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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ___________.
COMMISSION FILE NUMBER: 000-28843
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TURNSTONE SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0473640
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2220 CENTRAL EXPRESSWAY
SANTA CLARA, CALIFORNIA 95050
(Address of principal executive offices, including zip code)
(408) 907-1400
(Registrant's telephone number, including area code)
--------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
There were 65,221,908 shares of the Company's Common Stock, par value
$.001, outstanding on November 2, 2000.
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TURNSTONE SYSTEMS, INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C> <C>
PART I. FINANCIAL INFORMATION PAGE NO.
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2000 3
and December 31, 1999............................................
Condensed Consolidated Statements of Operations for the Three and
Nine Months Ended September 30, 2000 and 1999.................... 4
Condensed Consolidated Statements of Cash Flows for the Nine 5
Months Ended September 30, 2000 and 1999.........................
Notes to Consolidated Financial Statements........................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and 12
Results of Operations............................................
Item 3. Quantitative and Qualitative Disclosures About Market Risk........... 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................... 27
Item 2. Changes in Securities and Use of Proceeds............................ 27
Item 3. Default Upon Senior Securities....................................... 28
Item 4. Submission of Matters to Vote for Securities Holders................. 28
Item 5. Other Information.................................................... 28
Item 6. Exhibits and Reports on Form 8-K..................................... 28
Signatures ..................................................................... 29
</TABLE>
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TURNSTONE SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 229,231 $ 8,063
Short-term investments 56,350 -
Accounts receivable, net 18,914 6,439
Inventory 20,203 2,939
Prepaid expenses and other current assets 3,144 599
------------- -------------
Total current assets 327,842 18,040
Property and equipment, net 3,425 1,085
Restricted cash 3,639 -
Intangible assets 6,136 -
Other assets 207 132
------------- -------------
Total assets 341,249 19,257
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current obligations under capital leases 225 229
Accounts payable 11,871 783
Accrued compensation and benefits 2,853 920
Income tax payable 11,113 -
Customer deposits 3,795 1,328
Other current liabilities and accrued expenses 3,557 1,679
Deferred revenue 3,301 2,132
------------- -------------
Total current liabilities 36,715 7,071
Long-term obligations under capital leases, net of current
portion 67 260
Other long-term liabilities 2,352 35
------------- -------------
Total liabilities 39,134 7,366
------------- -------------
Stockholders' equity:
Convertible preferred stock - 15
Common stock, $.001 stated value, 200,000 shares authorized;
65,072 and 22,814 shares issued and outstanding at
September 30, 2000 and December 31, 1999, respectively 65 22
Additional paid-in capital 289,074 26,536
Deferred stock compensation (8,487) (9,701)
Accumulated other comprehensive loss (8) -
Retained earnings (accumulated deficit) 21,471 (4,981)
------------- -------------
Total stockholders' equity 302,115 11,891
------------- -------------
Total liabilities and stockholders' equity $ 341,249 $ 19,257
============= =============
</TABLE>
The accompanying notes are an integral part of the financial statements.
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TURNSTONE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
THE THREE MONTHS THE NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues $ 56,227 $ 9,033 $120,387 $ 14,704
Cost of revenues 23,356 3,834 49,188 6,920
-------- -------- -------- --------
Gross profit 32,871 5,199 71,199 7,784
Operating expenses:
Research and development (Exclusive of non-cash
compensation of $904 and $549 for the three months ended
September 30, 2000 and 1999 and $3,034 and $778
for the nine months ended September 30, 2000 and
1999, respectively) 5,884 1,756 12,234 3,609
Sales and marketing (Exclusive of non-cash
compensation of $460 and $257 for the three months
ended September 30, 2000 and 1999 and $1,512 and
$426 for the nine months ended September 30,
2000 and 1999, respectively) 3,495 1,100 9,208 2,429
General and administrative (Exclusive of non-cash
compensation of $370 and $71 for the three months
ended September 30, 2000 and 1999 and $1,002 and
$956 for the nine months ended September 30, 2000
and 1999, respectively) 1,643 444 3,539 943
Amortization of intangible assets 231 - 231 -
Amortization of deferred stock compensation 1,734 877 5,548 2,160
-------- -------- -------- --------
Total operating expenses 12,987 4,177 30,760 9,141
-------- -------- -------- --------
Operating income (loss) 19,884 1,022 40,439 (1,357)
Interest income (expense) and other, net 1,446 29 3,839 112
-------- -------- -------- --------
Income (loss) before income tax 21,330 1,051 44,278 (1,245)
Income tax expense 8,515 63 17,826 63
-------- -------- -------- --------
Net income (loss) $ 12,815 $ 988 $ 26,452 $ (1,308)
Basic net earnings (loss) per share of common stock $ .24 $ .11 $ .56 $ (.17)
Diluted net earnings (loss) per share of common stock $ .19 $ .02 $ .41 $ (.17)
Weighted-average shares of common stock outstanding used in
computing basic net earnings (loss) per share 53,559 9,399 47,276 7,672
Weighted-average shares of common stock outstanding used in
computing diluted net earnings (loss) per share 66,647 55,400 65,110 7,672
</TABLE>
The accompanying notes are an integral part of the financial statements.
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TURNSTONE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
THE NINE MONTHS ENDED SEPTEMBER 30,
2000 1999
--------------- ---------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 26,452 $ (1,308)
Adjustments to reconcile net income (loss) to net cash provided (used) in
operating activities:
Depreciation and amortization 807 212
Amortization of deferred stock compensation 5,548 2,160
Common stock issued for services -- 13
Provision for doubtful accounts and sales returns 696 226
Loss on disposal of property and equipment 55 --
Effect of changes in foreign currency 91 --
Changes in assets and liabilities:
Accounts receivable (12,735) (5,001)
Inventory (17,264) (3,281)
Prepaid expenses and other current assets (2,532) (65)
Accounts payable 11,086 3,635
Accrued compensation and benefits 1,892 795
Income tax payable 11,104 --
Accrued expenses and other current and long-term liabilities 1,930 526
Deferred revenue 1,169 1,152
Customer deposits 2,467 --
--------------- ---------------
Net cash provided (used) in operating activities 30,766 (936)
INVESTING ACTIVITIES
Acquisition of Paragon Solutions Limited, net of cash acquired of $374 (4,626) --
Acquisition of property and equipment (2,937) (332)
Proceeds from disposal of property and equipment 9 --
Purchases of available-for-sale investments, net (76,923) --
Proceeds from sales and maturities of available-for-sale investments 20,565 --
Increase in other assets (75) (106)
Increase in restricted cash (3,639) --
--------------- ---------------
Net cash used in investing activities (67,626) (438)
FINANCING ACTIVITIES
Net proceeds from issuance of common stock 258,232 966
Net proceeds from issuance of convertible preferred stock -- 6,174
Principal payments of capital lease obligations (169) (152)
--------------- ---------------
Net cash provided by financing activities 258,063 6,988
Effect of exchange rate changes on cash and cash equivalents (35) --
Net increase in cash and cash equivalents 221,168 5,614
Cash and cash equivalents at beginning of period 8,063 1,338
--------------- ---------------
Cash and cash equivalents at end of period $ 229,231 $ 6,952
=============== ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 22 $ 17
Cash paid for income tax $ 6,775 $ 3
NONCASH INVESTING AND FINANCING ACTIVITIES:
Note payable issued for acquisition of Paragon Solutions Limited $ 2,283 $ --
Equipment purchases under capital leases $ -- $ 266
Deferred stock compensation $ 4,334 $ 11,115
</TABLE>
The accompanying notes are an integral part of the financial statements.
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TURNSTONE SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2000
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared by Turnstone Systems, Inc. (the Company), pursuant
to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures, normally
included in financial statements prepared in accordance with generally
accepted accounting principles, have been condensed or omitted
pursuant to such rules and regulations. While in the opinion of the
Company, the unaudited consolidated financial statements reflect all
adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the financial position at
September 30, 2000, the operating results for the three and nine
months ended September 30, 2000 and 1999 and cash flows for the nine
months ended September 30, 2000 and 1999, these consolidated financial
statements and notes should be read in conjunction with the Company's
audited financial statements and notes thereto, included in the
Company's Registration Statement on Form S-1 filed with the Securities
and Exchange Commission on September 1, 2000. The condensed balance
sheet at December 31, 1999 has been derived from audited financial
statements as of that date.
The results of operations for the three and nine months ended
September 30, 2000 and 1999 are not necessarily indicative of results
that may be expected for any other interim period or for the full
fiscal year ending December 31, 2000.
During July 2000, the Board of Directors authorized a two-for-one
stock split of the Company's common stock effected in the form of a
stock dividend on August 23, 2000 to holders of record as of the close
of business on August 9, 2000. All common shares, common options and
per share amounts in the accompanying financial statements have been
adjusted to reflect the stock split.
2. Completion of Public Offerings
In February 2000, the Company completed its initial public offering.
The Company issued 6,900,000 shares of common stock in exchange for
net proceeds of approximately $92.1 million. Upon the completion of
the initial public offering, all outstanding convertible preferred
stock converted into an aggregate of 29,700,000 shares of common
stock.
In September 2000, the Company completed a secondary public offering.
The Company issued 3,500,000 shares of common stock in exchange for
proceeds of approximately $165.2 million, net of underwriting
discounts and direct offering expenses.
As of September 30, 2000, the Company was authorized to issue
200,000,000 shares of common stock, $0.001 par value, and 5,000,000
shares of undesignated preferred stock, $0.001 par value.
3. Summary of Significant Accounting Policies
Revenue Recognition
The Company recognizes revenue from product sales upon shipment,
assuming collectibility of the resulting receivable is probable. When
the arrangement with the customer includes future obligations or
obtaining
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customer acceptance, revenue is recognized when those obligations have
been met or customer acceptance has been received. Revenue from
services and support provided under the Company's comprehensive
maintenance programs is deferred and recognized on a straight line
basis over the period of the contract. Deferred revenue represents
amounts received from customers for comprehensive maintenance programs
in advance of services and support to be provided. Revenue from
transactions involving the Company's software application products is
accounted for in accordance with Statement of Position (SOP) 97-2,
Software Revenue Recognition, and SOP 98-9, Software Revenue
Recognition with Respect to Certain Arrangements. Accordingly, the
Company recognizes revenue from licenses of software application
products provided that a purchase order has been received, the
software and related documentation have been shipped, collection of
the resulting receivable is deemed probable, and the fee is fixed or
determinable. To date, revenue from such transactions has not been
significant.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with a maturity of
90 days or less when acquired to be cash equivalents. Cash equivalents
as of September 30, 2000 and December 31, 1999 consist primarily of
cash on deposit with banks, money market funds, commercial paper and
government debt securities. Short-term investments at September 30,
2000 consist primarily of government and corporate debt securities.
The Company has adopted Statement of Financial Accounting Standards
(SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities. SFAS No. 115 requires entities to classify investments in
debt and equity securities with readily determined fair values as
"held-to-maturity," "available-for-sale" or "trading" and establishes
accounting and reporting requirements for each classification. The
Company has classified its investment securities as
available-for-sale. Available-for-sale securities are carried at fair
value. Unrealized gains and losses are included in other comprehensive
income (loss). Realized gains and losses are computed using the
specific identification method.
Inventory
At September 30, 2000 and December 31, 1999, inventory consisted of
the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
-------------- --------------
<S> <C> <C>
Raw materials $ 4,804 $ 85
Finished goods 15,399 2,854
-------------- --------------
$ 20,203 $ 2,939
-------------- --------------
</TABLE>
Segment Information
SFAS No. 131, Disclosure About Segments of an Enterprise and Related
Information, establishes standards for the manner in which public
companies report information about operating segments, products and
services, geographic areas and major customers in annual and interim
financial statements. The method of determining what information to
report is based on the way that management organizes the operating
segments within the enterprise for making operating decisions and
assessing financial performance.
The Company's chief operating decision maker is considered to be the
Company's Chief Executive Officer (CEO). The Company consists of one
product line. The CEO reviews financial information on a single entity
level basis for purposes of making operating decisions and assessing
financial performance. The entity level financial information is the
same as the information presented in the accompanying statements of
operations. Accordingly, the Company has determined that it is engaged
in a single operating segment.
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Substantially all of the Company's assets are located in the United
States. All of the Company's revenues in fiscal 1999 were derived from
customers located in the United States. For the three months ended
September 30, 2000, approximately 19% of revenues were derived from
sales to customers located outside the United States.
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries located in New Zealand, the
United Kingdom, and Australia. All significant intercompany accounts
and transactions have been eliminated in consolidation.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities,
which establishes accounting and reporting standards for derivative
instruments, including derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging
activities. The Company will adopt SFAS No. 133, as amended by SFAS
No. 137, Deferral of the effective date of the FASB Statement No. 133,
in fiscal year 2001. The adoption of SFAS No. 133 is not currently
expected to have a material impact on the financial condition or
results of operations of the Company.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101). This summarizes certain areas
of the Staff's views in applying generally accepted accounting
principles to revenue recognition in financial statements. The
application of SAB 101 is required to be implemented no later than the
fourth fiscal quarter of fiscal years beginning after December 15,
1999. SAB 101 is currently not expected to have a material impact on
the results of operations of the Company.
4. Net Earnings (Loss) per Share
Basic and diluted net earnings (loss) per share have been computed in
accordance with SFAS No. 128, Earnings Per Share. Basic net earnings
(loss) per share is computed using the weighted-average number of
outstanding shares of common stock excluding weighted-average number
of shares of restricted stock subject to repurchase. Diluted net
earnings (loss) per share is computed using the weighted-average
number of shares of common stock outstanding and, when dilutive,
shares of restricted common stock subject to repurchase, potential
shares of common stock from options and warrants using the treasury
stock method and from convertible securities using the "as-if
converted basis". The following table presents the calculation of
basic and diluted net earnings (loss) per share (in thousands, except
per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Numerator:
Net earnings (loss) $ 12,815 $ 988 $ 26,452 $ (1,308)
Denominator:
Weighted average shares - basic 53,559 9,399 47,276 7,672
Effect of dilutive securities
Shares issuable under stock options 5,240 2,927 5,085 --
Restricted stock subject to repurchase 7,848 13,105 9,329 --
Shares issuable pursuant to warrants -- 255 58 --
Shares of convertible preferred stock -- 29,714 3,362 --
---------- ---------- ---------- ----------
Weighted average shares - diluted 66,647 55,400 65,110 7,672
---------- ---------- ---------- ----------
</TABLE>
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<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Net earnings (loss) per share - basic $ .24 $ .11 $ .56 $ (.17)
---------- ---------- ---------- ----------
Net earnings (loss) per share - diluted $ .19 $ .02 $ .41 $ (.17)
---------- ---------- ---------- ----------
</TABLE>
Options to purchase 506,800 shares of common stock at a
weighted-average exercise price of $69.97 for the three months ended
September 30, 2000, and options to purchase 1,810,400 shares of common
stock at a weighted-average exercise price of $64.83 for the nine
months ended September 30, 2000, have been excluded from the
computation of diluted net earnings per share for the three and nine
months ended September 30, 2000, as their effect would have been
antidilutive.
Options to purchase 5,998,000 shares of common stock at a
weighted-average exercise price of $.88, warrants to purchase 270,000
shares of convertible preferred stock (on an "as-if converted basis")
at an average per share exercise price of $.25, 14,099,018 shares of
common stock subject to repurchase at an average per share exercise
price of $.06, and 29,713,860 shares of convertible preferred stock
(on an "as-if converted basis") have been excluded from the
computation of diluted net loss per share for the nine months ended
September 30, 1999, as their effect would have been antidilutive.
5. Comprehensive Income
The following table presents the calculation of comprehensive income
as required by SFAS No. 130. The components of comprehensive income
are as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- -----------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss) $ 12,815 $ 988 $ 26,452 $ (1,308)
Change in net unrealized gain (loss) on available-
for-sale investments, net of tax 23 -- (8) --
-------- -------- -------- --------
Total comprehensive income $ 12,838 $ 988 $ 26,444 $ (1,308)
-------- -------- -------- --------
</TABLE>
Tax effects of other comprehensive loss were not significant.
6. Acquisition
On August 8, 2000, the Company completed the acquisition of Paragon
Solutions Limited (Paragon), a privately-held New Zealand company.
Paragon is an engineering design services company that specializes in
the design of telecommunications services products. In connection with
this acquisition and in exchange for all outstanding ordinary shares
of Paragon, the former shareholders of Paragon received $5.0 million
in cash in August 2000. On the first anniversary of the closing date,
they are entitled to receive an additional $2.5 million and a further
$2.5 million if certain conditions are met, for a maximum second
installment of $5.0 million. As a result of the acquisition, Paragon
became a wholly-owned subsidiary of the Company. The accompanying
unaudited condensed consolidated statements of operations for the
three and nine months ended September 30, 2000 include the results of
operations of Paragon for the period from August 8, 2000 to September
30, 2000.
The acquisition was accounted for under the purchase method of
accounting in accordance with APB Opinion No. 16. Under the purchase
method of accounting, the purchase price is allocated to the assets
acquired and liabilities assumed based on their estimated fair values.
Management's best estimates of the
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fair values of the assets and liabilities of Paragon have been
combined with the recorded values of the assets and liabilities of the
Company.
The purchase price consists of the first installment of $5.0 million
and the minimum $2.5 million payment of the second installment. The
minimum amount of the second installment is valued at approximately
$2.3 million based on the present value computed at an average annual
return of 9.5%.
The total purchase price was allocated as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Property and equipment $ 93
Accounts receivable, net 480
Net tangible assets acquired, excluding property
and equipment and accounts receivable 351
Assembled workforce 1,160
Goodwill 5,199
------
Total $7,283
------
</TABLE>
The goodwill and assembled workforce are being amortized on a
straight-line basis over a four year period. At September 30, 2000,
accumulated amortization related to the goodwill and assembled
workforce acquired in the Paragon acquisition totaled $231,000.
If the maximum amount of the second installment payment is made on the
first anniversary of the consummation of the transaction and is added
to the purchase price, there would be an increase to intangible assets
of $2.5 million. Amortization of this additional purchase
consideration would commence at that time on a straight-line basis
over the remainder of the initial four year period.
The following summarized financial information, prepared on an
unaudited pro forma basis, reflects the condensed consolidated results
of operations for the nine month periods ended September 30, 2000 and
1999, assuming Paragon had been acquired at the beginning of the
periods presented (in thousands, except per share data):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
2000 1999
----------- -----------
<S> <C> <C>
Net revenue $ 121,630 $ 15,606
Net income (loss) $ 25,826 $ (2,303)
Basic net earnings (loss) per share of common
stock $ .55 $ (.30)
Diluted net earnings (loss) per share of common
stock $ .40 $ (.30)
</TABLE>
The pro forma results are not necessarily indicative of what would
have occurred if the acquisition had been in effect for the periods
presented. In addition they are not intended to be a projection of
future results or a representation of the effects of the combined
operations.
7. Commitments
In May 2000, the Company entered into an operating lease agreement for
new corporate facilities. The lease term commenced on July 1, 2000 and
will extend through June 30, 2010. Lease payments will be made on an
escalating basis for total minimum lease payments of $42.7 million
over the lease term. In May 2000, the
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Company was required to make an advance lease payment for the first
twelve months of the lease. As of September 30, 2000, the Company had
remaining prepaid rent of $2.8 million included in prepaid expenses
and other current assets.
Upon execution of the lease agreement in May 2000 and extending
through the duration of the lease term, the Company is required to
maintain a standby letter of credit in the amount of $3.6 million.
This letter of credit requires the Company to hold funds in the form
of a certificate of deposit with a financial institution. The Company
has classified these funds as restricted cash on the balance sheet at
September 30, 2000.
8. 2000 Nonstatutory Stock Plan
The Board of Directors adopted the 2000 Nonstatutory Stock Plan in
August 2000. The 2000 Nonstatutory Stock Plan provides for the grant
of nonstatutory stock options to employees and consultants. Options
granted under the 2000 Nonstatutory Stock Plan generally become
exercisable at the rate of 25% of the total number of shares subject
to the option twelve months after the date of grant and approximately
1/48 of the shares subject to the option each month thereafter. A
total of 4,000,000 shares of common stock have been reserved for
issuance under this plan.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In addition to the other information in this report, certain
statements in the following Management's Discussion and Analysis of Financial
Condition and Results of Operation (MD&A) are forward looking statements. When
used in this report, the word "expects," "anticipates," "estimates," and similar
expressions are intended to identify forward looking statements. Such statements
are subject to risks and uncertainties that could cause actual results to differ
materially from those projected. Such risks and uncertainties are set forth
below under "Factors Affecting Future Operating Results." The following
discussion should be read in conjunction with the Condensed Consolidated
Financial Statements and notes thereto included elsewhere in this report.
Overview
From inception on January 2, 1998 through December 1998, our
operating activities consisted primarily of research and development and
building our management team. We introduced our first products in October 1998,
and entered live service trials in November 1998. In January 1999, our CX100
successfully completed network equipment building standards testing, a
telecommunications industry standard. We began shipping our products in the
first quarter of 1999.
To date, we have derived substantially all of our revenues from sales
of our CX100. Revenues from our CrossWorks software have not been material. Our
success will depend on our ability to sell our CX100 to additional customers as
well as our ability to develop and sell additional products.
We recognize product revenues at the time of shipment unless we have
future obligations or customer acceptance is required, in which case revenue is
recognized when these obligations have been met or the customer accepts the
product. Revenues from maintenance contracts are deferred and recognized ratably
over the term of the contracts.
We sell our products to domestic and international local exchange
carriers through our direct sales force and through an indirect original
equipment manufacturer channel. A customer's network planning and purchase
decisions normally involve a significant commitment of its resources and a
lengthy evaluation and product qualification process. Since the decision to
purchase the CX100 is made as part of this network planning process, our sales
cycle is lengthy, often as long as one year or more. Substantially all of our
sales are made on the basis of purchase orders rather than long-term agreements.
As a result, we commit resources to the development and production of products
without having received advance purchase commitments from customers.
Based on our limited operating history, we believe that on a relative
basis, purchases by our customers tend to be lower in the fourth calendar
quarter. Many of our customers typically establish annual network buildout plans
which are often completed prior to the fourth calendar quarter. As a result, we
expect that some of our customers will cease or significantly reduce purchases
of our products in the fourth calendar quarter. If we experience a significant
reduction in sales of our products in the fourth calendar quarter, our revenues
for that quarter may decline substantially. We cannot be certain, however, that
this trend will continue or that additional patterns of seasonality will not
occur in international markets as we expand our international operations.
Many of our customers have limited financial resources available for
the continued development of their networks. These customers rely on the
availability of capital from the public equity and debt markets or on vendor
financing from large equipment vendors to obtain the funds for the purchase of
our equipment. Should they be unable to raise additional capital in the public
markets or secure additional vendor financing they may cease or significantly
delay their purchases of our products. In addition, some of our customers may
reduce the scale of their previously announced network build plans and, as a
result, require fewer of our products than we had anticipated.
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To date, a significant portion of our revenues has resulted from a
small number of relatively large orders from a limited number of customers. We
anticipate that our operating results for any given period will continue to be
dependent to a significant extent on large purchase orders, which can be delayed
or cancelled by our customers without penalty. In addition, we anticipate that
our operating results for a given period will continue to be dependent on a
small number of customers. If we fail to receive a significant purchase order
that we expect for a given quarter, our revenues for that quarter, and possibly
following quarters, will be adversely affected. Furthermore, if any of our
customers experience financial difficulties, our sales to that customer may be
reduced and we may have difficulty in collecting accounts receivable from that
customer.
We currently use A-Plus Manufacturing, a contract manufacturer, to
manufacture our products. A-Plus Manufacturing was recently acquired by C-MAC
Industries Inc., a large international contract manufacturer. This
subcontracting arrangement includes material procurement, board level assembly,
final assembly, testing and shipment to our customers. If our contract with
A-Plus Manufacturing is terminated, we would be required to purchase any excess
inventory held by them. In addition, the development of new or enhanced products
could cause inventory held by A-Plus Manufacturing to become obsolete. In that
event, we would also be obligated to purchase that inventory from them. We use a
combination of standard parts and components, that are generally available from
more than one vendor, and certain key components that are purchased from sole or
limited source vendors for which alternative sources are not currently
available. In addition, lead times for some of the materials and components we
use are very long. Further, the market for components used in telecommunications
equipment has been characterized by frequent shortages for many components.
These long lead times and component shortages have in the past
caused, and may in the future cause, us to purchase inventories of some parts
ourselves ahead of demand. Limited sources of supply of, and competition with
other manufacturers for, key components may increase the price we pay to obtain
these components and lower our gross margins. If we purchase components in
excess of actual demand we may have to write-off the unused inventory. Any
write-off of inventory could harm our results of operations and financial
condition.
We continue to develop additional products and product features based
on our assessment of the needs of our customers. This has resulted in increased
research and development expenses and may result in reduced operating margins on
our products and a longer sales cycle.
Currently, competition in our market is intense. Due to competition
and potential pricing pressures from large customers in the future, we expect
that the average selling price and gross margins for our products will decline
over time. If we fail to reduce our production costs, our gross margins will
decline rapidly.
In connection with the granting of stock options to our employees, we
recorded deferred stock-based compensation totaling approximately $17.6 million
from inception through September 30, 2000. This amount represents the difference
between the exercise price and the deemed fair value of our common stock for
accounting purposes on the date these stock options were granted. We are
amortizing the deferred stock compensation over the vesting periods of the
applicable options and the repurchase periods for restricted stock purchases.
The service period over which deferred stock compensation is amortized is
determined separately for each 25% portion of the total award, in accordance
with Financial Accounting Standards Board Interpretation No. 28. The result of
this accounting treatment is that approximately 52% of the unearned deferred
compensation will be amortized in the first year, 27% in the second year, 15% in
the third year and 6% in the fourth year following the date of the grant. We
recorded related stock-based compensation amortization expense of $3.6 million
for the year ended December 31, 1999 and $29,000 for the period from inception
to December 31, 1998. We recorded $1.7 million during the three months ended
September 30, 2000 and $5.5 million during the nine months ended September 30,
2000 of related stock-based compensation amortization expense. As of September
30, 2000, we had an aggregate of $8.5 million of related deferred compensation
to be amortized. The amortization of this amount will result in additional
charges to operations through 2004. The amortization of stock-based compensation
is presented as a separate component of operating expenses in our statements of
operations.
In August 2000, we acquired Paragon Solutions Limited, a
privately-held New Zealand company, for a total acquisition cost of a minimum of
$7.5 million in cash, and an additional $2.5 million in cash if certain
conditions
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<PAGE> 14
specified in the purchase agreement are met. We accounted for the transaction
using the purchase method of accounting. The purchase price allocation includes
an allocation of $6.4 million to goodwill and other intangibles, which we are
amortizing on a straight-line basis over four years.
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
NET REVENUES
Net revenues increased to $56.2 million for the quarter ended September 30,
2000 from $9.0 million for the comparable quarter in 1999. Net revenues
increased to $120.4 million for the nine months ended September 30, 2000 from
$14.7 million for the comparable period in 1999. The increase in net revenues is
primarily the result of increased shipments of our CX100 due to the expansion of
our sales force and to a larger domestic and international customer base. Our
revenues to date have been recognized from a small number of customers. We
expect that the majority of our revenue will continue to depend on sales of the
CX100 to a small number of customers and that our net revenues will continue to
be dependent on timing of orders and shipments to such customers. For the three
month period ended September 30, 2000, our net revenues from international
customers were approximately 19% of our total net revenues.
COST OF REVENUES
Cost of revenues includes amounts paid to A-Plus Manufacturing and related
overhead expenses, consisting primarily of salary and other expenses for
personnel engaged in procurement, vendor management, quality assurance and
customer service. Cost of revenues increased to $23.4 million, or 41.5% of net
revenues, for the three months ended September 30, 2000 from $3.8 million, or
42.4% of net revenues, in the comparable period of 1999. Cost of revenues
increased to $49.2 million, or 40.9% of net revenues, for the nine months ended
September 30, 2000 from $6.9 million, or 47.1% of net revenues, in the
comparable period of 1999. The increase in cost of revenues reflected the
increase in CX100 sales. Cost of revenues as a percentage of net revenues has
decreased due to increased unit shipments and associated manufacturing
efficiencies and cost savings from volume purchasing.
RESEARCH AND DEVELOPMENT
Research and development expenses, net of non-cash compensation expense,
consist primarily of salaries and related expenses for personnel engaged in
research and development, fees paid to consultants and outside service
providers, cost of certification and compliance testing and material costs for
prototype and test units. They also include other expenses related to the
design, development, testing and enhancements of our products. We expense all of
our research and development costs as they are incurred. Research and
development expenses increased 235.1% to $5.9 million for the three months ended
September 30, 2000 from $1.8 million in the comparable period of 1999. Research
and development expenses increased 239.0% to $12.2 million for the nine months
ended September 30, 2000 from $3.6 million in the comparable period of 1999. The
increase was due primarily to a significant increase in personnel, including the
additions to headcount from our acquisition of Paragon Solutions Limited, and
related costs associated with new product development, verification testing,
certification and compliance testing and other engineering expenses. Development
is essential to our future success and we expect that research and development
expenses will increase in absolute dollars in future periods.
SALES AND MARKETING
Sales and marketing expenses, net of non-cash compensation expense, consist
primarily of salaries, commissions, and related expenses for personnel engaged
in marketing, sales and customer support functions. These expenses also include
costs associated with trade shows, promotional activities and public relations.
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<PAGE> 15
Sales and marketing expenses increased 217.7% to $3.5 million for the three
months ended September 30, 2000 from $1.1 million in the comparable period of
1999. Sales and marketing expenses increased 279.1% to $9.2 million for the nine
months ended September 30, 2000 from $2.4 million in the comparable period of
1999. This increase was primarily due to an increase in the number of sales and
marketing personnel both domestically and internationally, increased commissions
associated with higher net revenues and increased sales and sales support
personnel, increased trade show activities and marketing expenses, and other
customer-related costs.
We intend to expand our sales and marketing operations and efforts
substantially, both domestically and internationally, in order to increase
market awareness and to generate sales of our products. We expect that sales and
marketing expenses will increase in absolute dollars in future periods.
GENERAL AND ADMINISTRATIVE
General and administrative expenses, net of non-cash compensation expense,
consist primarily of salaries and related expenses for executive, finance and
accounting and information systems personnel, professional fees, and costs
associated with expanding our information systems.
General and administrative expenses increased 270.0% to $1.6 million for the
three months ended September 30, 2000 from $444,000 in the comparable period of
1999. General and administrative expenses increased 275.3% to $3.5 million for
the nine months ended September 30, 2000 from $943,000 in the comparable period
of 1999. This increase was primarily due to an increase in the number of general
and administrative personnel, increased facilities costs, and increased legal,
accounting and other professional services expenses associated with our growing
business activities.
We expect these expenses to increase in absolute dollars as we add personnel
and incur additional costs related to growing our business, expanding our
information infrastructure and operating as a public company.
AMORTIZATION OF DEFERRED STOCK COMPENSATION
Deferred stock compensation for stock options granted at prices subsequently
deemed to be below fair value on the date of grant totaled $8.5 million at
September 30, 2000 and $9.7 million at December 31, 1999.
We are amortizing the deferred stock compensation over the vesting periods
of the applicable options and the repurchase periods for restricted stock
purchases. The service period over which deferred stock compensation is
amortized is determined separately for each 25% portion of the total award, in
accordance with Financial Accounting Standards Board Interpretation No. 28. The
result of this accounting treatment is that approximately 52% of the unearned
deferred compensation will be amortized in the first year, 27% in the second
year, 15% in the third year and 6% in the fourth year following the date of the
grant. We amortized approximately $1.7 million of deferred stock compensation
for the three months ended September 30, 2000 and $877,000 of deferred stock
compensation for the comparable period in 1999. We amortized approximately $5.5
million of deferred stock compensation for the nine months ended September 30,
2000 and $2.2 million of deferred stock compensation for the comparable period
in 1999.
INTEREST INCOME (EXPENSE) AND OTHER, NET
Interest income (expense) and other, net includes income from our cash
investments net of expenses related to our lease financing obligations. We had
net interest and other income of $1.4 million for the three months ended
September 30, 2000 and net interest and other income of $29,000 for the
comparable period in 1999. We had net interest and other income of $3.8 million
for the nine months ended September 30, 2000 and net interest and other income
of $112,000 for the comparable period in 1999. Interest income consists
primarily of interest earned on the net cash proceeds of approximately $92.1
million received in connection with the completion of our initial public
offering in February 2000 and, upon the completion of our secondary offering on
September 26, 2000, interest earned on the related cash proceeds of
approximately $165.2 million, net of underwriting discounts and direct offering
expenses. In future periods we expect
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<PAGE> 16
interest income (expense) and other, net to vary depending upon changes in the
amount and mix of interest-bearing investment and short and long-term debt
outstanding during each period.
INCOME TAX EXPENSE
We have recorded a tax provision of $8.5 million for the quarter ended
September 30, 2000 for a total of $17.8 million for the nine months ended
September 30, 2000. We did not provide for income tax expense in 1999 due to our
net loss for that period. The provision for income tax consists primarily of
federal and state taxes at an effective tax rate of 40%.
LIQUIDITY AND CAPITAL RESOURCES
Our principal source of liquidity as of September 30, 2000 consisted of
$229.2 million in cash and cash equivalents and $56.4 million in short-term
investments. As of September 30, 2000, we had $292,000 in obligations under
capital leases to be repaid over a period of three years from lease inception.
Since our inception, we have financed our operations through private and public
sales of securities and cash generated in operations.
During the nine months ended September 30, 2000, we generated $30.8 million
from operating activities compared to the same period in 1999 in which we used
$936,000 in operating activities. This positive cash flow resulted primarily
from our net income for the nine months ended September 30, 2000 and from
increases in accounts payable and accrued compensation and benefits, income tax
payable, deferred revenue and customer deposits and accrued expenses and other
current and long-term liabilities, partially offset by increases in our
inventory, accounts receivable and prepaid expense and other current asset
balances.
Net cash used in investing activities in the nine months ended September 30,
2000 was $67.6 million compared to net cash used in investing activities of
$438,000 in the same period in 1999. Cash used in investing activities in the
nine months ended September 30, 2000 consists of the purchases of
available-for-sale investments of $76.9 million, net of proceeds from sales and
maturities of $20.6 million. There were no maturities or sales of
available-for-sale investments in the nine months ended September 30, 1999. Cash
used in investing activities during the nine months ended September 30, 2000
also included the first installment payment of $5.0 million for our cash
purchase of Paragon Solutions Limited, net of $374,000 of cash acquired. The
maximum purchase price of this acquisition is $10.0 million. The second
installment of $2.5 million or, if certain conditions specified in the purchase
agreement are met, of $5.0 million, will be payable by us in cash in August
2001.
Capital expenditures increased $2.6 million for the nine months ended
September 30, 2000 compared to the same period in 1999 due primarily to
additions of office equipment and computer software and hardware associated with
our increases in staffing and expansion of information infrastructure, including
expenditures associated with our establishment of offices in Australia and the
United Kingdom. We expect that our capital expenditures will continue to
increase in future periods as we continue to expand our operations worldwide. In
May 2000, we entered into an operating lease agreement for new corporate
facilities. Upon execution of the lease agreement in May 2000 and extending
through the duration of the lease term, we are required to maintain a standby
letter of credit in the amount of $3.6 million. This letter of credit requires
us to hold funds in the form of a certificate of deposit with a financial
institution. Net cash used in investing activities for the nine months ended
September 30, 2000 included an increase to restricted cash of $3.6 million for
the certificate of deposit associated with this standby letter of credit.
Net cash provided by financing activities in the nine months ended September
30, 2000 was $258.1 million compared to $7.0 million for the comparable period
in 1999. Cash provided by financing activities in the nine months ended
September 30, 2000 was primarily from net proceeds of $92.1 million from our
initial public offering in February 2000 and net proceeds of $165.2 million from
our follow on offering in September 2000. Cash provided by financing activities
in the nine months ended September 30, 1999 was primarily due to net proceeds of
$6.2 million from the issuance of convertible preferred stock and net proceeds
of $966,000 from the issuance of common stock, partially offset by principal
payments on capital lease obligations.
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<PAGE> 17
We expect to devote substantial capital and operating resources to continue
our research and development efforts, to hire and expand the sales, support,
marketing and product development organizations, to expand marketing programs,
to expand operations worldwide and for other general corporate activities.
Although we believe that current cash balances will be sufficient to fund
operations for at least the next 12 months, we cannot assure you that we will
not require additional financing within this time frame or that such additional
funding, if needed, will be available on acceptable terms. Any additional
issuance of equity or equity-related securities will be dilutive to our
stockholders.
FACTORS AFFECTING FUTURE RESULTS
IF WE FAIL TO GENERATE CONSISTENT REVENUE GROWTH AND MAINTAIN PROFITABILITY, THE
MARKET PRICE OF OUR COMMON STOCK WILL DECLINE.
We may not succeed in generating revenue growth consistent with our recent
operating results, and our revenues may decline or may not be sufficient to
maintain profitability. If we incur losses, the market price of our common stock
may decline substantially. We expect to continue to incur significant product
development, sales and marketing and administrative expenses. In particular, we
anticipate that our expenses will increase substantially in the next 12 months
as we:
- increase our sales and marketing activities, particularly by expanding
our international sales and support organization;
- develop our technology, expand our existing product lines and add new
features to penetrate new markets; and
- develop additional infrastructure and hire additional management to
keep pace with our growth.
Our operating expenses are largely based on currently anticipated revenue
trends, which may not be realized, and a high percentage of our expenses are and
will continue to be fixed in the short term. We will need to generate
significant revenues to maintain profitability.
IF DSL TECHNOLOGY FAILS TO GAIN WIDESPREAD MARKET ACCEPTANCE, THE DEMAND FOR OUR
PRODUCTS MAY DECREASE.
If DSL technology fails to gain widespread acceptance, our revenues and
results of operations will be harmed. Our products are primarily used by local
exchange carriers who offer DSL-based services. Our future success is
substantially dependent upon whether DSL technology gains widespread market
acceptance by local exchange carriers, of which there are a limited number, and
by end users of their services. Local exchange carriers are continuously
evaluating alternative high-speed data access technologies and may at any time
adopt technologies other than DSL. Numerous other high-speed access
technologies, including cable modems, wireless technology and satellite
technologies compete with DSL-based services. Cable modem service can
theoretically provide faster download speeds than DSL. Both wireless and
satellite technologies enable users to transmit and receive information using
radio frequencies at speeds close or comparable to DSL transmission speeds.
These competing technologies may ultimately prove to be superior to
DSL-based services and reduce or eliminate the demand for our products.
IF OUR CUSTOMERS ARE UNABLE TO ACQUIRE AND RETAIN DSL SUBSCRIBERS, THEY MAY
CURTAIL THEIR DSL DEPLOYMENT PLANS AND REDUCE THEIR PURCHASES OF OUR PRODUCTS.
To date, our customers have deployed DSL equipment, including our products,
in substantially larger volumes than their current subscriber count. The
inability of our current or future customers to acquire and retain subscribers
as planned, or to respond to competition for their services or reduced demand
for their services, could cause them to reduce or eliminate their DSL deployment
plans. If our customers are forced to reduce or eliminate their DSL deployment
plans, our sales to them will decline.
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<PAGE> 18
SUBSTANTIALLY ALL OF OUR REVENUES COME FROM NEW AND EMERGING COMPETITIVE LOCAL
EXCHANGE CARRIERS, WHOSE INABILITY TO OBTAIN CAPITAL COULD CAUSE THEM TO REDUCE
OR DISCONTINUE THE PURCHASE OF OUR PRODUCTS AT ANY TIME.
Because our customer base consists principally of new and emerging
businesses, we will not be able to increase our revenues if our customers'
business models, which are largely unproven, are not successful or if the
financial condition of our customers deteriorates. To date, our customers have
consisted principally of competitive local exchange carriers. These carriers
require substantial capital for the development, construction and expansion of
their networks and the introduction of their services. If the telecommunications
sector experiences a general market downturn and our customers are unable to
raise the capital necessary to fund their budgeted buildout plans, they may
cease or significantly reduce their purchases of our products or may be unable
to pay or delay payment for products they had previously purchased. In addition,
we may choose to provide financing to our customers, which will subject us to
additional financial risk and may reduce our profitability. The
telecommunications service provider industry has recently experienced
consolidation. The loss of a customer, through industry consolidation or
otherwise, could reduce or eliminate our sales to that customer.
THE CX100 IS CURRENTLY OUR ONLY VOLUME PRODUCT, AND IF IT FAILS TO ACHIEVE
INCREASED MARKET ACCEPTANCE, WE WILL NOT BE ABLE TO GROW OUR REVENUES.
Our future growth and a significant portion of our future revenue depend on
the success of our CX100, which is the only volume product that we currently
offer. Accordingly, failure of the CX100 or future products to maintain
meaningful levels of market acceptance and customer satisfaction would limit our
sales and our revenue growth. We only began shipping the CX100 in the first
quarter of 1999, and the CX100 may not achieve increased market acceptance,
particularly in the international markets that we have just begun to penetrate.
Many potential customers who have evaluated the CX100 have not yet deployed the
product in production network environments and may choose not to deploy our
current product or any of our future products. Other potential customers may
have already deployed another technology and may therefore be unwilling to
deploy the CX100.
Even when customers do purchase and deploy our product, due to the variety
and complexity of environments in which the CX100 is installed, it may not
operate as expected. Failure of the CX100 to operate as expected could delay or
prevent its volume deployment, which could decrease our revenues and increase
our expenses as we devote additional development resources to improving product
performance. The success and deployment into our customers' networks of the
CX100 will also depend on customer satisfaction with our products and numerous
other factors, including:
- the realization of operating cost efficiencies for our customers when
CX100 products are deployed and our customers' ability to quantify these
operational efficiencies;
- our successful development of systems and software that address customer
infrastructure requirements; and
- our customers' successful integration of our CrossWorks software into
their operational support systems.
WE DERIVE A MAJORITY OF OUR REVENUES FROM A SMALL NUMBER OF CUSTOMERS, AND ANY
DECREASE IN REVENUES FROM A MAJOR CUSTOMER COULD PREVENT US FROM MEETING
SECURITIES ANALYSTS' EXPECTATIONS AND CAUSE OUR STOCK PRICE TO FALL.
We began recognizing revenues from the CX100 in the quarter ended March 31,
1999. The majority of our revenues to date have been recognized from a small
number of customers. Purchases by large customers and, therefore, our revenues,
may vary significantly from quarter to quarter. The loss of any one of our major
customers or a reduction or delay in purchases of our products from any one of
these customers would cause our revenues to decline and could cause our stock
price to decline if our revenues are below analysts' expectations. Revenues from
significant customers as a percentage of our total revenues for the three months
ended September 30, 2000 and the year ended December 31, 1999 were as follows:
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<PAGE> 19
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, 2000 DECEMBER 31, 1999
---------------------------------------
<S> <C> <C>
Lucent Technologies 17% 15%
Nokia 11% N/A
Rhythms NetConnections Less than 10% 41%
Network Access Solutions Less than 10% 19%
Covad Communications Less than 10% 11%
</TABLE>
We expect that the majority of our revenues will continue to depend on sales
of the CX100 to a small number of customers, specifically competitive local
exchange carriers. To date, our customers have consisted principally of these
carriers. In addition, a small number of customers may account for substantially
all of our revenues in any particular quarter, and these customers may change
from quarter to quarter. We have no long term contracts with any customers for
the purchase of the CX100, and customers may reduce or discontinue purchases at
any time. Customers may also delay or cancel purchase orders without penalty.
There is a limited number of local exchange carriers that are potential
customers, and this number may not increase in the future. Consolidation among
local exchange carriers may increase our reliance on a small number of customers
in future periods. Accordingly, our future revenues will depend significantly
upon the timing and size of future purchase orders from our largest customers.
Some of our customers are significantly larger than us and are able to exert
a high degree of influence over us. They have sufficient bargaining power to
demand low prices and other terms and conditions that may negatively affect our
business and results of operations.
OUR OPERATING RESULTS MAY FLUCTUATE DUE TO SEASONAL BUYING PATTERNS OF OUR
CUSTOMERS.
Based on our limited operating history, we believe that on a relative basis,
purchases by our customers tend to be lower in the fourth calendar quarter. Many
of our customers typically establish annual plans for building out their
networks. These plans are established at the beginning of the calendar year and
are often completed prior to the fourth calendar quarter. As a result, we expect
that some of our customers will cease or significantly reduce purchases of our
products in the fourth calendar quarter. If we experience a significant
reduction in sales of our products in the fourth quarter, our revenues for that
quarter may decline substantially. We cannot be sure, however, that this trend
will continue or that additional patterns of seasonality will not occur in
international markets as we expand our international operations.
THE LONG SALES CYCLE FOR THE CX100 MAY CAUSE OUR REVENUES AND OPERATING RESULTS
TO VARY SIGNIFICANTLY FROM QUARTER TO QUARTER.
Because the sales cycle for our CX100 is long, our revenues in a given
quarter may not meet market expectations if we experience delays in customer
orders. In addition, we may have incurred substantial sales and marketing
expenses during that quarter, without offsetting revenues. As a result, delays
resulting from our lengthy sales cycle could reduce our revenues and decrease
our profits, or result in a loss. Specifically, our customers' network planning
and purchase decisions normally involve a significant commitment of resources
and a lengthy evaluation and product qualification process. The decision to
purchase the CX100 is made as part of this network planning process, and our
sales cycle can be as long as one year or more. Throughout the sales cycle, we
often spend considerable time and resources educating and providing information
to prospective customers regarding the use and benefits of the CX100. Even after
making the decision to purchase the CX100, our customers may delay or cancel the
deployment of the CX100. Timing of deployment is unpredictable, can vary widely
and depends on a number of factors, many of which are beyond our control,
including:
- customers' current network deployment procedures;
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<PAGE> 20
- customers' level of expertise;
- status and performance of customers' other network equipment;
- degree of software development and integration necessary for the
customer to deploy the CX100; and
- financial and administrative resources of the customer.
INTENSE COMPETITION IN OUR INDUSTRY COULD RESULT IN OUR LOSING CUSTOMERS OR
BEING UNABLE TO ATTRACT NEW CUSTOMERS. AS A RESULT, OUR REVENUE COULD DECLINE OR
WE COULD EXPERIENCE LOSSES.
The market for telecommunications equipment is highly competitive. If we are
unable to compete effectively, our revenues could decline, our expenses could
increase, and our earnings could decrease or we could experience losses. A
number of companies produce products that compete with ours, including Harris
Corporation, Hekimian Laboratories, Lucent Technologies, Nokia Corporation,
Nortel Networks, Teradyne Corporation and Tollgrade Communications. Many of our
current and potential competitors have significantly greater sales and
marketing, technical, manufacturing, financial and other resources. In addition,
a number of smaller companies are expected to produce products that compete with
ours. Due to the rapidly evolving market in which we compete, additional
competitors with significant market presence and financial resources, including
other large telecommunications equipment manufacturers, may enter that market,
thereby further intensifying competition.
We also compete with DSL equipment providers, including Alcatel, Lucent,
Nokia and Nortel, who have each announced plans to incorporate competitive
features and functionality into their DSL access multiplexers. A DSL access
multiplexer is a network device, usually located at a telephone company's
central office, that receives signals from multiple DSL connections and puts the
signal on a larger, high-speed transmission line. Lucent has announced plans to
produce DSL access multiplexer products that will include some of the same
features and functions as our CX100 product. Recently, Nokia acquired
DiscoveryCom, a company that has developed a product which purports to perform
many of the same functions as the CX100. Nokia is now actively marketing the
product in many of its accounts, some of which have already purchased our
products. If our current and potential customers choose to deploy competing
products or DSL access multiplexers that include features and functions that are
competitive with our products, or delay purchases of our products to evaluate
these alternatives, our business could be seriously harmed. To the extent we
expand the capabilities of our products to incorporate functionality
traditionally contained in other equipment, we may also face increased
competition from other vendors.
WE EXPECT AVERAGE SELLING PRICES AND GROSS MARGINS OF OUR PRODUCTS TO DECREASE,
AND WE MAY NOT BE SUCCESSFUL IN REDUCING OUR COSTS OR REDESIGNING OUR PRODUCTS
TO REMAIN COMPETITIVE.
The market for telecommunications equipment is characterized by declining
prices due to increased competition, new products and increasing unit volumes.
Due to competition and potential pricing pressures from large customers in the
future, we expect that the average selling price and gross margins for our
products will decline over time. If we fail to reduce our production costs, our
gross margins will decline rapidly. We may not be successful in redesigning our
products or achieving cost reductions in a timely manner, particularly as we
introduce new products. In addition, redesign may not provide sufficient cost
reductions to allow us to remain competitive.
SOME KEY COMPONENTS IN OUR PRODUCTS COME FROM SOLE OR LIMITED SOURCES OF SUPPLY,
WHICH EXPOSES US TO POTENTIAL SUPPLY INTERRUPTIONS THAT COULD PREVENT OR DELAY
THE MANUFACTURE AND SALE OF OUR PRODUCTS AND COULD REDUCE GROSS MARGINS OF OUR
PRODUCTS.
Our contract manufacturer currently purchases a number of key components
used in the manufacture of our CX100 product from sole or limited sources of
supply for which alternative sources are not currently qualified and may not be
available. We and our contract manufacturer have no guaranteed supply
arrangement with these suppliers, and we or our contract manufacturer may fail
to obtain these supplies in a timely or cost effective manner. Financial or
other
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<PAGE> 21
difficulties faced by these suppliers or significant changes in market demand
for, or supply of, these components could limit the availability to us of these
components. We have experienced supply delays in the past and may experience
delays in the future. Such delays could:
- significantly increase the cost of manufacturing our products and reduce
gross margins of our products;
- adversely affect our ability to meet scheduled product deliveries to our
customers; and
- cause us to lose sales to existing and future customers.
In addition, the purchase of these components on a sole source basis
subjects us to risks of price increases and potential quality assurance
problems.
Our contract manufacturer currently purchases key components for which there
are currently no substitutes available from approximately 8 suppliers. All of
these components are critical to the production of our products, and competition
exists with other manufacturers for these key components. We might not be able
to qualify or identify alternative suppliers in a timely fashion, or at all.
Consolidations involving suppliers could further reduce the number of
alternatives for us and affect the cost of components. An increase in the cost
of components could make our products less competitive and result in lower
margins.
IF WE FAIL TO ACCURATELY PREDICT OUR MANUFACTURING REQUIREMENTS, WE COULD INCUR
ADDITIONAL COSTS OR EXPERIENCE MANUFACTURING DELAYS.
We have a supply contract with A-Plus Manufacturing to build our products.
A-Plus Manufacturing was recently acquired by C-MAC Industries Inc., a large
international contract manufacturer. We provide product demand forecasts to
A-Plus Manufacturing no less than six months prior to scheduled delivery of
products to our customers. If we overestimate our requirements, A-Plus
Manufacturing may have excess inventory, which we could be obligated to
purchase. If we underestimate our requirements, A-Plus Manufacturing may have
inadequate inventory, which could interrupt manufacturing of our products and
result in delays in shipments and revenues, or add additional costs to our
products to expedite delivery of certain long lead time components. If we reduce
our forecasted purchases of our components, we may lose certain volume discounts
which could increase our product costs and reduce our profits.
In addition, lead times for some of the materials and components used in our
products are very long and depend on factors such as the specific supplier,
contract terms and demand for each component at a given time. Long lead times
for some materials and components have in the past, and may in the future, cause
us to purchase inventories of some parts ourselves, increasing our costs and
risk of the parts' obsolescence. If we or A-Plus Manufacturing fail to carry a
sufficient inventory of long lead time items, if lead times increase or if
demand for our products increases unexpectedly, we may have insufficient access
to components necessary to meet demand for our products on a timely basis.
IF WE FAIL TO ENHANCE EXISTING PRODUCTS OR DEVELOP AND SELL NEW PRODUCTS THAT
MEET CUSTOMER REQUIREMENTS, OUR SALES WILL SUFFER.
Our failure to develop products or offer services that satisfy customer
requirements would reduce our sales and harm our operating results. Many of our
current and potential customers may require product features that our CX100
product does not have. In addition, some potential customers have sought to use
our products for uses we have not anticipated, and we have been required to
determine whether the requested functionality could be integrated into our
product. To the extent we are required to add features to our products in order
to achieve a sale, our sales cycle will lengthen, and we will incur increased
development costs for our products. To increase our sales, we must effectively
anticipate and adapt to customer requirements and offer products and services
that meet customer demands.
IF WE DO NOT MANAGE NEW PRODUCT INTRODUCTIONS EFFECTIVELY, WE COULD EXPERIENCE
CANCELLED ORDERS OR PRODUCT RETURNS OR BE REQUIRED TO PURCHASE OBSOLETE
INVENTORY FROM OUR CONTRACT MANUFACTURER.
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<PAGE> 22
The introduction of new or enhanced products requires that we manage the
transition from older products in order to minimize disruption in customer
ordering patterns and ensure that adequate supplies of new products can be
delivered to meet anticipated customer demand. Our inability to effectively
manage a product transition may cause material delays in the deployment of DSL
services by our customers, which could cause our customers to cancel orders or
return our products. The introduction of new and enhanced products may cause
certain customers to defer or cancel orders for, or to return, existing
products. Although we maintain reserves for product returns, these reserves may
not be adequate. In addition, the development of new or enhanced products could
cause inventory held by our contract manufacturer, A-Plus Manufacturing, to
become obsolete. In that event, we could be obligated to purchase that inventory
from A-Plus Manufacturing.
THE EQUIPMENT WE HAVE INTRODUCED TO ENABLE OUR CX100 TO OPERATE IN A LINE
SHARING ENVIRONMENT MAY NOT FUNCTION AS ANTICIPATED OR MAY NOT ACHIEVE MARKET
ACCEPTANCE.
On November 18, 1999, the Federal Communications Commission, or FCC, ordered
that line sharing, a network arrangement in which incumbent local exchange
carriers must share the existing subscriber line with competitive local exchange
carriers, be made available to competitive local exchange carriers by June 6,
2000. To enable our CX100 to operate in a line sharing environment, we recently
released a new line card. This new card has not been shipped, may not function
as anticipated when deployed by customers and may not achieve market acceptance.
To the extent that competitive local exchange carriers elect to provide DSL
services on shared lines that they would have otherwise deployed on separate
lines and our new line card does not achieve market acceptance, the demand for
our products could be significantly reduced or eliminated. Further, we may need
to redesign or modify our products for shared line configurations.
Adjustments to the FCC's regulations regarding line sharing, new FCC
regulations or regulations set forth by other regulatory bodies may also reduce
demand for our products. Because the competitive local exchange carriers do not
have access to the incumbent local exchange carriers' line maintenance systems,
the competitive local exchange carriers have typically implemented an
independent line maintenance system and several have deployed the CX100 as a key
component of this system. In the future, the FCC may expand line sharing to give
competitive local exchange carriers access to incumbent local exchange carriers'
line maintenance infrastructure, which would eliminate or reduce the need for
our products.
WE DEPEND ON A SINGLE CONTRACT MANUFACTURER THAT HAS NO OBLIGATION TO PROVIDE US
WITH FIXED PRICING OR QUANTITIES. IF WE ARE UNABLE TO OBTAIN SUFFICIENT PRODUCTS
FROM OUR CONTRACT MANUFACTURER ON ECONOMICAL TERMS, WE MAY NOT BE ABLE TO TIMELY
FILL CUSTOMER ORDERS.
We rely on a single contract manufacturer, A-Plus Manufacturing, to build
our products. If A-Plus Manufacturing is unable to provide us with adequate
supplies of high-quality products, or terminates its relationship with us, we
may be unable to fulfill customer orders on a timely basis, which may delay the
DSL deployment schedules of our customers and strain our relationships with
them. Because we currently do not have a long-term supply contract with A-Plus
Manufacturing, they are not obligated to supply products to us for any specific
period, in any specific quantity or at any certain price, except as may be
specified in a particular purchase order. Our current supply contract with
A-Plus Manufacturing can be terminated by either party with 120 days notice for
any reason. If the contract is terminated, we would be required to purchase any
excess inventory held by A-Plus Manufacturing, they would no longer be obligated
to manufacture products for us and our ability to supply products to our
customers could be seriously harmed. We may be unable to develop alternative
manufacturing arrangements on a timely basis, or at all. In addition, A-Plus
Manufacturing may not meet our future requirements for product quality or timely
delivery.
BECAUSE OUR PRODUCTS ARE DEPLOYED IN COMPLEX ENVIRONMENTS, THEY MAY HAVE ERRORS
OR DEFECTS THAT ARE FOUND ONLY AFTER FULL DEPLOYMENT, WHICH COULD RESULT IN
LIABILITY CLAIMS AGAINST US.
Errors or other problems in our CX100 or other products could result in:
- loss of or delay in revenues and loss of customers or market share;
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<PAGE> 23
- failure to achieve market acceptance;
- diversion of development resources;
- increased service and warranty costs;
- legal actions by our customers; and
- increased insurance costs.
Because our products are designed to provide critical services, if errors,
defects or failures are discovered in our current or future products, or as new
versions are released, we may be exposed to significant legal claims. Any
claims, whether or not successful, could damage our reputation and our business,
increase our expenses and impair our operating results. Although we maintain
product liability insurance covering some damages arising from implementation
and use of our products, our insurance may not fully cover claims sought against
us. Liability claims could require us to spend significant time and money in
litigation or to pay significant damages.
The CX100 is designed for large and complex networks and, in many cases,
have not been fully deployed in our customers' networks. Consequently, our
customers may discover errors or defects in our hardware or software only after
it has been fully deployed and operated as part of their infrastructure in
connection with products from other vendors, especially DSL access multiplexers
and DSL modems.
WE MAY NOT BE ABLE TO GROW OUR BUSINESS IF WE FAIL TO DEVELOP AND MAINTAIN
RELATIONSHIPS WITH THIRD PARTIES TO MARKET AND SELL OUR PRODUCTS.
Our growth will largely be dependent upon relationships with third parties
who market and sell our products. In particular, we have entered an original
equipment manufacturer agreement with Lucent Technologies under which we have
agreed to co-brand and sell our products to Lucent. If Lucent reduces its
purchases of our products or breaches or terminates the agreement, our business
will be harmed. Our agreement does not require Lucent to sell specified volumes
of our products. In addition to our CX100 products, Lucent resells products
manufactured by Tollgrade, a competitor. Lucent has also announced plans to
produce DSL access multiplexer products that will include some of the same
features and functions as our CX100 product. Lucent may choose to sell these
alternative products or other competing products instead of our products. In
addition, Nokia has acted as a reseller of our equipment without a formal
original equipment manufacturer agreement. Recently, Nokia purchased
DiscoveryCom, a company that offers a product that purports to have much of the
same functionality as the CX100. Nokia has begun to actively market the
DiscoveryCom product to its existing and potential customers including those
customers who have already purchased our equipment. As a result, we may not be
successful in selling additional equipment to those customers.
IF WE CANNOT ATTRACT EXPERIENCED SALES PERSONNEL, SPECIALIZED ENGINEERS AND
HIGHLY-TRAINED CUSTOMER SERVICE PERSONNEL, WE WILL NOT BE ABLE TO SELL AND
SUPPORT OUR PRODUCTS.
Our products and services require a sophisticated selling effort targeted at
several key people within our prospective customers' organizations. This process
requires the efforts of experienced sales personnel as well as specialized
systems and consulting engineers. In addition, the complexity of our products
and the difficulty of configuring and maintaining them require highly trained
customer service and support personnel. We intend to hire a significant number
of engineering, sales, marketing and customer service and support personnel in
the future. We believe our success depends, in large part, upon our ability to
attract and retain these key employees. Competition for such persons is intense,
especially in the San Francisco Bay area. We may not be successful in attracting
and retaining these individuals.
WE DEPEND ON A SINGLE APPLICATION SERVICE PROVIDER FOR INFORMATION SYSTEMS AND
SERVICES. IF THOSE SERVICES ARE INTERRUPTED, OUR ABILITY TO PROCESS TRANSACTIONS
WILL BE IMPAIRED.
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<PAGE> 24
We rely on a single application service provider, AristaSoft Corporation, to
provide accounting and operations software and support. If AristaSoft is unable
to provide the level and quality of service we currently anticipate, our ability
to process orders, ship products, prepare invoices and manage our day-to-day
financial transactions will be impaired. Locating and educating a new
application service provider would be time consuming and would put further
strain on our management personnel. In addition, the terms of our arrangement
with an alternative provider could be less advantageous, which could increase
our expenses. AristaSoft began providing information systems and services to us
on a regular basis in August 1999, at which time we were their only customer. In
December 1999, we entered into a three year agreement with AristaSoft for access
to customer service, financial, logistics and manufacturing software. In order
for us to realize our business goals, AristaSoft must be able to provide and
manage a scalable and reliable information technology infrastructure to support
the growth of our business. If AristaSoft is unable to meet our expectations, we
may be unable to obtain alternative services on a timely or economical basis.
IF WE FAIL TO MANAGE EXPANSION EFFECTIVELY, THIS WILL PLACE SIGNIFICANT STRAIN
ON OUR MANAGEMENT AND OPERATIONAL RESOURCES.
We have expanded our operations rapidly since our inception and intend to
continue to expand in order to pursue existing and potential market
opportunities, particularly in international markets that have just begun to
experience deregulation. Our planned rapid growth places a significant strain on
management and operational resources. Our customer relationships could be
strained if we are unable to devote sufficient resources to them as a result of
our growth.
WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS THAT COULD LIMIT OUR
SALES AND ADD TO OUR COST OF OPERATIONS.
We market and sell our products in the United States and have recently
started to sell our products internationally. We intend to expand our
international operations substantially and to enter new international markets.
This expansion will require significant management attention and financial
resources. We may not be able to maintain or increase international market
demand for our products.
We have limited experience in marketing and distributing our products
internationally. International operations are subject to inherent risks,
including:
- tariffs, export controls and other trade barriers;
- longer accounts receivable payment cycles and difficulties in collecting
accounts receivable;
- difficulties and costs of staffing and managing foreign operations;
- certification and regulatory requirements with which we may be
unfamiliar; and
- reduced protection of intellectual property rights in some countries.
RAPID TECHNOLOGICAL CHANGE IN THE TELECOMMUNICATIONS INDUSTRY COULD RENDER OUR
PRODUCTS OBSOLETE.
The markets for high-speed telecommunications products are characterized by
rapid technological developments, frequent enhancements to existing products and
new product introductions, changes in customer requirements and evolving
industry standards. Intense competition among numerous high-speed access
technologies has further driven innovation and increasingly complex product
requirements. We may be unable to improve the performance and features of our
products as needed to respond to these developments. The introduction or market
acceptance of products incorporating superior technologies or the emergence of
alternative technologies or new industry standards could render our existing or
potential future products less economical, obsolete and unmarketable. For
example, if semiconductor, robotic or other technologies become effective
alternatives for our product architecture, our products may become obsolete.
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<PAGE> 25
WE COULD LOSE OUR COMPETITIVE ADVANTAGE IF WE ARE UNABLE TO PROTECT OUR
INTELLECTUAL PROPERTY.
If we fail to adequately protect our proprietary rights, our competitors
could offer similar products relying on technologies developed by us,
potentially harming our competitive position and decreasing our revenues. We
have filed five patent applications to date. Our existing and future patent
applications, if any, may not be approved, any issued patents may not protect
our intellectual property and any issued patents could be challenged by third
parties. Furthermore, other parties may independently develop similar or
competing technology or design around any patents that may be issued to us.
Attempts may be made to copy aspects of our products or to obtain and use
information that we regard as proprietary. We attempt to protect our
intellectual property rights by limiting access to the distribution of our
software, documentation and other proprietary information and by relying on a
combination of copyright, trademark and trade secret laws. In addition, we enter
into confidentiality agreements with our employees and certain customers,
vendors and strategic partners. These steps may fail to prevent the
misappropriation of our intellectual property, particularly in foreign countries
where the laws may not protect our proprietary rights as fully as in the United
States.
IF WE BECOME INVOLVED IN A PROTRACTED INTELLECTUAL PROPERTY DISPUTE, OR ONE WITH
A SIGNIFICANT DAMAGES AWARD, OR WHICH REQUIRES US TO CEASE SELLING OUR PRODUCTS,
WE COULD BE SUBJECT TO SIGNIFICANT LIABILITY AND THE TIME AND ATTENTION OF OUR
MANAGEMENT COULD BE DIVERTED.
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights, including among
companies in telecommunications and Internet industries. Intellectual property
claims against us and any resulting lawsuit, if successful, could subject us to
significant liability for damages and invalidate our proprietary rights. These
lawsuits, regardless of their success, would likely be time-consuming and
expensive to resolve and would divert management time and attention. Any
potential intellectual property litigation also could force us to do one or more
of the following:
- cease selling, incorporating or using products or services that
incorporate the infringed intellectual property;
- obtain from the holder of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on acceptable terms, if at all; or
- redesign those products or services that incorporate the disputed
technology.
If we are subject to a successful claim of infringement against us and fail
to develop non-infringing technology or license the infringed technology on
acceptable terms and on a timely basis, our revenues may decline or our expenses
may increase. We may in the future initiate claims or litigation against third
parties for infringement of our proprietary rights or to determine the scope and
validity of our proprietary rights or the proprietary rights of competitors.
These claims could result in costly litigation and the diversion of our
technical and management personnel.
CONTROL BY OUR EXISTING STOCKHOLDERS MAY LIMIT YOUR ABILITY TO INFLUENCE MATTERS
REQUIRING STOCKHOLDER APPROVAL AND COULD DELAY OR PREVENT A CHANGE IN CONTROL,
WHICH COULD PREVENT YOU FROM REALIZING A PREMIUM IN THE MARKET PRICE OF OUR
COMMON STOCK.
The concentration of ownership of our common stock by existing stockholders
could delay or prevent a change in our control or discourage a potential
acquirer from attempting to obtain control of us, which could cause the market
price of our common stock to fall or prevent our stockholders from realizing a
premium in the market price associated with an acquisition. As of September 30,
2000, our executive officers, directors and principal stockholders and their
affiliates owned 42,545,914 shares or approximately 65% of the outstanding
shares of our common stock. These stockholders, if acting together, would be
able to significantly influence all matters requiring approval by our
stockholders, including the election of directors and the approval of mergers or
other business combination transactions.
WE EXPECT TO EXPERIENCE VOLATILITY IN OUR STOCK PRICE WHICH COULD NEGATIVELY
AFFECT YOUR INVESTMENT.
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<PAGE> 26
Prior to February 2000, you could not buy or sell our common stock
publicly. An active public market for our common stock may not be sustained in
the future. The market for technology stocks has been extremely volatile. The
following factors could cause the market price of our common stock to fluctuate
significantly from the price paid by investors in this offering:
- announcements by us or our competitors of significant contracts, new
products or technological innovations, acquisitions, strategic
relationships, joint ventures or capital commitments;
- changes in financial estimates by securities analysts;
- release of lock-up or transfer restrictions on our outstanding shares of
common stock or sales of additional shares of common stock;
- changes in market valuations of networking and telecommunications
companies; and
- fluctuations in stock market prices and volumes.
SHOULD OUR STOCKHOLDERS SELL A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK
IN THE PUBLIC MARKET, THE PRICE OF OUR COMMON STOCK COULD FALL.
Our executive officers, directors and principal stockholders and their
affiliates hold a substantial number of shares, which they will be able to sell
in the public market in the near future. Sales of a substantial number of shares
of our common stock by them could reduce the market price of our common stock.
In addition, the sale of these shares could impair our ability to raise capital
through the sale of additional equity securities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE SENSITIVITY
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we have
invested in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the principal amount of the investment will probably decline. To minimize
this risk, we maintain our portfolio of cash equivalents and short-term
investments in a variety of securities, including money market funds, commercial
paper and government and non-government debt securities. In general, money
market funds are not subject to market risk because the interest paid on such
funds fluctuates with the prevailing interest rate. In addition, we invest in
relatively short-term securities.
The following table (in thousands, except interest rates) presents the
amounts of cash equivalents and short-term investments that are subject to
market risk by range of expected maturity and weighted average interest rates as
of September 30, 2000 and December 31, 1999. This table does not include money
market funds because those funds are not subject to market risk.
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<PAGE> 27
<TABLE>
<CAPTION>
MATURING
BETWEEN
MATURING IN THREE
THREE MONTHS MONTHS AND
AT SEPTEMBER 30, 2000 OR LESS ONE YEAR TOTALS
----------------------------------------------
<S> <C> <C> <C>
Included in cash and cash equivalents $ 42,285 -- $ 42,285
Weighted average interest rate 6.68% -- 6.68%
Included in short-term investments $ 3,702 $ 52,648 $ 56,350
Weighted average interest rate 6.56% 6.96% 6.93%
Total portfolio $ 45,987 $ 52,648 $ 98,635
Weighted average interest rate 6.67% 6.96% 6.82%
</TABLE>
<TABLE>
<CAPTION>
MATURING
BETWEEN
MATURING IN THREE
THREE MONTHS MONTHS AND
AT DECEMBER 31, 1999 OR LESS ONE YEAR TOTALS
----------------------------------------------
<S> <C> <C> <C>
Included in cash and cash equivalents $ 2,750 -- $ 2,750
Weighted average interest rate 6.76% -- 6.76%
</TABLE>
EXCHANGE RATE SENSITIVITY
Our operations are primarily maintained in the United States and, to date,
transactions worldwide have been denominated primarily in US dollars. Therefore,
we have not engaged in any foreign exchange hedging activities to date.
Currencies held in other than the US dollar in our subsidiaries have been
insignificant. As such, we have not had any material exposure to foreign
currency rate fluctuations.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Changes in Securities
In July 2000, our Board of Directors approved a two-for-one stock
split of our common stock, to be effected in the form of a stock dividend. The
stock split was effected on August 23, 2000 by distribution to each stockholder
of record as of August 9, 2000 of one share of common stock for each share of
common stock held.
(b) Use of Proceeds
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<PAGE> 28
In September 2000, we completed a follow on offering of 4,000,000
shares of our common stock, of which 500,000 shares were offered by selling
stockholders, registered under the Securities Act of 1933, as amended, on a
Registration Statement on Form S-1 (No. 333-45130). The managing underwriters in
the offering were Goldman, Sachs & Co., Dain Rauscher Wessels, Deutsche Banc
Alex. Brown, Robertson Stephens and U.S. Bancorp Piper Jaffray. We filed the
initial registration statement on September 1, 2000 and consummated the offering
on September 26, 2000 when we sold all of the 4,000,000 shares of common stock.
The Securities and Exchange Commission declared the Registration Statement
effective on September 20, 2000. The price to public of the offering was $50.00
per share for an aggregate public offering of $175.0 million.
We paid a total of $10.0 million in underwriting discounts and
commissions and approximately $1.1 million for costs and expenses associated
with the public offering. None of the costs and expenses related to the offering
were paid directly or indirectly to any of our directors, officers, general
partners or their associates, persons owning 10 percent or more of any class of
our equity securities or any of our affiliates.
After deducting the underwriting discounts and commissions and the
offering expenses, the net proceeds to us of the 3,500,000 shares sold by us in
the follow on offering were approximately $165.2 million. We did not receive any
proceeds from the sale of the 500,000 shares offered by the selling shareholders
in the follow on offering. The net proceeds from our follow on offering have
been invested in money market funds, certificate of deposits and other
investment grade securities. We may use a portion of the net proceeds to acquire
or invest in businesses, technologies, products or services and for general
corporate purposes.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
We filed a current report on Form 8-K with the
Securities and Exchange Commission on August 11, 2000 to report,
under Item 2, that we had entered into a share purchase agreement to
acquire all of the outstanding ordinary shares of Paragon Solutions
Limited for up to a maximum of US$10 million in cash. An amendment to
this current report on Form 8-K was filed with the Securities and
Exchange Commission by us on September 1, 2000 with the required
financial information.
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<PAGE> 29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
TURNSTONE SYSTEMS, INC.
Date: November 7, 2000 By: /s/ Richard N. Tinsley
-------------------------------------------
Richard N. Tinsley
President, Chief Executive
Officer and Director
(Principal Executive Officer)
Date: November 7, 2000 By: /s/ Terrence J. Schmid
-------------------------------------------
Terrence J. Schmid
Chief Financial Officer
(Principal Financial and Accounting
Officer)
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<PAGE> 30
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NUMBER EXHIBIT DESCRIPTION
-------------- -------------------
<C> <S>
27.1 Financial Data Schedule.
</TABLE>
