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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, 1998
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 of (I.R.S. Employer
incorporation or organization) Identification No.)
21300 Victory Boulevard, Suite 1200, 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, $.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 1, 1999 there were 25,002,362 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 $35,945,000 based on the closing
price of $1.75 per share. Shares of Common Stock held by each officer,
director and holder of 5% or more of the outstanding Common Stock of the
Registrant have been excluded in that such persons may be deemed to be
affiliates of the Registrant. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
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 13, 1999 (the "Annual Meeting").
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INTRODUCTORY STATEMENT
Except for the historical information presented, the matters discussed in
this Annual Report on Form 10-K are forward looking statements that involve
risks and uncertainties, including the risks of the timely deployment and
success of new and enhanced telecommunications management network (TMN)
products, the loss of key customer relationships, the impact of competitive
products and the dependence on key partners and alliances, the length of the
Company's sales cycle, the size and timing of license fees closed during the
fiscal year, the likely continued significant percentage of quarterly revenues
recorded in the last month of the quarter which makes forecasting difficult
and subject to a substantial risk of variance with actual results, the
acceptance of new technologies like TMN, the impact of competitive products
and pricing and the other risks detailed from time to time in the Company's
public disclosure filings with the U.S. Securities and Exchange Commission
(SEC). Copies of such filings are available upon request from Vertel's
Investor Relations Department.
PART I
ITEM 1. BUSINESS
General
Vertel Corporation, founded as Retix in 1985, is a provider of
telecommunications network management software and solutions. We offer
multiple software technologies supporting end-to-end network and service
management with high quality grade of service for network operations support
systems. Vertel's solutions are deployed worldwide by service providers,
network operators, telecommunications equipment manufacturers, independent
software vendors and systems integrators. Vertel also delivers turn-key
management applications that fit individual customer requirements through its
Professional Services organization.
In December 1997, we discontinued further investment in our broadband access
equipment subsidiary, Sonoma Systems, Inc. As a result of the successful
completion of financing by outside private investors in early 1998, voting
ownership in this subsidiary was reduced to 19.9%. In December 1998, we sold
Vertel's holdings of Series B and Series C preferred stock in Sonoma Systems
to a party related to Newbridge Networks Corporation. We retain an investment
in Sonoma Systems primarily consisting of $1.0 million of Series A Preferred
Stock that is non-convertible and non-voting.
In March 1998, our shareholders approved a change in our name from Retix to
Vertel Corporation, the name of the only operating subsidiary of Retix at that
time. At the same time, the subsidiary's name was changed to Vertel
Corporation I. Except where specifically noted, Vertel includes the parent and
all subsidiary companies. We also changed our Nasdaq Stock Market ticker
symbol to VRTL from RETX.
Vertel develops, markets and supports vertically integrated, object oriented
TMN based software solutions for the management of public telecommunications
networks. Vertel's solutions, are based upon the International
Telecommunications Union's TMN standard and support seamless 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. Vertel offers
embedded software for network equipment and software solutions to allow
telecommunications service providers to integrate proprietary or SNMP-based
network management systems with a TMN standards-based solution. In addition,
Vertel offers 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. Vertel has plans to expand into other network
management software and solutions that provide additional features and
capabilities for public and Internet protocol (IP) networks. An example is our
recently announced acquisition of Expersoft Corporation, a provider of Common
Object Request Broker Architecture (CORBA) technology.
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We also provide professional services that enable service providers to
deploy and maintain a complete network management solution complementing our
software products and development platforms. Our professional services include
system analysis and design, source code portation and interface, custom
application development, conformance and certification testing and technical
support services.
Our TMN solutions reduce the complexity of management system
interoperability and provide systems that are more efficient and simpler to
build and deploy. In addition, our solutions utilize object-oriented
interfaces, with object definitions that serve as reusable building blocks.
The object interfaces mask the complexity of underlying implementations while
providing all the functionality of the services and protocols of that
implementation.
Vertel believes that its TMN solutions allow telecommunications service
providers and their customers to reduce network operations costs, manage
diverse networks and network equipment with a single integrated management
system, derive incremental revenue by bringing new functionality and services
to market more rapidly, implement a complete network management solution and
preserve existing investments by integrating existing propriety systems
including TL-1 and SNMP.
Vertel's products enhance communications among service providers and
customers by enabling telecommunications service providers and enterprise
network operators to develop and deploy systems that manage new and existing
services across multiple service providers networks.
We have committed ourselves to customer service including: worldwide, 24
hours per day, 7 days per week technical support, on and off-site training
customized software design and engineering professional services.
We believe that the broad adoption and deployment of TMN and other
standards-based technologies will be key to our success and that this adoption
will depend, in part, upon the ability of service providers to implement
management solutions quickly and cost-effectively. Therefore we target
telecommunications service providers and network equipment manufacturers for
adoption of our standards-based solutions, and at the same time have committed
and will continue to commit substantial resources to the promotion of these
standards for telecommunications network management. Our customers include
U.S. Regional Bell Operating Companies, as well as many other service
providers, network operators worldwide and network element (NE) vendors
worldwide.
During 1997, Vertel began development and marketing of certain products
jointly with Hewlett Packard's Communications Telecom division (HP). In 1998,
the Company continued to develop, market and sell these products with HP
through both companies' sales and distribution channels. In addition, we plan
to continue to license code to service providers, network equipment
manufacturers and independent software developers. We believe that our
distribution strategy will help to establish our TMN solutions as the premier
standards-based products and will accelerate the general adoption of TMN.
We are a California corporation incorporated in 1985. The Company's
principal offices are located at 21300 Victory Boulevard, Suite 1200, Woodland
Hills, California 91367 and our telephone number at that location is (818)
227-1400.
Industry Background
The worldwide telecommunications industry continues to undergo significant
transformation. Global deregulation and international privatization have
resulted in intense intra-industry, cross-industry and geographic competition
in providing telecommunications services. Long distance and local
telecommunications service providers compete in each other's markets. Wireless
service providers, cable television operators and utilities are leveraging
existing infrastructure to provide voice, video and data transmission and
switching networks. In addition, independent service providers are leasing
transmission facilities from long distance carriers; local telephone companies
and emerging network providers to provide competing voice, video and data
services. At
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the same time, the complexity and size of public networks have increased. The
emergence of the Internet, intranets, graphical user interfaces and
telecommuting, as well as numerous new telecommunications services such as
high-speed data services, video teleconferencing and video-on-demand have
increased demand for bandwidth, reliability, data integrity and security. In
this dynamic environment, service providers are being forced to operate with
external public and private networks and need to differentiate themselves on
the basis of price, responsiveness, services offered, reliability and
security.
To meet increased demands and remain competitive in this dynamic
environment, traditional telecommunications service providers must upgrade
existing voice-based public networks. In addition, these providers, along with
new competitors, must deploy new networks that provide increased
functionality, reliability and secure services. Upgrading and deploying new
telecommunications networks and services requires the integration of diverse
transmission media and protocols, network equipment, network operations
platforms and network management systems. Moreover, the competitive
environment requires more effective network management, such as detection of
and automatic response to fault indications, remote configuration of networks
and equipment, automation of accounting and billing functions, optimization of
network performance and improvement of security. Network management systems
must operate seamlessly among service providers and interface with customer
network management systems.
Until recently, most telecommunications service providers managed their
voice networks exclusively with mainframe-based, proprietary systems written
in early generation programming languages. While these 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. In addition, because
these legacy systems are not based on a common standard, management among
telecommunications service providers and the provisioning of end-to-end
services are 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 proprietary and are based on earlier-generation
programming languages, they generally do not easily scale, 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 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, permit 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 identified 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 is known as the telecommunication management network or TMN standard. The
specifications comprising the TMN standard divide the telecommunications
management infrastructure into a framework of five logical layers: network
element (NEL) (equipment), element management (EML), network management (NML),
service management (SML) and business management (BML). The TMN standard
includes a set of interface specifications for
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communicating within and among layers to enable interoperability among service
providers (and their customers), network operating systems, network management
systems and network equipment.
TMN has been established as an international standard for public
telecommunications network management. If implemented correctly, TMN has the
potential to offer significant advantages over proprietary and SNMP-based
systems, including a reduction in network operations costs, the ability to
derive incremental revenue from new services and enhanced communications with
other service providers and with customers.
Strategy and Products
Vertel provides a broad suite of next-generation, telecommunication
management applications software and services that are facilitating the growth
of communications. These products provide TMN capabilities through
configurable components and platforms. Vertel products incorporate easy-to-
use, high performance development environments, platforms, tools, applications
and components that provide solutions at the NEL, EML, NML and SML of the TMN
model. Products include TMN-conformant management application development
environments, distributed platforms, Real-Time Embedded Operating Systems
(RTOS) based embedded TMN software, and Fault Configuration Accounting
Performance Security (FCAPS) TMN applications.
Vertel considers its engineering services, provided through its technical
support and professional services units, to be key to its success with its
customers. Our technical support department provides pre-and post-sales
support, training and maintenance services, while our professional services
unit provides customized software design and engineering, including designing,
developing, deploying and maintaining turn-key telecommunications management
solutions.
Vertel's TMN solutions allow telecommunications service providers and their
customers to:
Reduce costs. Vertel's TMN solutions enable telecommunications services
providers to reduce costs by efficiently managing diverse networks and network
equipment with a single, integrated management system. Unlike many proprietary
systems, our TMN solutions adhere to an object-oriented architecture and do
not require large, expensive technical organizations for additional
development and maintenance. Because our products and solutions use standard
interfaces, they allow multiple systems to work with 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 the Company's professional
services customers can reduce the cost of in-house development.
Derive incremental revenue. The TMN solutions also enable telecommunications
services 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 agent, manager and adapter 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 (electronic bonding).
Implement complete solutions. Successful implementation requires seamless
vertical integration of all the layers of the TMN standard. We believe that we
provide the only commercially available complete family of products and
services for implementing a fully integrated TMN network management system.
Network management systems based on our full suite of products and services
operate seamlessly with other TMN systems as well as with proprietary legacy
systems and can be adapted to SNMP systems and now CORBA.
Preserve existing investments. Our solutions enable telecommunications
services providers to continue to use and integrate their existing TL1, ASCII
message-based and SNMP-based network components in a total TMN solution. Our
technology and solutions manage TL1, SNMP and other legacy equipment and
systems within Vertel's solution framework.
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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.
Strategy
Our goal is to position Vertel as a leading provider of complete, vertically
integrated TMN solutions to telecommunications service providers, equipment
manufacturers, platform vendors and independent software developers.
Additionally, we plan to provide next generation communication services and
software solutions that support multiple management technologies. These
solutions are targeted to provide public and IP network 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:
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 implementation across layers and use the
unique features of the TMN architecture. We currently plan to develop
applications for electronic bonding, integrated alarm management and ATM
element management.
Leverage Technological Leadership. We believe that our technological
leadership, as evidenced by the breadth and functionality of our products and
services are, in part, the result of 12 years of experience deploying products
that implement the protocols and services that adhere to ITU specifications.
We plan to continue to invest significant resources in research and
development, to extend our technological leadership in TMN technologies,
maintain a time-to-market advantage and develop management solutions that
leverage our TMN implementation expertise.
Target Service Providers. We believe that increased penetration of
telecommunications service providers is necessary to hasten the broad
deployment of TMN. To this end, we provide management platforms, solutions for
operation support systems, customization and implementation services, software
that is easy to use and install and high quality training, consulting and
support. In addition, we offer Q-Adapter products that enable customers to
maintain their investment in legacy systems, bringing TL1, proprietary and
enterprise network components into the realm of TMN. Our customers include
U.S. Regional Bell Operating Companies, as well as many other service
providers, network operators worldwide and network element vendors worldwide.
Leverage Existing Relationships with Equipment Manufacturers. Historically,
we have derived a significant portion of our TMN revenue 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 TMN solutions in the marketplace by
service providers.
Establish Leadership in New Markets. One of the first areas to adopt the TMN
standard was the fiber optic transmission market, where new networks were
being deployed without the requirement to interoperate with legacy systems. As
data has become a greater portion of the traffic on telecommunications
networks and SNMP is proving inadequate for the performance and traffic
demands of public networks, we have also begun to target leading data
communications companies.
Expand Global Sales and Distribution Capability. We currently sell our
products primarily through a direct sales force in the United States and
internationally. We intend to expand our sales and distribution infrastructure
in the United States and internationally to increase sales coverage and
position ourselves to capture market share. 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 binary and source code to service
providers, network equipment manufacturers and independent
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software developers. Our customers have the right to distribute products,
services and applications, developed using our binary and source code, in
exchange for royalty payments. We believe that our distribution strategy will
help to establish our TMN solutions as the premier TMN products; and
accelerate the general adoption of TMN.
Promote the Deployment of TMN. We believe that the broad adoption and
deployment of TMN will be our key to our success. Correspondingly, we commit
substantial resources to the promotion of the TMN standard for
telecommunications network management. We are working with leading industry
experts, forums and working groups to define, refine and develop
specifications for TMN solutions. In addition, we sponsor the Global TMN
Summit and are a participant in trade shows, seminars and industry
conferences.
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. To date we have established relationships
with companies such as Hewlett Packard and Microsoft resulting in the
introduction of a number of new products and the increased visibility of TMN
within the telecommunications marketplace.
Expand PSU Customer Base. We believe that there is a large market for
customized network management solutions. Our professional services unit
provides customized software design and engineering, including designing,
developing, deploying and maintaining turn-key telecommunications management
solutions. By utilizing or enhancing existing Vertel products, our
professional services unit is capable of customizing and delivering carrier-
grade quality solutions that enable businesses to efficiently implement
network management solutions quickly and cost-effectively.
Products
For the past three years, Vertel has focused primarily on developing,
marketing, selling and supporting TMN software products and services.
We generally license our binary and source code to customers who may either
sublicense the code in binary form or integrated into additional products.
Revenue is derived from license fees received upon the shipment of the source
code and royalties relating to the distribution of the binary or embedded
versions of the software.
Our three product families, TMNTelecore(TM), TMNAccess(TM), and
TMNWorks(TM), provide full TMN capabilities through configurable components
and platforms. The products incorporate easy-to-use, high performance
development environments, platforms, tools, applications and components into
open, standards-based solutions. We supply fully implemented information
models for OSI, ATM, SONET/SDH and other telecommunications transport
technologies. The platforms incorporate object-oriented, fully integrated
building blocks and development environments. Our TMN Platforms and tools use
the TMF TMN/C++ API as the upper interface to the products. The TMN/C++ API
masks the complexities of the underlying agent or manager functionality behind
easy-to-use C++ object classes. Our communications stacks employ the seven
layer Open Systems Interconnect model and TCP/IP. Routing software packages
and other specialized stacks are also available. We produced the industry's
first fully functional, portable and/or ported, OSI protocols for all seven
OSI stack layers.
TMNTelecore Products
Our TMNTelecore product family provides comprehensive, telecom software
development environments and integrated deployment platforms for service
providers, network operators and system integrators. TMNTelecore facilitates
the quick deployment of TMN-conformant agents, managers, Q-adapters, and the
creation of analytical applications for network generated events.
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Based on the Vertel/HP jointly developed product suite, TMNTelecore
automates the tasks associated with the deployment of EMS, NMS, and OSS
interconnection applications. TMNTelecore is available for both UNIX and NT
environments.
The TMNTelecore product suite benefits telecommunication application
providers by offering shortened development cycles, improved application
quality and the reduction of ongoing support costs through the use of new and
integrated technologies. It provides a comprehensive platform that enables the
creation of integrated telecom management solutions. The environments offered
include:
Agent Development Environment (ADE) enables developers to build
customizable, dynamically configurable TMN conformant agents. Vertel's
TMNTelecore ADE automates most of the tasks associated with building an agent
application, leading each stage of application development--design,
prototyping, development, testing, and deployment. The resulting, fully
functional TMN Agent provides value added, agent role process for network
elements, Q-Adaptors, and mediation devices at all of the lower four layers of
the TMN model.
Manager Development Environment (MDE) enables developers to easily build
customizable, dynamically configurable, scalable, TMN conformant, manager
applications. TMNTelecore MDE automates most of the tasks associated with
building a manager application. The structure of the TMNTelecore MDE and its
integrated components leads the project team through each stage of manager
application development--design, prototyping, development, testing, and
deployment.
TMNTelecore Simulator uses TCL scripts to emulate the behavior of a fully
implemented, Q3-conformant management entity. It is easy to use and can act in
the role of agent, manager, or both. A customer can use the TMNTelecore
Simulator with a "live" agent or manager, a prototype agent or manager, or
with a script-driven responder. The TMNTelecore Simulator allows the customer
to test during any stage of development, greatly reducing the time to market.
TMNTelecore Designer provides all the software needed to quickly design and
build a prototype application. TMNTelecore Designer provides off-the-shelf
functionality and tools that simplify the process of designing object models
to integrate heterogeneous networks elements. It is part of an integrated TMN
family of products that streamlines the creation and deployment of complex
management solutions. Object models that are designed and tested with the
TMNTelecore Designer product may be used with other Vertel components
throughout the applications product lifecycle.
TMNTelecore Proxy provides automated TL1-to-TMN Q-adaption to simplify and
enhance the manageability of TL1 network elements, while accelerating the
development of TMN management solutions for TL1 NEs. TMNTelecore Proxy
provides integrated components that simultaneously monitor and control
hundreds of TL1-based NEs, preserving investments in existing NE
infrastructures and providing TMN based management of NEs based on
technologies such as SONET/SDH.
TMNAccess Products
Our TMNAccess products provide telephony and data communication equipment
vendors standards-based interoperability features in network elements.
TMNAccess consists of products and protocol options targeted for specific
industry technologies and markets, and acts as the bridge for mission critical
data transportation from the network to the operation support systems.
TMNAccess is comprised of a range of products and solutions:
TMNAccess ETS (Embedded Telecommunications Solutions) provides the most
complete and mature set of products for equipment vendors developing domestic
and international digital loop carrier devices (DLC), SONET/SDH transport
equipment, ATM switches, DWDM devices, SM, CDMA, TDMA, CDPD base stations and
newer optical switching devices.
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TMNAccess FTAM (File, Transfer, Access and Management) is a file transfer
protocol, used to download call detail records (CDR) that contain the critical
billing information that is passed to the billing systems.
TMNAccess DMH (Data Message Handler) is a set of development tools and
applications for real-time billing record exchange between cellular service
providers. It is based on TIA's IS-124 standard and enables the equipment
vendor and application developer to direct and process billing information.
These products allow equipment and systems in a wireless network to format and
communicate call detail information used in billing. IS-124 components include
the stacks, interfaces and platform tools to lead project teams through IS-
124/DMH function development, testing and deployment.
TMNWorks Products
TMNWorks consists of operation support systems applications for telecom
service providers, system integrators, network operators and equipment
manufacturers. A range of fault, configuration, accounting, performance,
security and connection management solutions are available to address multiple
network infrastructures. TMNWorks also includes a flexible mediation platform
to facilitate the adaption, translation and transport of data between
dissimilar or incompatible operational support systems.
Vertel Wireless Products
During 1998, we sold our CDPD and pACT wireless products, technologies and
contracts to AMP Incorporated. This enabled us to strengthen core product
offerings and expand our solutions portfolio for the access, operations
support system and backbone vertical markets. The remaining wireless products
are now part of our TMNAccess DMH product line.
Vertel ATN Router Software Products
In June 1998, Vertel granted a semi-exclusive license for its 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.
Competition
We compete on the basis of product characteristics, including quality,
performance, ease of use, functionality, interoperability, reliability,
scalability and extensibility and speed of implementation; price;
implementation and development services; technical support; 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. These competitors generally fall within four categories:
Customers' internal design and development organizations that produce
telecommunications network management systems and management applications
for their particular needs (e.g., Bellcore-based systems),
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Current TMN software providers including DSET and to a more limited extent
ONE, NetMansys, ISR Global, Cabletron, Euristix, Object Stream and Bull
Hardware and software vendors including IBM, Sun Microsystems and DEC
Providers of specific market applications including TCSI and OSI
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 such as Vertel. We
estimate 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 TMN and related open
management technology versus internal, proprietary telecommunication network
management systems and management applications.
The global acceptance of TMN could lead to increased competition as third
parties develop telecommunications network management systems and management
applications competitive with those offered by Vertel. Any of these
competitors may be able to respond more quickly with different technologies
and changes in customer requirements and to devote greater resources to the
development, promotion and sale of their products than Vertel. There can be no
assurance that our current or potential competitors will not develop products
comparable or superior to those developed by Vertel or adapt more quickly than
Vertel 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 29 people as of December 31, 1998.
Our marketing efforts are focused on increasing awareness of Vertel, TMN and
related technology solutions, and TMN in general, among telecommunications
service providers, network equipment manufacturers, independent software
vendors, systems integrators and platform vendors, and on positioning Vertel
as the leading provider of TMN 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, including the Global TMN
Summit, 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
9
releases, press/analyst tours, marketing literature, public relations, trade
shows and a world-wide web site. Our product management staff work with
customers and industry experts to ensure that our products will satisfy market
requirements.
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, the Company sells its 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 29 people engaged in sales and marketing, our direct sales
organization consisted of 19 people as of December 31, 1998.
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 43%, 40% and 53% of net revenues for each of the
fiscal years 1998, 1997 and 1996. 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 significant license backlog because we fill
substantially all orders within 30 days after receipt of a firm purchase
order.
Customer Service and Support
Professional Services
We believe that the adoption of TMN will depend, in part, upon the ability
of service providers, network operators, network hardware and software
vendors, and systems integrators to implement TMN solutions quickly and cost-
effectively. Our professional services organization works with systems
integrators, application developers and in-house customer engineers to enable
customers to deploy a complete TMN 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 have devoted substantial resources to the provision of professional
services in order to facilitate the implementation of our TMN products by
service providers and to differentiate ourselves from competitors. As of
December 31, 1998, our professional services organization consisted of 15
people, including consultants and employees.
Technical Support
In order to assist customers in fully designing and operating integrated TMN
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 the Company's California and
Berlin 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.
10
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.
As of December 31, 1998, our technical support organization consisted of 9
people.
We typically warrant software for 90 days. To date, we have not encountered
any significant product maintenance problems. See "Risk Factors--We Need to
Develop New Products to be Successful," and "Our Software is Complex and
Therefore is Prone to Bugs."
Research and Product Development
We have made substantial investments in the development of our products. We
believe that our future success depends in a large part on our ability to
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:
TMN Managers and Agents. Vertel deployed the industry's first TMN agent
toolkit in the early 1990's and the industry's first TMN agent and manager
products based upon the TMF TMN/C++ API (NMF API) -- an emerging standard for
a three-tiered, object-oriented interface. The TMN Agent Development
Environment (ADE) and TMN Manager Development Environment (MDE) are two
industry-leading products in the market today.
Vertel/HP Communications Telecom TMN Product Suite. We intend to continue to
build upon the combined strengths of HP Communications Telecom platforms and
the Company's TMN development products. With our Vertel/HP Communications
Telecom product suite, products include TMNDesigner, TMNAgent and TMNManager
Developer, runtime products and TMN Proxy.
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 run-time operating systems, 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.
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 Woodland
Hills, California. As of December 31, 1998, our research and development group
consisted of 54 people.
11
RISK FACTORS
Our Success is Dependent on Widespread, Timely Adoption of the TMN
Standard. Our software and services are all based on the TMN standard. If a
different protocol becomes the standard in the telecommunications industry,
service providers are unlikely to purchase our products. In recent years
standards that compete with TMN, such as SNMP and CMIP, have emerged. In
addition, telecommunications service providers have historically depended on
proprietary systems, which do not rely on any standards. While we invest
substantial efforts in encouraging service providers to adopt the TMN
standard, we do not have direct control over this process and we cannot
provide any assurance that the TMN standard will be adopted.
Telecommunications service providers could adopt a competing standard or no
standard at all. Similarly, they could adopt the TMN standard, but not do so
within the timeframe that we expect them to. If telecommunications service
providers adopt a standard other than TMN, adopt the TMN standard 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.
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 TMN-related software and 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.
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 which are in the early stage of their development, including the TMN
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 TMN
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 the TMN Standard, and (2) the
availability of software infrastructure products that allow telecommunications
equipment manufacturers and service providers to implement TMN in
12
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 either ourselves 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.
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. We currently
intend to increase funding of research and product development, increase sales
and market development activities and expand our distribution channels which
will increase our expense rates. 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.
13
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
to potential customers. Our customers often must secure executive level
approval to license our products and our license 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.
Increased Sales and Marketing Expenditures May Not Be Effective. During
1999, we plan to increase our number of direct sales and marketing personnel
to support the further development of TMN market opportunities. As we hire new
sales and marketing personnel we anticipate that there will be a delay before
they become effective. There can be no assurance that we will be successful in
attracting or retaining qualified sales and marketing personnel, that this
expansion will result in sales of our products, that the costs of this
expansion will not exceed the revenues generated, or that our sales and
marketing organization will successfully compete against the larger and better
funded sales and marketing organizations of our competitors.
Our Markets are Very Competitive and Many of Our Competitors are Larger than
We Are. We experience significant competition in telecommunications network
management from TCSI, OSI, IBM, Sun Microsystems, DSET and major
telecommunication vendors such as AT&T, all of whom have longer operating
histories and have 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 than we do 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.
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 Software Operates with Third-Party Software Which May Not be Year 2000
Compliant. New releases of our software have been designed to address
processing for the Year 2000 to the extent it has been required. We have
completed a review of all of our developed products and believe that all of
our products will be Year 2000 compliant by April 1999. However, to the extent
that others, such as system integrators, make use of our software in
developing solutions for third parties, we may have no knowledge as to the
Year 2000 readiness of those third party products. In addition it is possible
that third parties could assert claims against us or our customers concerning
Year 2000 issues and regardless of their merits or lack thereof, any claims
could be material.
14
Our Internal Systems May Not Be Year 2000 Compliant. As with other
organizations, our internal computer systems and programs were originally
designed to recognize calendar years by their last two digits. Calculations
performed using these truncated fields would not work properly with dates from
the Year 2000 and beyond. We have completed an evaluation of Year 2000 issues
associated with our internal computer systems. Most of our computer systems
are already Year 2000 compliant. Other internal computer and other systems
that have been identified as non-compliant and will be upgraded to be Year
2000 compliant by June 1999, however if we are unsuccessful in completing
these upgrades in a timely way, our business could be materially adversely
affected.
Our Suppliers' Systems May Not Be Year 2000 Compliant. We have also
completed an evaluation of the possible effects on our operations of the Year
2000 readiness of our key suppliers. We rely on third party manufacturers for
the proper functioning of our information systems, software and products. The
failure of those manufacturers to address Year 2000 issues could have a
material impact on our operations and financial results; however, the
potential impact and related costs are not known at this time.
Our Stock Price Could be 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 and
that 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 10 business days. Our stock price closed once below $1.00 in 1998 and it
has approached $1.00 in recent periods. 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 fraction
of our net revenues for 1996, 1997 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.
15
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.
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.
This document contains statements regarding the future including, among
other things, our expectations, beliefs, intentions and strategies. All of
these statements are based on information available to us as of the date of
this risk factors in addition to the risk factors set forth in our filings
with the SEC before making a decision to purchase any shares.
Employees
As of December 31, 1998 we employed 121 persons, of whom 69 were primarily
engaged in research and development activities or professional services, 38 in
sales, marketing, customer support and related activities and 14 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
The Company's principal administrative, sales and marketing, research and
development and support facilities are located in Woodland Hills, California.
The Company's headquarters and primary operations consist of approximately
34,000 square feet under a lease that will expire in January 2002. The
Company's field sales and service offices worldwide, exclusive of its
headquarters, consist of leased office space totaling approximately 15,000
square feet with leases expiring between 1999 and 2003. Vertel believes that
its existing facilities are adequate for presently foreseeable needs.
16
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor any of its subsidiaries is a party to, nor is their
property the subject of, any material pending legal proceeding. The Company
may, from time to time, become a party to various legal proceedings arising in
the normal course of its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
17
PART II.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON AND RELATED SHAREHOLDER MATTERS
Market Information
Our Common Stock is traded on the Nasdaq National 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, 1998 are as
follows:
1998 Fiscal Quarters Ended
---------------------------------
March 28 June 27 Sept 26 Dec 31
-------- ------- -------- -------
Low bid.................................. $4 $3 7/16 $ 29/32 $1 3/8
High bid................................. $5 3/8 $6 3/16 $3 15/16 $2 1/2
1997 Fiscal Quarters Ended
---------------------------------
March 29 June 28 Sept 27 Dec 27
-------- ------- -------- -------
Low bid.................................. $4 $3 5/8 $4 $4 1/32
High bid................................. $7 3/16 $5 7/8 $7 $ 7 3/8
There were approximately 400 shareholders of record on March 1, 1999.
Recent Sales of Unregistered Securities
On September 29, 1998, the Company sold 2,000,000 shares of common stock for
$1.50 per share ($3,000,000 in gross proceeds). The price per share was
determined as the greater of (a) the average closing price of the common stock
for the five days preceding the closing date and (b) $1.50.
Of the total shares issued, 1,000,000 shares were purchased by Sierra
Ventures V, a venture capital firm. Jeffrey M. Drazan, a General Partner of
Sierra Ventures, is a member of the Company's Board of Directors. The
remaining shares were purchased by Pequot Private Equity Fund, L.P. and Pequot
Offshore Private Equity Fund, Inc.
No underwriter was used in connection with the sale of such shares, which
was made in reliance upon Section 4 (2) of the Securities Act of 1933 as
exempt from registration.
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.
18
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, 1998
Years Ended December 31,
----------------------------------------------
1998 1997 1996 1995 1994
------- -------- ------- -------- --------
(in thousands, except per share data)
Consolidated Statements of
Operations:
Net revenues:
License..................... $12,564 $ 12,590 $11,714 $ 10,222 $ 12,209
License--related party...... 737 -- -- -- --
Service and other........... 5,066 5,887 4,443 5,324 11,428
------- -------- ------- -------- --------
Net revenues.............. 18,367 18,477 16,157 15,546 23,637
------- -------- ------- -------- --------
Cost of revenues:
License..................... 816 876 1,059 943 715
Service and other........... 3,863 3,606 1,917 2,346 7,445
------- -------- ------- -------- --------
Total cost of revenues.... 4,679 4,482 2,976 3,289 8,160
------- -------- ------- -------- --------
Gross profit.................. 13,688 13,995 13,181 12,257 15,477
------- -------- ------- -------- --------
Operating expenses:
Research and development ... 6,639 5,600 5,461 5,156 1,730
Sales and marketing......... 7,310 7,829 7,625 4,279 5,622
General and administrative.. 3,014 3,719 3,223 2,188 3,493
Restructuring expense
(benefit).................. -- 1,513 (197) 2,277 397
------- -------- ------- -------- --------
Total operating expenses.. 16,963 18,661 16,112 13,900 11,242
------- -------- ------- -------- --------
Operating income (loss) from
continuing operations........ (3,275) (4,666) (2,931) (1,643) 4,235
Other income, net............. 10,998 171 591 1,046 780
------- -------- ------- -------- --------
Income (loss) from continuing
operations before provision
for income taxes............. 7,723 (4,495) (2,340) (597) 5,015
Provision for income taxes ... 446 -- -- -- 2,006
------- -------- ------- -------- --------
Income (loss) from continuing
operations................... 7,277 (4,495) (2,340) (597) 3,009
Loss from discontinued
operations................... -- (6,415) (1,501) (31,212) (14,941)
------- -------- ------- -------- --------
Net income (loss)............. 7,277 (10,910) (3,841) (31,809) (11,932)
Other comprehensive income
(loss), net of tax........... 425 (42) (328) 121 391
------- -------- ------- -------- --------
Net comprehensive income
(loss)....................... $ 7,702 $(10,952) $(4,169) $(31,688) $(11,541)
======= ======== ======= ======== ========
Basic net income (loss) per
common share:
Income (loss) from continuing
operations................... $ 0.31 $ (0.21) $ (0.12) $ (0.03) $ 0.08
Loss from discontinued
operations................... -- (0.31) (0.07) (1.75) (0.76)
------- -------- ------- -------- --------
Net income (loss)............. $ 0.31 $ (0.52) $ (0.19) $ (1.78) $ (0.68)
======= ======== ======= ======== ========
Diluted net income (loss) per
common share:
Income (loss) from continuing
operations................... $ 0.29 $ (0.21) $ (0.12) $ (0.03) $ 0.08
Loss from discontinued
operations................... -- (0.31) (0.07) (1.75) (0.76)
------- -------- ------- -------- --------
Net income (loss)............. $ 0.29 $ (0.52) $ (0.19) $ (1.78) $ (0.68)
======= ======== ======= ======== ========
Consolidated Balance Sheet
Data:
Working capital .............. $19,345 $ 6,401 $15,338 $ 12,145 $ 27,191
Total assets.................. 28,317 13,731 23,622 22,584 37,065
Long term obligations, less
current portion.............. -- -- 236 65 478
Shareholders' equity ......... 22,172 7,733 17,602 14,360 44,928
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Vertel Corporation (the "Company"), founded as Retix in 1985, was originally
concentrated in the internetworking market. In 1996 the operating divisions of
the Company were split into three business units, each with its own management
structure. These three units focused on internetworking, network management
software and wireless applications software. In 1997, the Company merged the
wireless applications software subsidiary into its network management software
subsidiary. Additionally, in 1997, the Company's internetworking hardware
subsidiary, Sonoma Systems, Inc. ("Sonoma"), restructured to focus solely on
broadband access equipment for the telecommunications marketplace. In January
1998, the Company discontinued investing in Sonoma and its voting ownership
was subsequently reduced to 19.9% as Sonoma raised additional capital from
outside investors. In December 1998, the Company sold its holdings of Series B
and Series C preferred stock in Sonoma to a party related to Newbridge
Networks Corporation, a significant customer of Sonoma. The Company retains an
investment in Sonoma primarily consisting of $1.0 million of Series A
preferred stock that is non-convertible and non-voting. The results of
operations for 1997 have been reclassified to present the operating results of
Sonoma as a discontinued operation. The Company is now focused on its network
management software for the telecommunications industry. Further references to
the Company in Management's Discussion and Analysis of Financial Condition and
Results of Operations refer solely to the continuing operations of Vertel
unless specifically identified otherwise.
Vertel Corporation I was organized as a wholly-owned subsidiary of Retix in
February 1996. In conjunction with the formation, Retix transferred to the
Company the net assets of Retix's TMN product line, including the direct and
indirect subsidiaries through which Retix historically conducted such
business. The Company released its first TMN software products and services in
1995.
The Company is a leading provider of telecommunications network management
software and solutions. The Company offers multiple technologies supporting
end-to-end network and service management with high quality grade of service
for network operations support systems. Vertel's solutions are deployed
worldwide by service providers, network operators, telecommunications
equipment manufacturers, independent software vendors and systems integrators.
The Company also delivers turn-key management applications that fit individual
customer requirements through its professional services organization. The
Company's products are designed to reduce network management costs by
automating critical network management functions and to assist
telecommunications service providers in deriving incremental revenue by
enabling the rapid deployment of advanced services.
The Company offers embedded software for network equipment that allows
telecommunications service providers to integrate proprietary or SNMP-based
network management systems with a TMN standards-based solution and 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, optimization of network traffic and
security. The Company provides professional services to implement and maintain
a complete TMN-based solution efficiently, including system engineering,
custom application development and technical support.
The Company sells its products and services primarily through a direct sales
force in the United States and abroad and, in certain territories, utilizes
commissioned third-party agents. Additionally, the Company has a joint
development agreement with Hewlett Packard's Communications division whereby
the two companies jointly develop, market and sell certain products. The
Company's customers include telecommunications service providers and their
customers, network equipment manufacturers, independent software developers
and software platform vendors.
The Company derives revenue primarily from software source license fees,
royalties and services, including professional services, technical support and
maintenance. Source license fees consist primarily of licenses of the
20
Company's TMN software products and development platforms. The Company
recognizes product revenue upon delivery if a signed contract exists, the fee
is fixed and determinable, collection of the resulting receivables is probable
and no significant production, modification or customization of software is
required. For contracts with multiple elements (e.g., software products,
maintenance services and other services), the Company allocates revenue to
each element of the contract based on objective evidence of the element's fair
value. This objective evidence of fair value is specific to the Company and
consists either of prices derived from sales of elements when they are sold
separately or the price established by management for sale of elements in the
ordinary course of business. To date, substantially all source license fees
have been recognized upon delivery to the customer. Source license agreements
generally do not provide for a right of return. Reserves are maintained for
returns and potential credit losses, neither of which has had a material
effect on the Company's results of operations or financial condition through
December 31, 1998.
Pursuant to source code license agreements, licensees may distribute binary
or embedded versions of the Company's software in the licensees' products.
Royalties become due upon shipment of products containing the binary or
embedded code. Generally, software license royalty revenue is recognized upon
notification by the licensee that products incorporating the Company's
software have been shipped by the licensee or, for products for which the
Company has sufficient historical information, upon estimated amounts which
the Company expects the customer to report. Because of the development times
required for licensees to design and ship products containing binary or
embedded software, the Company generally does not receive royalties from
shipments of such products for at least three quarters from the date the
Company initially ships source code.
The Company separately offers professional services, including system design
and engineering, custom application development, source code portation,
conformance testing and certification and application development. Many of the
Company's 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 are
typically billed based upon the attainment of certain milestones or a per day
fee. Revenue from professional services generally is recognized using the
percentage of completion method, or on a time and materials basis. In certain
cases, customers reimburse the Company for non-recurring engineering efforts.
Such reimbursements are recognized as revenue and associated costs are
reflected as cost of revenues.
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 typically have ranged from 10-20% of the initial
source license fee and are recognized on a straight-line basis over the term
of the contract, which is generally six to twelve months. Other revenue from
training and on-site consulting are recognized as performed.
The Company's operating expenses have increased substantially since 1996 as
the Company has made investments related to the development and introduction
of its TMN products, expanded its sales force and established additional
general and administrative functions. The Company anticipates that operating
expenses will continue to increase for the foreseeable future as it continues
to develop its technology, increase sales and marketing efforts, establish and
expand distribution channels and institute additional general and
administrative functions.
The Company's prospects are dependent on market acceptance of the TMN
standard and must be evaluated in light of the risks and uncertainties
frequently encountered by companies dependent upon such early stage standards
and products. In addition, the Company's markets are new and rapidly evolving
which heightens these risks and uncertainties. To address these risks, the
Company must, among other things, successfully implement its marketing
strategy, respond to competitive developments, continue to develop and upgrade
its products and technologies more rapidly than its competitors and
commercialize its products and services incorporating these enhanced
technologies. There can be no assurance that the Company will succeed in
addressing any or all of these risks. See Item 1: Business; "Risk Factors--Our
Success is Dependent on Widespread, Timely Adoption of the TMN Standard."
21
Results of Operations
The following table sets forth certain items from the Company's Statement of
Operations as a percentage of net revenues:
Years Ended
December 31,
---------------------
1998 1997 1996
----- ----- -----
Net revenues................ 100.0% 100.0% 100.0%
Cost of revenues............ 25.5 24.3 18.4
----- ----- -----
Gross margin................ 74.5 75.7 81.6
Operating expenses:
Research and development.. 36.1 30.3 33.8
Sales and marketing....... 39.8 42.4 47.2
General and
administrative........... 16.4 20.1 19.9
Restructuring expense
(benefit)................ -- 8.2 (1.2)
----- ----- -----
Total operating
expenses............... 92.3 101.0 99.7
----- ----- -----
Operating loss from
continuing operations...... (17.8)% (25.3)% (18.1)%
===== ===== =====
Net Revenues. Net revenues remained relatively unchanged between 1997 and
1998, decreasing 0.6% to $18,367,000 in 1998 from $18,477,000 in 1997
following a 14.4% increase from $16,157,000 in 1996. The slight decrease in
net revenues in 1998 was due primarily to lower revenues from professional
service contracts and custom software engineering services, which was
partially offset by an increase in license revenues. The increase in net
revenues in 1997 was primarily due to growth in demand for the Company's TMN-
based products through both new product offerings and new customers.
Additionally, revenues were generated from existing customers who began to
utilize TMN for new systems as well as to interface with existing legacy
systems. Sales generated by the Company consist of network management software
license and service and other revenues.
License revenues consist primarily of licenses and royalties of the
Company's TMN-based software solutions and development platforms, and
typically have accounted for a substantial portion of total revenue in each
quarter. Annual license revenues increased 5.6% to $13,301,000 during 1998
from $12,590,000 in 1997 following a 7.5% increase from $11,714,000 in 1996.
The increase in license revenues in 1998 as compared to 1997 was due primarily
to two large license contracts. During the second quarter of 1998 the Company
completed a $1,000,000 semi-exclusive licensing contract of the Company's
Aeronautical Telecommunications Network (ATN) Router software. During the
third quarter of 1998 the Company licensed approximately $800,000 of
background technology in connection with the Company's sale of its CDPD and
pACT technologies to AMP. Additionally, the Company realized increases in
licensing of telecore and access products including joint HP/Vertel telecore
products that were introduced in 1998. These increases were partially offset
by the one time final billing of $1,900,000 related to the discontinuance of
the pACT-based two-way paging messaging products in the corresponding period
in 1997. The increase in license revenues in 1997 as compared to 1996 was
primarily due to the above-noted $1,900,000 in final billings.
Service and other revenues consist primarily of professional services,
maintenance, technical support, non-recurring engineering projects, training
and other revenues. Service and other revenues decreased 13.9% to $5,066,000
during 1998 from $5,887,000 in 1997 following a 32.5% increase from $4,443,000
in 1996. The decrease in service and other revenues in 1998 as compared to
1997 was primarily the result of fewer professional service contracts and
lower custom software engineering services. The increase in service and other
revenues in 1997 as compared to 1996 was primarily due to higher revenues from
professional service contracts, custom software engineering services and
maintenance revenues.
The Company intends to continue to introduce new products to expand its
position as a leader in providing telecommunications management solutions;
however, net revenues and operating results of future periods may be adversely
affected if the Company experiences delays in releasing new products, if such
new products are not accepted by the marketplace, or if the Company
experiences unanticipated decreases in other product revenues.
22
Sales to customers outside of the United States comprised approximately
42.9%, 40.3% and 52.6%, respectively, of net revenues in 1998, 1997 and 1996.
The Company has historically reported a high percentage of sales to customers
outside of the United States which the Company believes reflects a high degree
of investment by non-U.S. companies in new infrastructure, compared to their
U.S. counterparts. The Company expects to continue significant international
sales, however, continued economic turmoil in Asia and other parts of the
world could impact future sales in those regions.
Gross Margin. Cost of revenues consists primarily of professional
engineering services, primarily comprised of payroll and related costs, and
royalties paid under software licensing agreements and warranty costs. Gross
margin decreased to 74.5% of net revenues in 1998, from 75.7% in 1997 and from
81.6% in 1996. The decrease in 1998 compared to 1997 was primarily due to
reduced margins on professional engineering services. The decrease in 1997 as
compared to 1996 was primarily due to higher professional services revenue in
the product mix, which have lower margins compared to license revenue. The
Company anticipates that changes to pricing structures and distribution
strategies may occur, and that margins may fluctuate and could decline in
future periods.
Research and Development. The Company has invested heavily in research and
development to expand its expertise in TMN-based software solutions
applications technologies and to continue sustaining support of its product
offerings. The major components of R&D expenses are engineering salaries,
employee benefits and associated overhead, fees to outside contractors, the
cost of facilities and depreciation of capital equipment, which consists
primarily of computer and test equipment. Costs related to R&D in certain
cases are offset by customer reimbursement of non-recurring engineering
efforts.
Total R&D expenses increased 18.6% to $6,639,000 in 1998 from $5,600,000 in
1997 and increased 2.5% in 1997 from $5,461,000 in 1996. As a percentage of
revenue, R&D expenses increased to 36.1% in 1998, as compared to 30.3% in 1997
and 33.8% in 1996. The increase in R&D expenses during 1998 was primarily the
result of additional salaries and related expenses due to additional personnel
and an increase in the average level of compensation, as well as a reduction
in the amount of expenses being reimbursed by customers as a result of lower
non-recurring engineering services. The increase in R&D expense in 1997 as
compared to 1996 was primarily due to an increase in expenditures for further
expansion of TMN-based software development tools, stacks and applications.
The increase in R&D expense as a percentage of revenues reflects the increase
in expenditure levels, whereas the decrease in R&D expense as a percentage of
revenue in 1997 as compared to 1996 reflects the overall increase in revenues
for the period.
The Company expects to continue to make significant investments in the
development of new products and feature enhancements to existing product
lines, although such expenses may fluctuate from quarter to quarter both in
absolute dollars and as a percentage of revenue depending on the status of
various development projects, the level of non-recurring engineering services
and the amount of license revenue.
Sales and Marketing. Sales and marketing expenses consist primarily of
personnel and associated costs related to selling, support and marketing
activities, including marketing programs such as trade shows and other
promotional costs. The Company believes that substantial sales and marketing
expenditures are essential to developing the opportunities for revenue growth
and to sustaining the Company's competitive position. Sales and marketing
expenses are expected to continue to comprise a significant percentage of the
Company's total expenses because of costs associated with supporting the
worldwide sales and service functions necessary to meet the needs of the
Company's customer base and respond to the opportunities in the TMN
marketplace.
Sales and marketing expenses decreased 6.6% to $7,310,000 in 1998 from
$7,829,000 in 1997 and increased 2.7% in 1997 from $7,625,000 in 1996. Sales
and marketing expenses decreased in 1998 as compared to 1997, and decreased as
a percentage of revenues to 39.8% in 1998 from 42.4% in 1997 due primarily to
lower promotional expenses for trade shows during 1998 compared to the 1997.
In addition, sales salaries, commissions, and related expenses in the 1998
period were lower as a result of certain staff reductions which occurred
during 1997, and decreased technical support expenses as a result of the
Company's disposition of its
23
Irish operations in July 1998. The Company's Irish operations had previously
been devoted primarily to the development and support of the Company's ATN
software products. Sales and marketing expenses increased slightly in 1997 as
compared to 1996, but decreased as a percentage of revenues to 42.4% in 1997
from 47.2% in 1996 primarily due to slower growth of additional sales offices
in early 1997 as revenues increased over the prior year.
The Company has developed a strategy to capitalize on the emerging TMN
market through the establishment and growth of offices and sales personnel
around the world. In conjunction with this strategy, the Company intends to
expand its sales and marketing functions further during 1999 to support
anticipated broader market adoption of TMN and anticipates those dollar
expenditures on sales and marketing will be higher in 1999 as a result
thereof.
General and Administrative. General and administrative expenses consist
primarily of salaries, rent and other related expenses of administrative,
executive and financial personnel as well as professional fees, investor
relations costs and insurance premiums. General and administrative expenses
decreased 19.0% to $3,014,000 in 1998 as compared to $3,719,000 in 1997, and
increased 15.4% in 1997 from $3,223,000 in 1996. The decrease in 1998 was due
primarily to the elimination of certain corporate overhead expenses incurred
in 1997 when the Company had a holding company structure to oversee the
operations of its subsidiaries, including Sonoma Systems. The increase in
general and administrative costs in 1997 as compared to 1996 was primarily
attributable to increases in infrastructure costs including severance and
professional fees related to the merger of the Company's subsidiary, Wireless
Solutions, into Vertel in mid-1997, and charges for reductions in the
Company's Irish offices and staffing.
Restructuring Expense (Benefit). The Company operates in an industry that is
characterized by rapid development of new technology, which profoundly affects
product and marketing strategies of companies operating within the industry.
In December 1997, the Company announced plans to discontinue investment in its
broadband access equipment subsidiary, Sonoma. As a result, the Company's
management structure was reorganized and downsized to reflect the reduction of
the number of operating subsidiaries to one. The estimated costs of
restructuring recorded in the financial statements for the year ended December
31, 1997 were $1,816,000 and included costs of officer severance pay,
acceleration of vesting for certain officer and director stock options,
facility consolidation, professional fees and other related charges. These
costs were paid in 1998 except for $119,000 related to facility reserves.
Additionally, during the fourth quarter of 1997, the Company recorded a
reversal of certain restructuring reserves and accruals originally recorded in
1995 totaling $303,000, resulting in a net restructuring expense recorded for
fiscal 1997 of $1,513,000.
In 1995, the Company announced a major restructuring of its operations
resulting from the significant downsizing of its internetworking hardware
business unit, later known as Sonoma. The resulting restructuring charge
included costs for exiting certain leased facilities, inventory and fixed
asset write downs, severance payments for terminated employees, foreign office
closure costs and other reserves. The estimated costs of restructuring
recorded in the financial statements for the year ended December 31, 1995 was
$2,277,000. Subsequently, the Company recorded the reversal of excess
restructuring reserves totalling $303,000 and $197,000 for the years ended
December 31, 1997 and 1996, respectively, primarily as a result of favorable
lease exit costs and lower than anticipated severance costs. As of December
31, 1998, substantially all reserves related to the 1995 restructuring charge,
except for $105,000 related to costs for final closures of foreign
subsidiaries, had been utilized or reversed.
Loss from Continuing Operations. The Company incurred a loss from continuing
operations of $3,275,000 in 1998, $4,666,000 in 1997, and $2,931,000 in 1996.
The decrease in loss from continuing operations in 1998 as compared to 1997 is
primarily attributable to the restructuring expense in 1997, as the 1998
reductions in sales and marketing and general and administrative expenses are
partially offset by the lower gross margin and increased research and
development costs as noted above. The loss from continuing operations in 1996
is primarily attributable to increases in operating costs as the Company
expanded infrastructure.
24
Other Income, Net. Other income, net, in 1998 is principally comprised of
the following items: (i) an approximately $7,600,000 net gain that was
realized by the Company from the sale of its holdings of Series B Preferred
Stock and Series C Preferred Stock of Sonoma Systems; (ii) an approximately
$2,200,000 net gain from the sale of the Company's CDPD and pACT technologies
to AMP; (iii) an approximately $600,000 net gain resulting from the
curtailment of a non-U.S. pension plan that previously covered the Company's
Irish employees; (iv) a $437,000 gain on the sale of a software library and
the assignment of certain assets and liabilities of the Company's ATN
operations in Ireland to a subsidiary of Airtel ATN plc and, (v) net interest
income of $420,000. These amounts were partially offset by the realization of
a cumulative exchange loss of approximately $436,000 related to the
disposition of the Company's Irish operations. Other income, net, of $171,000
in 1997 was primarily interest income and the decrease from $591,000 in 1996
was primarily attributable to decreases in interest income from decreasing
cash balances during 1997 and lower interest rates earned on investments. It
is not expected that other income, net, will continue at the 1998 level.
Provision for Income Taxes. The Company recorded a provision for income
taxes of $446,000 on pre-tax income from continuing operations of $7,277,000
in 1998. No income tax benefit was recognized on pre-tax losses from
continuing operations of $4,495,000, and $2,340,000 in 1997 and 1996,
respectively. The Company's 1998 tax provision was positively impacted by the
utilization of approximately $6,330,000 of net operating losses carried
forward from prior years. Deferred tax assets and liabilities are recognized
based on differences between financial statement and tax bases of assets and
liabilities using presently enacted rates. A valuation allowance equal to the
total amount of the Company's net deferred tax assets of $21,680,000 at
December 31, 1998, has been established. The net deferred tax assets will be
realized to the extent that the Company operates profitably in the future
during the respective carryforward periods.
Liquidity and Capital Resources
Net cash generated from operating activities during 1998 was $1,755,000
compared to $4,277,000 used by operating activities in 1997 and $1,214,000
generated by operating activities in 1996. The positive cash flow from
operations in 1998 was comprised primarily of proceeds from the sale of the
Company's CDPD and pACT technologies ($2,000,000), non-cash depreciation and
amortization ($1,124,000), a decrease in accounts receivable ($954,000) and an
increase in accrued taxes ($310,000). These amounts were partially offset by
payments in 1998 of restructuring expenses that were accrued in 1997
($1,263,000). The negative cash flow from operating activities in 1997 was
comprised primarily of net loss ($4,495,000) and an increase in accounts
receivable ($710,000). These amounts were partially offset by non-cash
depreciation and amortization ($1,017,000). The positive cash flow from
operations in 1996 was comprised primarily of non-cash depreciation and
amortization ($1,003,000), an increase in other accrued liabilities ($926,000)
and an increase in accounts payable of ($753,000). These amounts were
partially offset by the net loss from continuing operations ($2,340,000).
Net cash provided by investing activities was $7,881,000, $7,899,000 and
$461,000 for 1998, 1997 and 1996 respectively. The net cash provided in 1998
was primarily due to the sale of the Company's holdings of Series B and Series
C Preferred Stock of Sonoma Systems ($10,093,000) partially offset by
purchases of property and equipment ($1,161,000) and purchases of short-term
investments ($978,000). The net cash provided in 1997 was primarily due to
sales of short-term investments ($7,748,000) and a reduction in others assets
($631,000), which was partially offset by purchases of property and equipment
($480,000). The net cash provided in 1996 was primarily due to sales of short-
term investments ($1,684,000), partially offset by an increase in others
assets ($883,000) and purchases of property and equipment ($340,000).
Net cash provided by financing activities was $3,338,000, $766,000 and
$7,411,000 for 1998, 1997 and 1996, respectively of which $2,971,000 and
$4,090,000 was received from private placements of Common Stock in 1998 and
1996, respectively; $341,000, $256,000 and $3,321,000 was received from the
exercise of stock options and stock sales under the employee stock purchase
plans in 1998, 1997 and 1996, respectively; and $25,000 and $510,000 was
received in 1998 and 1997, respectively, as the result of the repayment of
certain notes receivable originally issued from the exercise of certain stock
options.
Net cash provided by (used for) discontinued operations was $281,000,
($6,313,000) and ($6,057,000) for 1998, 1997 and 1996, respectively.
25
The Company believes that cash and short term investment balances
($20,473,000 at December 31, 1998) will be sufficient to meet the Company's
liquidity requirements for the next twelve months. From time to time, the
Company may also consider the acquisitions of, or evaluate investments in,
certain products and businesses complementary to the Company's business. Any
such acquisitions or investments may require additional capital resources.
At December 31, 1998 the Company's long-term liquidity needs consisted
principally of operating lease commitments related to facilities and office
equipment.
Year 2000 Issues
General. The Company is currently conducting a company-wide Year 2000
readiness program ("Y2K Program"). The Y2K Program is addressing the issue of
computer programs and embedded computer chips being unable to distinguish
between the year 1900 and the year 2000. Therefore, some computer hardware and
software will need to be modified prior to the Year 2000 in order to remain
functional. The Company anticipates that Year 2000 compliance will be
substantially complete by April 1999.
Y2000 Program. The Company's Y2K Program is divided into four major
sections: (1) Company developed products, (2) internal information processing
("IP") system, (3) non-IP system, and (4) third-party suppliers and customers.
The general phases common to all sections are: (1) inventorying Year 2000
items; (2) assessing the Year 2000 compliance of items determined to be
material to the Company; and (3) repairing or replacing material items that
are determined not to be Year 2000 compliant.
The Company has completed the review of all Company developed products for
Year 2000 compliance purposes. The Company believes that most (80%) of the
Company's products are Year 2000 compliant and that those that are not Year
2000 compliant will be upgraded to be Year 2000 compliant by April 1999, or
discontinued and replaced with Year 2000 compliant products providing the same
functionality. However, to the extent that others, such as system integrators,
make use of the Company's software in developing solutions for third parties,
the Company may have no knowledge as to the Year 2000 readiness of those third
party products. In addition it is possible that third parties could assert
claims against the Company or its customers concerning Year 2000 issues and
regardless of their merits or lack thereof, and such claims could be material.
The Company has completed an evaluation of Year 2000 issues associated with
its internal IP computer systems. Most of the Company's computer systems are
already Year 2000 compliant. Other internal computer systems that have been
identified as non-compliant will be upgraded to be Year 2000 compliant by
March 1999.
The Company has completed an evaluation of Year 2000 issues associated with
its non-IP systems. Most of them are Year 2000 compliant. Those non-IP systems
that are not Year 2000 compliant will be repaired or replaced by June 1999.
The Company has completed an evaluation of the possible effects on the
Company's operations of the Year 2000 readiness of its key suppliers. The
Company relies on third party manufacturers for the proper functioning of its
information systems, software and products. The failure of those manufacturers
to address Year 2000 issues could have a material impact on the Company's
operations and financial results; however, the potential impact and related
costs are not known at this time.
Costs. The total cost associated with required modifications to become Year
2000 compliant is not expected to be material to the Company's financial
position. Through December 31, 1998, the Company has spent less than $60,000
to implement the Year 2000 compliance program. That amount has been expensed.
The Company estimates that it may spend up to an additional $250,000 for other
replacements or upgrades and for communicating with key suppliers and
customers. Approximately $100,000 of that amount will relate to new computer
equipment and software and will be capitalized, and the remainder will be
expensed as incurred.
26
Risks. The failure to correct a material Year 2000 problem could result in
an interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of
Year 2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition. The Y2K Program is expected to
significantly reduce the Company's level of uncertainty about the Year 2000
problem. The Company believes that, with the implementation of new business
systems and completion of the Y2K Program as scheduled, the possibility of
significant interruptions of normal operations should be reduced.
The Company does not yet have a contingency plan to address the Year 2000
problem, but it is expected to create one by June 1999 if it appears that the
Company or its key suppliers and customers will not be Year 2000 compliant and
that such non-compliance is expected to have a material adverse impact on the
Company's operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
(a) Quantitative Information About Market Risk.
The Company's exposure to market risk for changes in interest rates
relates primarily to the Company's investment portfolio. The Company
maintains an investment policy that ensures the safety and preservation of
its invested funds by limiting default risk, market risk and investment
risk. As of December 31, 1998, the Company had $19,495,000 and $978,000 in
cash and cash equivalents and short-term investments, respectively, with a
weighted average variable rate 5.48% and 5.34%, respectively.
The Company mitigates default risk by investing in high credit quality
securities and by constantly positioning its portfolio to respond
appropriately to a significant reduction in a credit rating of any
investment issuer or guarantor and by placing its portfolio under the
management of professional money managers who invest within specified
parameters established by the Board of Directors. The portfolio includes
only marketable securities with active secondary or resale markets to
ensure portfolio liquidity and maintains a prudent amount of
diversification.
The Company currently has no short-term or long-term debt outstanding.
(b) Qualitative Information About Market Risk
While the Company's consolidated financial statements are prepared in
United States dollars, a portion of the Company's worldwide operations have
a functional currency other than the United States dollar. In particular,
the Company maintains operations in France, Germany, Japan, Korea and the
United Kingdom, where the functional currencies are: French Francs,
Deutschemarks, Yen, Won and British Pounds, respectively. Most of the
Company's revenues are denominated in the United States Dollar.
Fluctuations in exchange rates may have a material adverse effect on the
Company's results of operations and could also result in exchange losses.
The impact of future exchange rate fluctuations cannot be predicted
adequately. To date, exchange fluctuations have not had a material impact
on the Company's earnings and the Company has not sought to hedge the risks
associated with fluctuations in exchange rates, but may undertake such
transactions in the future. The Company does not have a policy relating to
hedging. There can be no assurance that any hedging techniques implemented
by the Company would be successful or that the Company's results of
operations will not be materially adversely affected by exchange rate
fluctuations.
(c) Euro Impact
In January 1999, eleven European countries, including France and Germany,
where the Company maintains operations, implemented a single currency (the
"Euro") to replace their separate currencies. While transactions may still
be consummated in the individual currencies of the member countries, the
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Company will be required to, and is currently in the process of,
implementing modifications to its payroll and benefits systems as well as
its contracts and other obligations in order to accommodate the Euro. The
Company does not currently believe that it will incur a material financial
expense in connection with such modifications. The introduction of the
Euro, presents certain risks for the Company including, risks associated
with its reduced ability to adjust pricing of its products based on local
currencies, fluctuations in the Euro based on economic turmoil in countries
other than those in which the Company does business and other risks
normally associated with doing business in international currencies, any of
which could have an adverse effect on the Company's business, financial
condition and results of operations.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
VERTEL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
December 31,
------------------
1998 1997
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................ $ 19,495 $ 6,252
Short-term investments .................................. 978 --
Trade accounts receivable (net of allowances of $556 and
$452 for 1998 and 1997, respectively)................... 3,883 4,941
Prepaid expenses and other current assets................ 1,134 925
Net assets of discontinued operations.................... -- 281