with competitors' offerings,
technological developments and changing industry standards.
Our current and prospective competitors offer a variety of solutions to
address the telecommunications network management systems and management
applications market. Each of our product lines has competitors as follows:
WebResolve: Competitors are other providers of hosted exchange services
such as Quintessent, Nightfire, as well as companies providing software
solutions such as DSET and many of the large consulting firms such as
Accenture, formerly Andersen Consulting, and Telcordia.
e*ORB: Competitors are other embeddable ORB vendors, such as OIS and
freeware such as TAO. We also face in-house developed technologies and in-
house developed ORBs.
Mediation Framework: Competitors are primarily internal software
development organizations and large consulting firms. To a limited extent,
there can be some competition from smaller companies include ONE and Trigon
Technology Group.
13
Network Management Professional Services Projects: Competitors are
primarily internal software development organizations and to a lesser
extent smaller companies such as ONE, TCSI and Trigon Technology Group.
TMN Tools and Services: Competitors in this area have been greatly
reduced. UH Communications could be considered a competitor.
Many of our current and potential customers continuously evaluate whether
to design, develop and support their own telecommunications network management
systems and applications or purchase them from outside vendors. These
customers have traditionally designed and developed their own software
solutions internally for their particular needs and may therefore be reluctant
to purchase products offered by independent vendors. We believe that a
significant percentage of telecommunications network management solutions are
still developed in-house. In addition, despite its limitations for deployment
in public or very large enterprise networks, SNMP continues to serve as the de
facto standard for managing enterprise data networks. As a result, we believe
that we must continuously educate existing and prospective customers as to the
advantages of open management technology versus internal, proprietary
telecommunication network management systems and management applications.
The global acceptance of our technologies could lead to increased
competition as third parties develop telecommunications network management
systems and management applications competitive with those offered by us. Any
of these competitors may be able to respond more quickly than we do, with
different technologies and changes in customer requirements and to devote
greater resources to the development, promotion and sale of their products.
There can be no assurance that our current or potential competitors will not
develop products comparable or superior to those developed by us or adapt more
quickly than we do to new technologies, evolving industry standards, new
product introduction or changing customer requirements. See "Risk Factors--Our
Markets are Very Competitive and Many of Our Competitors are Larger than We
Are."
Proprietary Technology
We primarily rely on a combination of copyright, trade secret and trademark
laws and nondisclosure and other contractual restrictions on copying and
distribution to protect our proprietary technology. In addition, as part of
our confidentiality procedures, we generally enter into nondisclosure
agreements with our employees, consultants, distributors and corporate
partners and limit access to and distribution of our software, documentation
and other proprietary information. It may be possible for a third party to
copy or otherwise obtain and use our products or technology without
authorization, or to develop similar technology. Particularly in light of the
fact that we license portions of our source code to certain customers and
distributors, there can be no assurance that the foregoing measures are
adequate to protect our proprietary technology. In addition, our products are
licensed in other countries and the laws of such countries may treat the
protection of proprietary rights differently from, and may not protect our
proprietary rights to the same extent as the law in the United States. See
"Risk Factors--Our Current Efforts to Protect Our Intellectual Property May Be
Insufficient."
Sales, Marketing and Customers
We market and sell our products and services through an internal sales and
marketing organization that consisted of 31 people as of December 31, 2000.
Our marketing efforts are focused on increasing awareness of Vertel, seeding
the market with our newer technologies and positioning the company as the
leading provider of CORBA software solutions. Our marketing programs have
three primary goals: market education and awareness, sales effectiveness and
product management. Our education and awareness activities include seminars,
speaking engagements, sponsorship of conferences, articles in industry
publications, participation in industry forums and working groups, and
inclusion in market studies by leading industry analysts. In addition, to
disseminate our marketing message and improve sales effectiveness, we use
direct mail, advertising, presentations, demos, press releases, press/analyst
tours, marketing literature, public relations, trade shows and a website. Our
product management staff works with customers and industry experts to ensure
that our products will satisfy market requirements.
14
The sales cycle for our products is lengthy and often requires us to
provide a significant level of education to prospective customers regarding
the use and benefits of our products. As a result, we sell our products
primarily through a direct sales organization of highly technical sales
people. See "Risk Factors--Lengthy Sales Cycles Make Predictions of Revenues
Difficult." Of the 31 people engaged in sales and marketing, 23 people
belonged to our direct sales organization as of December 31, 2000.
In 2000, we enabled a free evaluation download of our e*ORB software from
our website with an active evaluation key that expires after 30 days. This
allows prospective customers to evaluate our software within their
applications before making a buying decision. In addition, we sell software
through distributors and agents in certain other countries, and enable our
customers through source code licenses to distribute our products in exchange
for royalty payments.
We typically transact business in U.S. currency worldwide. International
sales totaled approximately $5,005,000 in 2000. See "Risk Factors--Our
International Sales are Subject to Factors Outside of Our Control" and "Our
International Sales are Subject to Currency Fluctuations."
Historically, we have not had a license backlog because we can fill
substantially all orders upon receipt of a firm purchase order.
Research and Product Development
We have made substantial investments in the development of our products. We
believe that our future success depends in large part on our ability to
capitalize on our core technologies by developing applications that utilize
them, enhance existing products, develop new products, maintain technological
competitiveness and meet a wide range of customer needs. Accordingly, we
intend to continue to make substantial investments in research and development
for the foreseeable future. Overall product development efforts include:
CORBA products. Our recently introduced e*ORB products represent the core
of our product evolution. In 1999, the majority of our R&D investment in CORBA
went into the commercialization of the e*ORB technology. Our 2000 development
included the addition of value-added CORBA services to enhance our CORBA
product portfolio as well as a Java edition and versions for Linux and the
Palm Operating System. In addition, the technology at the core of the e*ORB
product was used for management applications products. Continued future
development of applications based on this core technology is planned.
Mediation products. One such application which utilizes e*ORB at it's core
is our Mediation Framework software solution. It was made commercially
available in the spring of 2000. This software solution will also be enhanced
as we add software adapters that mediate new protocols.
Service Assurance exchange products. We will continue making investments in
our exchange products, adding additional service assurance functionality.
Customized Vertical Integration and Optimization. We believe that we are
unique in providing a single-vendor, object-oriented, integrated
implementation of OSI stacks, TMN agent and manager products, Q-adaption and
MIB translation. Our product software modules can be tightly integrated and
optimized for performance and efficient memory usage.
Portability. Our products can be ported in network elements, on UNIX and NT
platforms, in popular real-time operating systems (RTOS), in a wide range of
client-server, fault-tolerant architectures and environments. These products
provide encapsulations of the underlying communication network portation
details, flexible OSI and transport stack interfaces and communication
networks. Portability allows us to implement changes and enhancements to the
core technology once and to host those changes to many environments
simultaneously. Currently, we support five RTOSs, Solaris, HP-UX and Windows
NT.
15
Standards Conformance. Our implementations have successfully undergone many
conformance tests in a variety of contexts and environments. Conformance
testing guarantees that the standards have been implemented properly and
enables interoperability to occur.
Our research and development organization is located principally in San
Diego, California and Poznan, Poland. As of December 31, 2000, our research and
development group consisted of 44 people.
16
RISK FACTORS
Our Success is Dependent on Widespread, Timely Adoption of CORBA
Products. A significant portion of our software and services are CORBA-based.
If a different protocol becomes the standard in the telecommunications
industry, service providers are unlikely to purchase our CORBA products.
Telecommunications service providers have historically depended on proprietary
systems, which do not rely on any standards. While we invest substantial
effort in encouraging service providers to adopt the CORBA products, we do not
have direct control over this process and we cannot provide any assurance that
CORBA will be adopted. Telecommunications service providers could adopt a
competing standard or no standard at all. Similarly, they could adopt CORBA,
but not do so within the timeframe that we expect them to. If
telecommunications service providers adopt a standard other than CORBA, adopt
CORBA but not in a timely way or fail to adopt any standard at all, our
business, operating results, financial condition and strategic position would
be materially adversely affected.
The TMN Standard has not Been Widely Adopted in the U.S. or
Europe. Although popular in Asia, the TMN standard has not been widely adopted
in the U.S. or Europe. In recent years, our revenues have depended primarily
on products based on the TMN standard. In fiscal 2000, revenues from TMN
products declined significantly more than we had anticipated. We believe that
sales of TMN products will continue to decrease, although we are unable to
predict the rate of decrease.
We Need to Develop New Products to be Successful. The markets for our
products are characterized by rapidly changing technology and frequent new
product introductions. Therefore we believe that our future success will
depend on our ability to enhance our existing products and to develop and
introduce in a timely fashion new products that achieve market acceptance. We
have, from time to time, experienced delays in developing new products and
enhancements, and while these have not had a material adverse effect on our
business, if in the future, we are unable to develop and introduce new
products or product enhancements in a timely manner, this could have a
material adverse effect on our business, financial condition and results of
operations. In addition, if the products we develop are not widely accepted by
customers, we are not able to identify, develop, manufacture, market or
support new products successfully or we are unable to respond effectively to
technological changes, revisions in industry standards or product
announcements by competitors, our business, operating results and financial
condition would be adversely affected.
We Expect Our Revenue to be Primarily from New Products. We expect that new
products and related services will account for a substantial portion of our
revenues in the foreseeable future. Since we expect to rely less on existing
products for revenue, factors adversely affecting the pricing of or demand for
our newer Mediation and CORBA related software solutions and our WebResolve
services, such as competition for new products or lack of customer acceptance,
could have a disproportionately adverse effect on our business, operating
results and financial condition.
Part of our Success is Dependent Upon the Adoption of Service Bureaus. Part
of our success is dependent upon the adoption of service bureaus and
Application Service Providers (ASP) as a way for telecom service providers to
exchange sensitive service assurance information, instead of developing
customized point-to-point gateways. Demand for our WebResolve services may not
materialize if these service bureaus are not adopted as a way to conduct this
part of their business.
We Face Competition from Proprietary Solutions and Freeware. In a
tightening economy, potential customers may be reluctant to purchase our
products and services, instead choosing to rely on internally developed,
proprietary solutions or freeware. Even though these solutions are not
supported and have higher long-term development costs, they could pose a
threat to us, particularly our Mediation Framework and CORBA-based product
lines.
Future Revenues are Dependent Upon Successful Customer Development and
Deployment. Our business model for our e*ORB, Mediation Framework and TMN
products is dependent upon the successful development
17
and deployment by our customers of their products which incorporate our
technology. Some customers may get access to our software and then decide not
to use it for their product development. Even if our software is utilized in
our customers' product development, the end products may not be successful
when brought to market. Anticipated future royalty revenues may not
materialize if successful deployment does not occur.
Potential Future Products May Limit Current Product Sales. From time to
time we announce new products, capabilities or technologies that have the
potential to replace our existing product offerings. These announcements can
cause customers to defer purchasing or licensing our existing products, which
would adversely affect our business, operating results and financial
condition.
Changes in Governmental Regulations Could Make our Products Less
Marketable. The telecommunications industry is subject to regulation in the
United States and other countries, and therefore our products and the
businesses of our current and potential customers are required to receive
regulatory approvals from multiple organizations using different standards.
The enactment or amendment by federal, state or foreign governments of new
laws or regulations or changes in the interpretation of existing regulations
could adversely affect our products and the businesses of our current and
potential customers, and therefore affect our business, operating results and
financial conditions.
Our Products are Targeted at Undeveloped Markets; Our Success Depends on
their Maturation. As part of our corporate strategy, we have targeted product
markets that are in the early stage of their development, including the CORBA
market. If these markets do not mature as we expect them to, we will not have
the growth opportunities we currently hope for. We believe that the CORBA
applications market will take years to develop and that development of this
market will require: (1) a sufficient number of high quality, commercially
successful communications applications based on CORBA, and (2) the
availability of software infrastructure products that allow telecommunications
equipment manufacturers and service providers to implement our CORBA products
in their products. There can be no assurance that these conditions will be met
in a timely way, if at all. We cannot predict the size of the market or the
rate at which the market will grow and if the markets fail to grow, grow more
slowly than anticipated, or become saturated with competitors, our business,
financial condition and results of operations would be materially adversely
affected.
Our Quarterly Results are Based on a Small Number of Large Orders that are
Subject to Many Factors Outside of Our Control. A substantial portion of our
software revenues have been, and will continue to be, derived from a small
number of large orders placed by large organizations after extended
evaluation. The timing of orders and their fulfillment has caused and will
continue to cause material fluctuations in our operating results, particularly
on a quarterly basis. In addition, our quarterly operating results have in the
past and will in the future vary significantly depending upon factors such as:
. capital spending patterns of our customers;
. changes in pricing policies by ourselves and our competitors;
. increased competition;
. the cancellation of service or maintenance agreements;
. changes in operating expenses, personnel changes, demand for our
products;
. the number, timing and significance of new product and product
enhancement announcements by ourselves and/or our competitors;
. our ability to develop, introduce and market new and enhanced versions
of our products on a timely basis;
. the mix between U.S. and international sales;
. seasonality; and
. the mix of direct and indirect sales and general economic factors.
18
Based upon all of these factors, we believe that quarterly revenues and
operating results are likely to vary significantly in the future and that
period-to-period comparisons of results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
There can be no assurance that our revenue will increase or be sustained in
future periods or that we will be profitable in any future period. Further, it
is likely that in some future quarter our revenue or operating results will be
below the expectations of public market analysts and investors. In such event,
the price of our common stock is likely to be materially adversely affected.
A Portion of Our Revenues Are Seasonal. Our sales in Europe are adversely
affected in the third quarter of each year as many customers and end users
reduce their business activities during the summer months. These seasonal
factors may have an effect on our quarterly results of operations.
The Timing of Our Orders May Result in Large Swings in Quarterly Operating
Results. We typically realize a significant portion of our software license
revenues in the last month of a quarter, and frequently in the last weeks or
even days of a quarter. Since our revenues are based in large part on a
limited number of large orders, small delays in a limited number of orders can
have a dramatic effect on quarterly results.
Certain Portions of Our Costs are Fixed in the Short Term. Because only a
small portion of our expenses varies with revenue in the short term, net
income may be disproportionately affected by a reduction in revenue,
particularly since reductions in revenue may not be apparent until the last
days of a quarter. Similarly, to the extent additional expenses are not
subsequently followed by increased revenues, our business, operating results
and financial condition could be materially and adversely affected. If revenue
levels are below expectations, operating results are likely to be materially
adversely affected.
Lengthy Sales Cycles Make Predictions of Revenues Difficult. Our sales
cycle is subject to a number of significant delays over which we have little
control. Therefore, significant delays in implementation, or delays in
purchases by customers, whether or not such delays are within our control,
could materially adversely affect our business, operating results and
financial condition. Our products are complex and generally involve
significant investment decisions after extended evaluations by prospective
customers. Accordingly, we must engage in a lengthy sales cycle to provide a
significant level of education regarding the use and benefits of our products
and services to potential customers. Our customers often must secure executive
level approval to license our products or procure services and our license and
service agreements often involve lengthy negotiation. In addition, the
implementation of our software products involves a significant commitment by
customers over an extended period of time.
Our Fixed Price Arrangements Could Result in Losses. From time to time we
enter into fixed price arrangements for professional services. Fixed price
arrangements could in the future result in losses due to delays in the
implementation process or other complexities associated with completion of the
project underlying these arrangements, such as unknown characteristics of the
customer software for which we are providing services.
Our Markets are Very Competitive and Many of Our Competitors are Larger
than We Are. We experience significant competition in each of our product
lines from various competitors, who are both larger and smaller than we are.
The larger current and potential competitors, such as Accenture, Compaq, DSET,
Hewlett-Packard, IBM, Microsoft, Sun Microsystems, TCSI, Telecordia and Wind
River Systems and major telecommunication vendors such as AT&T, all have
longer operating histories and greater financial, technical, sales, marketing
and other resources than we do. There can be no assurance that we will be able
to identify, develop, manufacture, market or support products successfully or
that we will be able to respond effectively to technological changes or
product announcements by our competitors. Moreover, our current and potential
competitors may respond more quickly to new or emerging technologies or
changes in customer requirements. In addition, as the market develops, a
number of companies with significantly greater resources than us could attempt
to increase their presence in the market by acquiring or forming strategic
alliances with our competitors resulting in increased competition. There can
be no assurance that we will be able to compete successfully with these
competitors.
19
Our Software is Complex and Therefore is Prone to Bugs. The development,
enhancement and implementation of our products entail risks of product defects
or failures. In the past we have discovered software bugs in certain of our
products and software solutions. Although to date we have not experienced
material adverse effects resulting from any bugs, there can be no assurance
that errors will not be found in existing or new products or releases after
commencement of commercial licensing, which may result in delay or loss of
revenue, loss of market share, failure to achieve market acceptance, or may
otherwise adversely impact our business, operating results and financial
condition. Moreover, the complexities involved in implementing and customizing
our software solutions entail additional risks of performance failures.
Our Stock Price is Volatile. Announcement of new products by us or our
competitors and quarterly variations in financial results could cause the
market price of our common stock to fluctuate substantially. In addition, the
stock market has experienced price and volume fluctuations from time to time
that have affected the market prices of many technology-based companies, which
are not necessarily related to the operating performance of these companies.
Our Stock May be Delisted. The Nasdaq Stock Market has announced a policy
of delisting securities that trade below the price of $1.00 per share for more
than 30 consecutive trading days. Our stock price occasionally approached
$1.00 in 2000. If the price of our common stock falls below $1.00 and our
common stock is subsequently delisted our shares would become highly illiquid.
In addition, we could spend material financial and management resources in an
attempt to avoid delisting.
Our International Sales are Subject to Factors Outside of Our
Control. Sales to customers outside of the United States accounted for a
substantial portion of our net revenues for 2000, 1999 and 1998 and we expect
that international sales will continue to be a significant portion of our
business. International sales and operations are subject to many factors
outside of our control, such as the imposition of governmental controls,
export license requirements, restrictions on the export of critical
technology, political instability, trade restrictions and tariffs.
Furthermore, because we have to maintain sales offices in different countries
in order to make these sales, our management must address differences in
regulatory environments and cultures. If we are unable to address these
differences successfully our business, financial condition and results of
operations would be adversely affected.
Our International Sales are Subject to Currency Fluctuations. Although our
international sales are typically denominated in U.S. Dollars, they still may
be adversely affected by exchange rate fluctuations if the relative cost of
our products becomes higher. Fluctuations in exchange rates could also result
in exchange losses. The impact of future exchange rate fluctuations cannot be
predicted adequately. To date, we have not sought to hedge the risks
associated with fluctuations in exchange rates, but may begin hedging in the
future. There can be no assurance that our results of operations will not be
materially adversely affected by exchange rate fluctuations.
We Depend on Third Parties for Key Elements of Our Technology. We license
certain technology included in our products. While we do not believe that any
of this technology could not be replaced, it might require substantial time
and effort to do so. If we become unable to utilize this technology our
operations could be adversely affected.
Losing a Limited Number of Key Employees Could Adversely Affect Our
Business. Our success depends to a significant degree upon the continued
contributions of key management, sales, marketing, engineering and research
and development personnel, many of whom would be difficult to replace. If
certain of these employees were to leave, we would be adversely affected.
Recruiting the Type of Employees We Require is Difficult. We believe our
future success will also depend in large part upon our ability to attract and
retain highly skilled software engineers, and managerial, sales and marketing
personnel. Competition for these types of personnel is intense and there can
be no assurance that we will be successful in attracting and retaining the
necessary personnel. To the extent we are not successful in attracting or
retaining key personnel, we could also be adversely affected.
20
Our Current Efforts to Protect Our Intellectual Property May Be
Insufficient. We regard our products as proprietary and rely primarily on a
combination of statutory and common law copyright, trademark and trade secret
laws, customer licensing agreements, employee and third party nondisclosure
agreements and other methods to protect our proprietary rights. We also
generally enter into confidentiality and invention assignment agreements with
our employees and consultants. Additionally, we enter into confidentiality
agreements with certain of our customers and potential customers and limit
access to, and distribution of, our source code and other proprietary
information. Despite these precautions, it may be possible for a third party
to copy or otherwise obtain and use our technologies without authorization, or
to develop similar technologies independently. Furthermore, the laws of
certain countries in which we do business, such as China and Korea, do not
protect our software and intellectual property rights to the same extent, as
do the laws of the United States. We do not include in our software any
mechanisms to prevent or inhibit unauthorized use, but generally either
require the execution of an agreement that restricts copying and use of our
products or provides for the same in a break-the-seal license agreement. If
unauthorized copying or misuse of our products were to occur to any
substantial degree, our business, financial condition and results of
operations could be materially adversely affected. We cannot provide any
assurance that our means of protecting our proprietary rights will be adequate
or that our competitors will not independently develop similar technology.
It is Possible that We Infringe the Intellectual Property of Third
Parties. While we have not received claims alleging infringement of the
proprietary rights of third parties which we believe would have a material
adverse effect on our business, financial condition or results of operations,
nor are we aware of any similar threatened claims, we cannot provide any
assurance that third parities will not claim that our current or future
products infringe the proprietary rights of others. Any claim, with or without
merit, could result in costly litigation or might require us to enter into
royalty or licensing agreements. Royalty or licensing agreements, if required,
may not be available on reasonable terms, or at all.
Employees
As of December 31, 2000 we employed 145 people, of whom 44 were primarily
engaged in research and development activities, 30 in professional services
activities, 31 in sales and marketing activities, 14 in technical support and
related activities, 9 in WebResolve services, and 17 in general management,
administration and finance. We have no collective bargaining agreements with
our employees. We believe that we maintain competitive compensation, benefit,
equity participation and workplace policies that assist in attracting and
retaining qualified employees. We believe that our future success will depend,
in part, on our ability to attract and retain qualified personnel. We have
experienced no work stoppages and believe that our employee relations are
good.
ITEM 2. PROPERTIES
Our principal administrative, sales and marketing, and support facilities
are located in Woodland Hills, California. Our principal research and
development facilities are located in San Diego, California and Poznan,
Poland. Our headquarters and primary operations consist of approximately
22,000 square feet under a lease that will expire in January 2002. Our field
sales, research and development, and service offices worldwide, exclusive of
our headquarters, consist of leased office space totaling approximately 32,000
square feet with leases expiring between 2001 and 2003. We believe that our
existing facilities are adequate for our presently foreseeable needs.
ITEM 3. LEGAL PROCEEDINGS
Neither Vertel Corporation nor any of our subsidiaries is a party to, nor
is their property the subject of, any material pending legal proceeding. We
may, from time to time, become a party to various legal proceedings arising in
the normal course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
21
PART II.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
MATTERS
Market Information
Our Common Stock is traded on The Nasdaq Stock Market under the symbol
VRTL. Prior to April 1998, we were known as Retix and traded under the symbol
RETX. The low and high closing sales prices for our stock during each
quarterly period in the two fiscal years ended December 31, 2000 and 1999 are
as follows:
2000 Fiscal Quarters Ended
---------------------------------------
March 31 June 30 Sept 30 Dec 31
-------- ------- ------- ------
Low bid........................... $ 7 $11 13/16 $ 5 5/8 $1 5/16
High bid.......................... $47 1/8 $ 23 $17 3/16 $9 9/32
1999 Fiscal Quarters Ended
---------------------------------------
March 31 June 30 Sept 30 Dec 31
-------- ------- ------- ------
Low bid.......................... $1 9/32 $1 9/32 $1 3/4 $1 3/16
High bid......................... $2 13/32 $2 1/4 $2 31/32 $ 9
There were 370 shareholders of record on March 20, 2001 and the closing
market price per share for our common stock on The Nasdaq Stock Market was
$1.56.
Dividend Policy
We have never paid cash dividends on our capital stock. We currently
anticipate that we will retain all available funds for use in our business and
do not anticipate paying any cash dividends in the foreseeable future.
22
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial information has been derived from Vertel's
Consolidated Financial Statements. The information set forth below is not
necessarily indicative of results of future operations and should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and
related notes thereto included elsewhere in this Form 10-K.
Selected Consolidated Financial Data
Five Years Ended December 31, 2000
Years Ended December 31,
--------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- -------- -------
(in thousands, except per share data)
Consolidated Statements of
Operations:
Net revenues:
License........................ $ 9,578 $12,359 $12,564 $ 12,590 $11,714
License-related party.......... -- -- 737 -- --
Service and other.............. 6,820 7,456 5,066 5,887 4,443
------- ------- ------- -------- -------
Net revenues................. 16,398 19,815 18,367 18,477 16,157
------- ------- ------- -------- -------
Cost of revenues:
License........................ 835 1,595 816 876 1,059
Service and other.............. 5,420 5,726 4,784 4,845 3,010
------- ------- ------- -------- -------
Total cost of revenues....... 6,255 7,321 5,600 5,721 4,069
------- ------- ------- -------- -------
Gross profit.................... 10,143 12,494 12,767 12,756 12,088
------- ------- ------- -------- -------
Operating expenses:
Research and development....... 5,170 7,319 6,639 5,600 5,461
Sales and marketing............ 6,978 8,194 6,389 6,590 6,532
General and administrative..... 3,512 4,307 3,014 3,719 3,223
G&A non-employee stock
compensation.................. 553 192 -- -- --
Goodwill amortization.......... 952 754 -- -- --
Restructuring expense
(benefit)..................... -- 641 -- 1,513 (197)
------- ------- ------- -------- -------
Total operating expenses..... 17,165 21,407 16,042 17,422 15,019
------- ------- ------- -------- -------
Operating loss from continuing
operations..................... (7,022) (8,913) (3,275) (4,666) (2,931)
Other income, net............... 1,909 727 10,998 171 591
------- ------- ------- -------- -------
Income (loss) from continuing
operations before provision for
income taxes................... (5,113) (8,186) 7,723 (4,495) (2,340)
Income tax benefit (provision).. (147) 427 (446) -- --
------- ------- ------- -------- -------
Income (loss) from continuing
operations..................... (5,260) (7,759) 7,277 (4,495) (2,340)
Loss from discontinued
operations..................... -- -- -- (6,415) (1,501)
------- ------- ------- -------- -------
Net income (loss)............... (5,260) (7,759) 7,277 (10,910) (3,841)
Other comprehensive income
(loss)......................... (262) (40) 425 (42) (328)
------- ------- ------- -------- -------
Net comprehensive income
(loss)......................... $(5,522) $(7,799) $ 7,702 $(10,952) $(4,169)
======= ======= ======= ======== =======
Basic net income (loss) per
common share:
Income (loss) from continuing
operations..................... $ (0.19) $ (0.31) $ 0.31 $ (0.21) $ (0.12)
Loss from discontinued
operations..................... -- -- -- (0.31) (0.07)
------- ------- ------- -------- -------
Net income (loss)............ $ (0.19) $ (0.31) $ 0.31 $ (0.52) $ (0.19)
======= ======= ======= ======== =======
Diluted net income (loss) per
common share:
Income (loss) from continuing
operations..................... $ (0.19) $ (0.31) $ 0.29 $ (0.21) $ (0.12)
Loss from discontinued
operations..................... -- -- -- (0.31) (0.07)
------- ------- ------- -------- -------
Net income (loss)............ $ (0.19) $ (0.31) $ 0.29 $ (0.52) $ (0.19)
======= ======= ======= ======== =======
Consolidated Balance Sheet Data:
Working capital................. $10,624 $ 9,514 $19,345 $ 6,401 $15,338
Total assets.................... 20,809 23,827 28,317 13,731 23,622
Long term obligations, less
current portion................ -- -- -- -- 236
Shareholders' equity............ 15,842 16,882 22,172 7,733 17,602
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Background
We are a provider of telecommunications software and middleware in the form
of products and services for network management applications and
telecommunications devices. We develop, market, and support vertically
integrated, object oriented software solutions for the management of public
telecommunications networks. Our solutions cover the Telecommunications
Management Network (TMN) market and the emerging Common Object Request Broker
Architecture (CORBA) telecommunications market. Our TMN products are based
upon the International Telecommunications Union's TMN standard and support
network operation and management over diverse transmission media and
protocols. We believe that we offer the only commercially available, fully
interoperable suite of products and tools that span the network element,
element management, network management and service management layers of the
TMN model. Our CORBA software products (e*ORB) are designed to enable
Operations Support Systems (OSS) and network infrastructure to integrate in
ways which will accelerate network and service deployment and provide for the
transition from TMN managed networks to CORBA solutions. Our CORBA software
also provides command and control software infrastructure for
telecommunications hardware and systems. The Vertel Mediation Framework
(Mediation Framework) software product is used to simplify and accelerate the
integration of network infrastructure with telecom OSS infrastructure. We
offer embedded software for network equipment and software solutions to allow
telecommunications service providers to integrate proprietary, Simple Network
Management Protocol (SNMP), TMN, and CORBA-based network management systems
with standards-based solutions. In addition, we offer object oriented software
platforms that facilitate the rapid development of network and service
management applications and features such as fault detection and automatic
response, remote improvement of network configuration, automation of
accounting and billing functions and optimization of network traffic and
security.
In September 2000, we announced plans to offer a new set of services based
on our Mediation Framework. These web-based hosted services, known as
WebResolve, are designed to automate service assurance functions for
telecommunications providers. Costs of approximately $900,000 relating to the
introduction of WebResolve are included in the 2000 financial statements.
However, we do not expect any material revenues from WebResolve until the
second half of 2001.
We also provide professional services, such as turnkey management
solutions, in addition to product integration and product application
services. Our professional services include system analysis and design, source
code portation and interface, custom application development, conformance and
certification testing and technical support services.
We sell products and services primarily through a direct sales force in the
United States and abroad and, in certain territories, through third party
agents. Our customers include telecommunications service providers and their
customers, network equipment manufacturers, independent software developers
and software platform vendors.
We derive revenue primarily from software license fees, royalties and
services, including professional services, technical support and maintenance.
Software license fees consist primarily of licenses of our software products.
We recognize software license revenue based on the American Institute of
Certified Public Accountants Statement of Position No. 97-2, as amended. Our
software license agreements generally do not provide for a right of return. We
maintain reserves for returns and potential credit losses, neither of which
has had a material effect on our results of operations or financial condition
through December 31, 2000.
Pursuant to our license agreements, licensees may distribute binary or
embedded versions of our software in our licensees' products. Royalties or
runtime revenues become due upon shipment of products containing the binary or
embedded code. Generally, software license royalty revenue is recognized upon
notification by our licensee that products incorporating our software have
been shipped by our licensee or, for customers for which we have sufficient
historical information, upon estimated amounts which we expect the customer to
report.
24
Because of the development times required for licensees to design and ship
products containing binary or embedded software, we generally do not receive
royalties from shipments of such products for at least three quarters from the
date we initially ship source code.
We separately offer professional services, including system design and
engineering, custom application development, source code portation,
conformance testing and certification and application development. Many of our
customers contract for professional services. These services are typically
based on a detailed statement of work. Professional services revenue varies
according to the size, timing and complexity of the project and is typically
billed based on satisfaction of certain milestones or on a per day fee.
Revenue from professional services is recognized using the percentage of
completion method, or on a time and materials basis. In certain cases,
customers reimburse us for non-recurring engineering efforts. Such
reimbursements are recognized as revenue and associated costs are reflected as
cost of revenues.
Our technical support services consist of product support and maintenance,
training and on-site consulting. Product support and maintenance fees have
constituted the majority of technical support and service revenue. Product
support and maintenance fees are recognized on a straight-line basis over the
term of the contract, which is generally twelve months. Other revenue from
training and on-site consulting is recognized as performed.
Results of Operations
The following table sets forth certain items from our Statement of
Operations as a percentage of net revenues:
Years Ended
December 31,
---------------------
2000 1999 1998
----- ----- -----
Net revenues..................................... 100.0 % 100.0 % 100.0 %
Cost of revenues................................. 38.1 36.9 30.5
----- ----- -----
Gross margin..................................... 61.9 63.1 69.5
Operating expenses:
Research and development....................... 31.5 36.9 36.1
Sales and marketing............................ 42.6 41.4 34.8
General and administrative..................... 21.4 21.7 16.4
General and administrative non-employee stock
compensation.................................. 3.4 1.0 --
Goodwill amortization.......................... 5.8 3.8 --
Restructuring expense.......................... -- 3.2 --
----- ----- -----
Total operating expenses..................... 104.7 108.0 87.3
----- ----- -----
Operating loss from continuing operations........ (42.8)% (44.9)% (17.8)%
===== ===== =====
Overview
Fiscal 2000 was a transition year for Vertel. We experienced declining
revenues from our traditional TMN-based products that had generated most of
our revenues in the past. The TMN standard is being superseded by new
technology far more quickly than we had anticipated. Also, our international
sales continued to face the challenge of a strong dollar, making our products
more expensive for our Asian and European markets which in part contributed to
lower sales in those markets.
At the same time, however, we moved forward aggressively with a new
generation of products that have met with good market acceptance. Our e*ORB
and Mediation Framework software products have been licensed by Alcatel,
Lucent, Motorola, Nokia and the U.S. Department of Defense, among others. Our
Professional Services Unit (PSU) revenues increased over the prior year in
total, but were lower in the second half of the year reflecting the overall
downturn in spending within the telecommunications industry. Late in the year
we
25
announced WebResolve, which has received positive feedback and may find a
larger potential market than we first predicted.
We had expected that our older TMN-based technologies would generate
sufficient revenue in 2000 to allow us time to begin to benefit from
anticipated future revenue streams from our new technologies. However, most of
our customers are still in the development stage with new products utilizing
e*ORB. We anticipate increased revenue from e*ORB and our Mediation Framework
from royalties as customers actually deploy products that include our
software. Therefore, revenues from our new products in 2000 were not
sufficient to make up for steeper revenue declines in our older TMN-based
products than we had anticipated. It also remains difficult to predict the
timing of such revenues because we do not yet have a representative sample of
customers who have completed the sales and development cycle and have moved on
to the deployment phase.
Notwithstanding revenue declines, benefits from our cost-cutting program
implemented in October 1999 helped us to reduce our operating loss by 21%
compared to 1999.
Our outlook for 2001 is optimistic. We believe demand for our new products
will increase. Our products facilitate communication between
telecommunications network software and wireless handheld products and
network-based servers, and make connections between otherwise incompatible
telecom software and support software for billing and customer service
possible. Our new WebResolve speeds the process of identifying performance
failures in services provided by traditional telecommunication and emerging
service providers such as Internet service providers, so that problems can be
corrected promptly. We believe the market for these products is good and that
we have reorganized the way we develop and market these products so that we
can serve this market in an increasingly cost-effective way. We recognize that
we must constantly update our products and continue to keep a tight control on
costs.
Net Revenues. Net revenues declined 17.2% in 2000 to $16,398,000 from
$19,815,000 in 1999, with lower revenues in both the license and service and
other segments. The decline followed a 7.9% increase in net revenues in 1999
compared to net revenues of $18,367,000 in 1998. License revenue declined in
1999 as well as 2000, but was offset in 1999 by higher revenues from
professional service contracts and maintenance. Sales to customers outside the
United States comprised approximately 30.5%, 48.6% and 40.3% respectively of
net revenues in 2000, 1999 and 1998. We have historically reported a high
percentage of sales to such customers and expect international sales to
continue to be significant to our business. International sales in 2000 were
hurt by the continued strong dollar against Asian and European currencies,
which reduced our sales abroad. If the dollar strengthens significantly, we
may not be able to remain competitive in Asian and/or European markets. In
addition, even if currency conditions are favorable, our sales cycle is
usually lengthy and results in quarterly fluctuations between geographic
markets. Finally, any political or economic turmoil in our major Asian markets
(China, Japan and Korea) could impact future sales in the affected area.
License. License revenues consist primarily of license fees and royalties
derived from software products, including TMN-based products and new offerings
such as e*ORB and Mediation Framework. Historically license revenues have
accounted for a substantial portion of total revenue. In 2000, license
revenues declined 22.5% to $9,578,000 from $12,359,000 in 1999, accelerating a
7.1% decline from $13,301,000 in 1998. The decline in 2000 was due primarily
to lower TMN product revenues due to technological changes in the
telecommunications industry and to lower revenues from legacy CORBA products
as we concentrated our development and sales efforts on the higher performance
e*ORB product line. While we expect to continue to sell TMN-based software,
particularly in Asia and the Pacific Rim, we expect that these products will
be phased out over time as new technology such as e*ORB and Mediation
Framework takes its place. License revenues from new products helped to
mitigate the decline in license revenues. The decrease in license revenues in
1999 was due primarily to an unusual comparison with a stronger performance in
1998, when we recognized significant licensing fees from a semi-exclusive
licensing contract for our Aeronautical Telecommunications Network (ATN)
Router ($1,000,000), from licensing revenues in connection with our sale of
our CDPD and pACT technologies ($800,000), revenues from our ATN and CDPD
product lines in the first half of the year prior to their sale ($550,000) and
a one-time fee for a license to a related party ($737,000). The decline in
1999 was partially offset by Expersoft licensing revenues recognized in 1999
($2,200,000).
26
Service and Other. Service and other revenues consist primarily of
professional services, maintenance, technical support, non-recurring
engineering projects, training and other revenues. Revenues for this segment
declined 8.5% in 2000 to $6,820,000 from $7,456,000 in 1999. The decline
resulted from lower software maintenance revenues ($631,000), primarily due to
non-renewal of maintenance contracts on older or discontinued products and
lower non-recurring engineering services revenues ($476,000). The decline was
partially offset by higher professional service revenues ($497,000) resulting
primarily from higher utilization of professional service personnel. Service
and other revenues increased 47.2% in 1999 from $5,066,000 1998 as a result of
higher professional service revenues ($1,583,000) and higher maintenance
revenues ($1,115,000), arising primarily from the acquisition of Expersoft.
The increase was partially offset by lower non-recurring engineering services
revenues.
Our professional services revenues are dependent on a limited number of
consulting contracts from both new and existing customers. During the second
half of 2000, we experienced a decrease in professional services revenues due
to the slowdown in spending within the telecommunications sector. Any
continued economic slowdown may lead to deferrals or elimination of such
contracts which would adversely impact our personnel utilization and operating
results. Additionally, during 2000, we made significant investments in
launching WebResolve which is designed to automate service assurance functions
for telecommunications providers. A continued economic slowdown may result in
a delay or elimination of contracting with new customers which would adversely
impact future operating results.
Cost of Revenues--License. Cost of license revenues consists primarily of
royalty fees paid for third party software incorporated in our products, the
cost of reproduction of our software and user documentation, and delivery of
software. Cost of license revenues decreased 47.6% in 2000 to $835,000, or
8.8% of license revenue. The improvement was primarily the result of the
comparison to unusually high cost of license revenues in 1999, resulting from
two non-recurring items. In 1999, we made a one-time payment of $150,000
required under a third party license agreement related to our Trader Service
CORBA product and recorded costs of an Expersoft license transaction valued at
$402,000, of which $385,000 in costs and estimated earnings had accrued to
Expersoft prior to its acquisition by Vertel. The 1999 cost of license
revenues of $1,595,000 increased $779,000, or 95.5%, from $816,000 in 1998. We
anticipate that changes in pricing structures and distribution strategies may
occur and that license revenue margins can be expected to continue to
fluctuate and could decline in future years.
Cost of Revenues--Service. Cost of service revenues consists primarily of
costs associated with performing professional consulting services, software
maintenance and customer technical support such as telephone support, training
services and non-recurring engineering services. In 2000 these costs included
approximately $650,000 related to the introduction of WebResolve. Cost of
service revenues was $5,420,000, $5,726,000 and $4,784,000 for 2000, 1999 and
1998, respectively, representing 80%, 76% and 94% of service revenues
respectively. The higher percentage of cost of service revenues in 2000
compared to 1999 primarily resulted from expenses relating to the introduction
of WebResolve. The decrease in percentage of cost of service revenues in 1999
from 1998 was due to the increase in professional service revenue, improved
operational efficiencies in our professional services unit and improved
maintenance margins due to the addition of Expersoft's maintenance customers.
We expect to hire additional consulting personnel in 2001 in anticipation of
additional consulting service contracts and to staff WebResolve. To the extent
that new consulting service contracts do not materialize or WebResolve does
not generate anticipated revenue, our future profit margins from services
would be adversely impacted.
Research and Development. The major components of R&D expenses are
engineering salaries, employee benefits and associated overhead, fees to
outside contractors, cost of facilities and depreciation of capital equipment,
which consists primarily of computer and test equipment. In some cases, R&D
costs for non-recurring engineering projects are reimbursed by customers.
We have historically invested heavily in research and development. However,
total R&D expenses declined 29.4% in 2000 to $5,170,000 from $7,319,000 in
1999 and also decreased as a percentage of revenue to 31.5%
27
in 2000 from 36.9% in 1999. The decline was primarily the result of a
restructuring plan announced in October 1999, which reduced our overall
workforce by 20%, of which the TMN product development staff in the United
States accounted for approximately half of the total workforce reduction. We
moved the remaining TMN product development function to our Poland operations
where costs are lower. Payroll, consulting, recruiting and related costs
therefore were reduced ($2,070,000). The percentage decline from 1999 was also
a result of the comparison to 1999, in which we had higher costs from a non-
recurring expense for development software ($75,000), the expense of
Expersoft's product development organization ($1,659,000) as well as a lower
charge-back to cost of revenues for non-recurring engineering services
($379,000). Our R&D expenses in 1999 of $7,319,000 represented 36.9% of
revenue, a slight increase from 36.1% in 1998, when R&D expenses were
$6,639,000.
We expect to continue to make investments at approximately the current
level in the development of new products and feature enhancements to existing
product lines but changes in net revenues of future quarters could influence
expenditures in future periods. Since the restructuring, our R&D expenditures
are concentrated in the areas of CORBA product development (primarily e*ORB
product) and related application services and our Mediation Framework which is
designed for the integration of telecom Operation Support Systems and the
underlying network equipment management systems.
Sales and Marketing. Sales and marketing expenses consist primarily of
personnel and associated costs related to selling and marketing, including
trade shows and other promotional costs. We believe that substantial sales and
marketing expenditures are essential to developing opportunities for revenue
growth and sustaining our competitive position. However, sales and marketing
expenses were reduced 14.8% in 2000 to $6,978,000 from $8,194,000 in 1999,
primarily as a result of our personnel reduction in late 1999 and consequent
reductions in associated payroll, commissions, recruiting, relocation and
travel costs ($1,210,000). We maintained our spending on trade shows and
incurred marketing costs related to the introduction of WebResolve, both of
which partially offset the reductions. As a percentage of revenues, sales and
marketing expenses increased in 2000 to 42.6% from 41.4% in 1999.
Sales and marketing expenses in 1999 had increased 28.3% from $6,389,000 in
1998, when they comprised 38.4% of revenues. The increase in 1999 was due
primarily to increased personnel and associated payroll, commission,
recruiting, relocation and travel costs ($1,143,000), as well as higher
consulting ($33,000), trade show ($150,000), public relations ($82,000),
advertising expenses ($33,000) and the addition of expenses of Expersoft's
sales and marketing organization ($374,000).
General and Administrative. General and administrative expenses consist
primarily of salaries, employee benefits and other related expenses of
administrative, executive and financial personnel as well as professional fees
and investor relations costs. General and administrative expenses decreased
18.5% to $3,512,000 in 2000 from $4,307,000 in 1999 primarily due to lower
payroll and facility costs ($759,000). The decline was partially offset by
increased investor relations ($75,000) costs primarily due to a larger number
of shareholders in 2000. General and administrative expenses increased 42.9%
in 1999 from $3,014,000 in 1998, primarily due to the addition of Expersoft's
general and administrative organization ($1,022,000) and increased
professional and consulting fees ($344,000). These increases were partially
offset by lower recruiting fees ($53,000).
General and Administrative--Non-employee Stock Compensation. Non-employee
stock compensation resulted in $553,000 in expenses in 2000, an increase of
188.0% from $192,000 in 1999. The charges reflect the value of stock options
held by non-employee directors which became fully vested during the year,
while the charge in 1999 was a non-recurring charge related to the value of
stock options granted to three former officers in January 1999. There were no
such charges in 1998.
Goodwill Amortization. Goodwill amortization for 2000 was $952,000 compared
to $754,000 in 1999 and zero in 1998. Goodwill resulted from the purchase of
Expersoft in March of 1999 and is being amortized over five years at
approximately $238,000 per quarter.
28
Restructuring Expense. In October 1999, we announced a restructuring plan
designed to reduce operating costs. We reduced our overall workforce at that
time by approximately 20%. The estimated costs of restructuring recorded in
the financial statements for the year ended December 31, 1999 were $764,000
and included costs of employee severance pay and the costs of vacating a
portion of a facility. Of these costs, $246,000 was paid in 1999 and $470,000
was paid in 2000. At December 31, 2000, facility reserves totaled $48,000.
Additionally, during the third and fourth quarters of 1999, we recognized a
benefit of $123,000, on the reversal of restructuring reserves originally
recorded in 1995 and 1997, resulting in a net restructuring expense recorded
for fiscal 1999 of $641,000. There was no restructuring benefit or expense
recorded in 2000.
Operating Loss. We incurred losses from operations of $7,022,000 in 2000
and $8,193,000 in 1999. The decrease in loss from operations in 2000 was due
to lower operati