<PAGE> 1
As filed with the Securities and Exchange Commission on January 10, 2000
Registration No. 333-91427
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
TURNSTONE SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
<TABLE>
<S> <C> <C>
DELAWARE 3669 77-047640
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
274 FERGUSON DRIVE
MOUNTAIN VIEW, CALIFORNIA 94043
(650) 404-0200
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
RICHARD N. TINSLEY
PRESIDENT AND CHIEF EXECUTIVE OFFICER
TURNSTONE SYSTEMS, INC.
274 FERGUSON DRIVE
MOUNTAIN VIEW, CALIFORNIA 94043
(650) 404-0200
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
COPIES TO:
<TABLE>
<S> <C>
THOMAS C. DEFILIPPS, ESQ. JOHN L. SAVVA, ESQ.
ROBERT F. KORNEGAY, ESQ. ALBERT Y. LIU, ESQ.
TED S. HOLLIFIELD, ESQ. JAMES OEHLER, ESQ.
SANDRA PAK KNOX, ESQ. SULLIVAN & CROMWELL
WILSON SONSINI GOODRICH & ROSATI 1888 CENTURY PARK EAST
PROFESSIONAL CORPORATION LOS ANGELES, CALIFORNIA 90067
650 PAGE MILL ROAD (310) 712-6600
PALO ALTO, CALIFORNIA 94304
(650) 493-9300
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
<TABLE>
<S> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
TITLE OF EACH CLASS PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
OF SECURITIES TO SHARES TO BE OFFERING PRICE AGGREGATE OFFERING REGISTRATION
BE REGISTERED REGISTERED PER SHARE(1) PRICE(1) FEE
- -----------------------------------------------------------------------------------------------------------------------
Common Stock ($0.001 par value)...... 3,450,000 $17.00 $58,650,000 $15,484(2)
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Estimated solely for the purpose of computing the amount of the registration
fee pursuant to Rule 457(a) under the Securities Act of 1933.
(2) Of which $13,427 was previously paid.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON
SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE
CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
PRELIMINARY PROSPECTUS IS NOT AN OFFER TO SELL NOR DOES IT SEEK AN OFFER
TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT
PERMITTED.
SUBJECT TO COMPLETION. DATED JANUARY 10, 2000.
3,000,000 Shares
<TABLE>
<S> <C> <C>
[Turnstone Systems, Inc.
Logo] TURNSTONE SYSTEMS, INC.
</TABLE>
Common Stock
-------------------------
This is an initial public offering of shares of common stock of Turnstone
Systems, Inc. All of the 3,000,000 shares of common stock are being sold by
Turnstone Systems.
Prior to this offering, there has been no public market for our common
stock. It is currently estimated that the initial public offering price will be
between $15.00 and $17.00 per share. Application has been made for quotation of
our common stock on the Nasdaq National Market under the symbol "TSTN".
See "Risk Factors" beginning on page 4 to read about factors you should
consider before buying shares of the common stock.
-------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
-------------------------
<TABLE>
<CAPTION>
Per Share Total
--------- --------
<S> <C> <C>
Initial public offering price............................... $ $
Underwriting discount....................................... $ $
Proceeds, before expenses, to Turnstone Systems............. $ $
</TABLE>
To the extent the underwriters sell more than 3,000,000 shares of common
stock, the underwriters have the option to purchase up to an additional 450,000
shares from Turnstone Systems at the initial public offering price less the
underwriting discount.
-------------------------
The underwriters expect to deliver the shares in New York, New York on
, 2000.
GOLDMAN, SACHS & CO.
DAIN RAUSCHER WESSELS
ROBERTSON STEPHENS
-------------------------
Prospectus dated , 2000.
<PAGE> 3
PROSPECTUS SUMMARY
This summary does not contain all of the information that you should
consider before investing in our common stock. You should read the entire
prospectus carefully, especially "Risk Factors" beginning on page 4. Unless
otherwise indicated, this prospectus assumes the exercise of a warrant to
purchase 90,000 shares of our Series A Preferred Stock and that the underwriters
do not exercise their option to purchase additional shares in this offering. In
addition, unless otherwise indicated, this prospectus gives effect to the
automatic conversion of our outstanding preferred stock into common stock upon
the closing of the offering.
TURNSTONE SYSTEMS, INC.
We are a leading provider of products that enable local exchange carriers
to rapidly deploy and efficiently maintain digital subscriber line, or DSL,
services. Our products enable the automation and remote control of installation,
qualification and maintenance of copper telephone lines. The Copper CrossConnect
CX100, our first product, enables local exchange carriers to rapidly and
efficiently deploy high speed digital services on existing copper telephone
lines. The CX100 is currently being installed in telephone company central
offices by competitive local exchange carriers to speed their deployment of DSL
services. A competitive local exchange carrier is a company that, following the
Telecommunications Act of 1996, is authorized to compete in a local
communications services market. We began shipping our CX100 in the first quarter
of 1999, and currently the CX100 is our only volume product. We sell our CX100
through our direct sales force and through an original equipment manufacturer
relationship with Lucent Technologies, who has chosen to sell the CX100 as a
co-branded system. For the year ended December 31, 1999, we shipped over 2,500
CX100 systems and recognized $27.2 million in revenues, incurring a net loss of
$183,000. Rhythms NetConnections accounted for 41% of our revenues for the year
ended December 31, 1999, while Network Access Solutions accounted for 19% and
Covad Communications accounted for 11%. Fifteen percent of our revenues were
generated through our relationship with Lucent.
OUR INDUSTRY
We believe that Internet content and the number of users accessing the
Internet will continue to grow rapidly. As more users access more content, the
ability to connect to the Internet at high speeds is becoming increasingly
important for users. DSL networks provide high-speed access services over
existing telephone lines. These copper lines, commonly referred to as the local
loop, were installed as part of analog telephone networks developed and deployed
over the past 100 years to carry voice traffic, and frequently require
qualification and preparation to support DSL deployment. To date, DSL deployment
and maintenance have been difficult, expensive and labor intensive. Traditional
deployment and maintenance procedures, often based on proprietary software and
requiring on-site technicians using hand-held test equipment, are difficult and
expensive to integrate with new DSL equipment and modern operational support
systems. These traditional procedures limit the ability of telecommunications
service providers to rapidly scale their networks and expand their subscriber
base for high-speed digital services. We believe widespread deployment of
competitive DSL services requires a shift from labor-intensive processes to new
infrastructure equipment providing for the automation and remote management of
line installation, qualification and maintenance.
1
<PAGE> 4
OUR SOLUTION AND STRATEGY
We believe that our CX100 and CrossWorks software represent the first
commercially available solution specifically designed for the automation and
remote control of installation, qualification and maintenance of copper
telephone lines for DSL service. With our solution in place, local exchange
carriers can rapidly and efficiently deploy DSL services.
The benefits of our local loop management solution include:
- RAPID AND EFFICIENT DSL DEPLOYMENT. Our CX100 enables carriers to
remotely identify and qualify any line in their network, without the need
for on-site labor.
- IMPROVED NETWORK RELIABILITY. The CX100 improves network reliability and
availability and allows service to be restored rapidly in the event of
failure in DSL equipment, enabling local exchange carriers to offer
guaranteed levels of service.
- AUTOMATED OPERATIONS. Our CrossWorks software operates in conjunction
with the CX100 to automate the collection, analysis and archiving of
information regarding subscribers, line quality, test histories and other
information.
- COMPATIBLE WITH ALL SERVICES AND PLATFORMS. The CX100 is designed to be
compatible with all types of services delivered on copper telephone lines
and all types of DSL access multiplexers. A DSL access multiplexer is a
network device that receives signals from multiple DSL connections and
puts the signals on a larger, high-speed transmission line. A single
CX100 may be deployed with multiple DSL access multiplexers from a
variety of vendors, including Alcatel, Cisco, Copper Mountain, Lucent,
Nokia and Paradyne.
The following are key elements of our strategy:
- increase our penetration of competitive local exchange carriers and
penetrate new markets as they emerge;
- enhance product offerings to provide better value to existing and new
customers;
- leverage relationships with original equipment manufacturers and
complementary equipment vendors; and
- outsource manufacturing of our products to lower manufacturing costs and
enhance flexibility.
CORPORATE INFORMATION
We were incorporated in Delaware in January 1998. Our principal executive
offices are located at 274 Ferguson Drive, Mountain View, California 94043, and
our telephone number is (650) 404-0200.
2
<PAGE> 5
THE OFFERING
Shares offered........................ 3,000,000 shares
Shares to be outstanding after the
offering.............................. 29,353,842 shares
Proposed Nasdaq National Market
symbol................................ "TSTN"
Use of proceeds....................... For general corporate purposes,
including working capital and
capital expenditures and potential
acquisitions of, or investments in,
complementary businesses,
technologies and products.
The total number of shares outstanding after the offering is based on
information as of December 31, 1999 and assumes the exercise for cash of a
warrant to acquire 90,000 shares that would otherwise expire upon the closing of
this offering. It excludes:
- 3,339,212 shares of common stock issuable upon exercise of options
outstanding under our 1998 stock plan at a weighted average exercise
price of $2.65 per share;
- 803,376 shares available for future issuance under our 1998 stock plan;
- 5,000,000 shares available for future issuance under our 2000 stock plan;
- 500,000 shares available for issuance under our 2000 employee stock
purchase plan; and
- 45,000 shares of common stock issuable upon exercise of an outstanding
warrant at an exercise price of $0.50 per share.
SUMMARY FINANCIAL INFORMATION
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 2, 1998
(INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1998 1999
--------------- ------------
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues................................................ $ -- 27,196
Gross profit................................................ -- 14,837
Operating income (loss)..................................... (4,941) 100
Net loss.................................................... (4,749) (183)
</TABLE>
The balance sheet data displayed in the "Pro Forma As Adjusted" column
below reflects:
- the assumed exercise for cash of a warrant to purchase 90,000 shares of
our Series A Preferred Stock;
- the automatic conversion of our outstanding preferred stock into common
stock upon the closing of the offering; and
- our sale of shares of common stock offered by this prospectus at an
assumed initial public offering price of $16.00 per share and the
application of our net proceeds from the offering.
<TABLE>
<CAPTION>
DECEMBER 31, 1999
---------------------
PRO FORMA
ACTUAL AS ADJUSTED
------- -----------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 8,063 $51,548
Working capital............................................. 10,969 54,454
Total assets................................................ 19,257 62,742
Long-term obligations under capital leases, less current
portion................................................... 260 260
Stockholders' equity........................................ 11,891 55,376
</TABLE>
3
<PAGE> 6
RISK FACTORS
This offering and an investment in our common stock involve a high degree
of risk. You should carefully consider the risks described below before making
an investment decision.
WE ONLY BEGAN SELLING OUR PRODUCTS IN THE FIRST QUARTER OF 1999. AS A RESULT,
INVESTORS AND ANALYSTS MAY FIND IT DIFFICULT TO FORECAST OUR FUTURE REVENUE AND
OPERATING RESULTS. THE PRICE OF OUR COMMON STOCK COULD FALL SUBSTANTIALLY IF OUR
REVENUE OR OPERATING RESULTS ARE LESS THAN PROJECTED.
If we do not achieve our expected revenue growth, our operating results
will be below our expectations and the expectations of investors and market
analysts, which could cause the price of our common stock to decline
substantially. Our operating history is limited, however, and it is difficult or
impossible to accurately forecast our revenues. In addition, we have limited
meaningful historical financial data upon which to base planned operating
expenses. Specifically, we began operations in January 1998, introduced our
Copper CrossConnect CX100 in October 1998 and only began shipping the CX100 in
the first quarter of 1999. The revenue and income potential of our business is
unproven, and you should not rely on our results for any historic period as an
indication of our future performance.
WE HAVE LOST MONEY IN THE PAST AND MAY EXPERIENCE LOSSES IN THE FUTURE, WHICH
COULD CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DECLINE.
We may not succeed in generating revenue growth consistent with our recent
experience, and our revenues may not be sufficient to achieve profitability. If
we incur losses, the market price of our common stock may decline substantially.
We had an accumulated deficit of $4.9 million as of December 31, 1999. We lost
$4.7 million in our first year of operations which ended December 31, 1998 and
$183,000 in the year ended December 31, 1999. We only recently became profitable
on a quarterly basis. We may not maintain or increase our profitability in the
future. 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 direct sales force;
- 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 THE MARKET FOR DSL SERVICES DOES NOT GROW AS WE ANTICIPATE, OUR REVENUE
GROWTH WILL SLOW, OR OUR REVENUES COULD DECLINE.
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. These competing technologies may
ultimately prove to be superior to DSL-based services and reduce or eliminate
the demand for our products.
4
<PAGE> 7
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 competitive local exchange carrier 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, and our
business will be harmed.
THE CX100 IS CURRENTLY OUR ONLY VOLUME PRODUCT, AND IF IT FAILS TO GAIN MARKET
ACCEPTANCE, OUR REVENUES WILL NOT INCREASE AND OUR OPERATING RESULTS WILL
SUFFER.
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 and
achieve meaningful levels of market acceptance and customer satisfaction would
limit our sales and harm our results of operations. We only began shipping the
CX100 in the first quarter of 1999, and the CX100 may not gain widespread market
acceptance. 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 OUR REVENUES FROM A SMALL NUMBER OF CUSTOMERS, AND ANY DECREASE IN
REVENUES FROM A MAJOR CUSTOMER COULD SERIOUSLY HARM OUR BUSINESS.
We began recognizing revenues from the CX100 in the quarter ended March 31,
1999. 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 seriously harm our
business. Revenues from significant customers as a percentage of our total
revenues for the quarter and year-ended December 31, 1999 were as follows:
<TABLE>
<CAPTION>
QUARTER ENDED YEAR ENDED
DECEMBER 31, 1999 DECEMBER 31, 1999
----------------- -----------------
<S> <C> <C>
Rhythms NetConnections.................... 26% 41%
Network Access Solutions.................. 14% 19%
Covad Communications...................... 23% 11%
Lucent Technologies....................... 23% 15%
</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. A competitive local exchange carrier is a company that,
5
<PAGE> 8
following the Telecommunications Act of 1996, is authorized to compete in the
local communications services market. 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. Accordingly, our
future revenues will depend significantly upon the timing and size of future
purchase orders from our largest customers.
In addition, because we are dependent on a limited number of customers, we
expect to experience volatility relating to the budgeting cycles of our
customers and the telecommunications industry in general. Adverse changes in our
revenues or operating results as a result of these budgeting cycles or any other
reduction in capital expenditures by our large customers could substantially
reduce the trading price of our common stock.
Our customers tend to be 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.
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. Financing may not be
available to emerging competitive local exchange carriers on favorable terms, if
at all. A reduction in the financing available to our customers, or the
inability of our customers to obtain financing, could impair our ability to make
future sales as well as to collect for sales we have already made. 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 and cause our
operating results to suffer.
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
6
<PAGE> 9
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;
- 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 SUBSTANTIALLY IMPAIR OUR BUSINESS AND
OUR OPERATING RESULTS.
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, Hewlett-Packard Company, Lucent
Technologies, 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. If our current and potential
customers choose to deploy DSL access multiplexers that include features and
functions that are competitive with our products, or delay purchases of our
products to evaluate these DSL access multiplexers, 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,
WHICH COULD HARM OUR OPERATING RESULTS.
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.
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. For instance, some of our potential
7
<PAGE> 10
customers, particularly incumbent local exchange carriers, require management
and testing capabilities for traditional analog telephone services, and our
products do not currently offer this functionality. An incumbent local exchange
carrier is a communications company that held an exclusive license to offer
local telephone services prior to the Telecommunications Act of 1996. The
regional Bell operating companies are examples of incumbent local exchange
carriers. 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.
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 would reduce our sales and increase our expenses and
could result in our experiencing substantial losses. 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.
REGULATION OF THE COMMUNICATIONS INDUSTRY COULD REDUCE OR DELAY SALES OF OUR
PRODUCTS OR REQUIRE US TO MODIFY OUR PRODUCTS.
The jurisdiction of the Federal Communications Commission, or FCC, extends
to the communications industry, to our customers and to the products and
services that our customers offer. Future FCC regulations, or regulations set
forth by other regulatory bodies, may reduce the demand for our products. For
example, the FCC regulates access to copper telephone lines and the ability of
competitive local exchange carriers to deploy equipment at an incumbent local
exchange carrier's facility. In addition, international regulatory bodies are
beginning to adopt standards for the communications industry. The delays that
these governmental processes entail may cause order cancellations or
postponements of product purchases by our customers, which would reduce our
revenues and harm our operating results.
The operational and regulatory relationship between incumbent local
exchange carriers and competitive local exchange carriers could change in ways
that would reduce the need for our products. Substantially all of our revenue is
derived from competitive local exchange carriers who lease copper lines from
incumbent local exchange carriers in the United States. 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 may deploy the
CX100 as a key component of this system. In the future, competitive local
exchange carriers may gain access to incumbent local exchange carriers' line
maintenance infrastructure if mandated by the FCC, which would eliminate or
reduce the need for our products.
On November 18, 1999, the FCC ordered line sharing, a network arrangement
in which incumbent local exchange carriers must share the existing subscriber
line with competitive local exchange carriers. Some of the functions of our
CX100 product line may not function as effectively or at all in a shared line
configuration. To the extent that competitive local exchange carriers elect to
8
<PAGE> 11
provide DSL services on shared lines that they would have otherwise deployed on
separate lines, the demand for our products could be significantly reduced or
eliminated. In addition, we may need to redesign or modify our products for
shared line configurations.
In addition to complying with FCC regulations, our products are required to
meet certain safety requirements. Typically, our products must be network
equipment building standard compliant, a telecommunications industry standard,
and certified by Underwriters Laboratory before they may be deployed in central
office applications. We might not obtain the regulatory approvals and
certifications we need to sell our products on a timely basis, or at all. If we
fail to obtain these approvals and certifications on a timely basis, our future
revenues and business could suffer.
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.
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.
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 attempt to mitigate these lead times by purchasing inventories of some
parts ourselves, increasing our costs and risk of 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.
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, OUR BUSINESS COULD BE
SEVERELY HARMED.
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, our relationships with our customers
could suffer and our financial condition and results of operations could be
harmed. 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.
SOME KEY COMPONENTS IN OUR PRODUCTS COME FROM SOLE OR LIMITED SOURCES OF SUPPLY,
WHICH EXPOSES US TO POTENTIAL SUPPLY INTERRUPTIONS THAT COULD PREVENT THE
MANUFACTURE AND SALE 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
9
<PAGE> 12
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
manner in the future. Financial or other difficulties faced by these suppliers
or significant changes in market demand for these components could limit the
availability to us of these components. Any interruption or delay in the supply
of any of these components could:
- adversely affect our ability to meet scheduled product deliveries to our
customers;
- cause us to lose sales to existing and future customers; and
- harm our operating results and financial condition.
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 12 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.
BECAUSE OUR PRODUCTS ARE DEPLOYED IN COMPLEX ENVIRONMENTS, THEY MAY HAVE ERRORS
OR DEFECTS THAT ARE FOUND ONLY AFTER FULL DEPLOYMENT, WHICH COULD SERIOUSLY HARM
OUR BUSINESS.
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;
- 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. The CX100 was only
recently introduced and, to date, has been deployed on a limited basis.
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.
OUR BUSINESS MAY BE SERIOUSLY HARMED IF WE ARE UNABLE 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
10
<PAGE> 13
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 Tollgrade or other competing products instead of our products.
WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLY
CHANGING MARKET. IF WE ARE UNABLE TO RETAIN OUR KEY PERSONNEL OR HIRE ADDITIONAL
PERSONNEL, OUR ABILITY TO EXECUTE OUR BUSINESS STRATEGY OR GENERATE SALES COULD
BE HARMED.
The loss of the services of any of our key employees or the inability to
attract or retain qualified personnel in the future or delays in hiring required
personnel could impair our ability to develop, introduce and sell our products.
Our future success depends upon the continued services of our executive officers
and other key engineering, sales, marketing and support personnel. In
particular, Richard N. Tinsley, President and Chief Executive Officer, and P.
Kingston Duffie, Chief Technology Officer, possess industry and technical
knowledge and are especially critical to our future success. None of our
officers or key employees is bound by an employment agreement for any specific
term, nor do we have key person life insurance policies covering any of our
employees.
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 these
personnel is intense, especially in the San Francisco Bay area. We may not be
successful in attracting and retaining these individuals.
In addition, companies in the telecommunications industry whose employees
accept positions with competitors frequently claim that such competitors have
engaged in unfair hiring practices. We could incur substantial costs in
defending ourselves against these claims, regardless of their merits.
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 HARMED.
We rely on a single application service provider, AristaSoft Corporation,
to provide accounting and operations software and support. If there is a service
interruption or 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
harmed, and our results of operations could suffer. 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 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, OUR BUSINESS, FINANCIAL CONDITION
AND PROSPECTS COULD BE SERIOUSLY HARMED.
We have expanded our operations rapidly since our inception and intend to
continue to expand in order to pursue existing and potential market
opportunities. Our planned rapid growth places a significant strain on
management and operational resources. Our operating results could suffer and
11
<PAGE> 14
our relationships with our customers could be harmed if we are unable to manage
this growth effectively.
We expect to require additional office space within the next 12 months. We
may be unable to locate necessary office space on commercially reasonable terms
or in a timely manner. Failure to do so would disrupt our business and could
harm our operating results and financial condition.
RAPID TECHNOLOGICAL CHANGE 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. We could 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 business would
be seriously harmed.
OUR BUSINESS WILL BE ADVERSELY AFFECTED 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 one patent application 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,
OUR OPERATING RESULTS WOULD SUFFER.
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.
12
<PAGE> 15
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. As a result, our operating results could
suffer and our financial condition could be harmed.
THE YEAR 2000 COMPUTER PROBLEM COULD DISRUPT OUR OPERATIONS, EXPOSE US TO
LIABILITY IF OUR CX100 IS NOT YEAR 2000 COMPLIANT OR REDUCE OUR REVENUES IF IT
CAUSES CUSTOMERS TO DEFER PURCHASING OUR PRODUCTS.
The year 2000 computer problem refers to the potential for system and
processing failures of date-related data as a result of computer-controlled
systems using two digits rather than four to define the applicable year. Since
January 1, we have not become aware of any material malfunctions of our products
or internal systems relating to year 2000. If not fully resolved, however, the
year 2000 computer problem could result in a system failure or miscalculations
causing disruptions of our operations.
We have designed the CX100 product line and accompanying software for use
in the year 2000 and beyond and believe it is year 2000 compliant. An undetected
programming error could result in the CX100 failing to be year 2000 compliant,
in which case our business would suffer. We may also face claims based on year
2000 problems in other companies' products or based on issues arising from the
integration of multiple products within the overall network. If our suppliers,
vendors, major distributors, partners, customers, service providers, contract
manufacturer and applications service provider fail to correct their year 2000
problems, these failures could interrupt our normal business activities.
WE MAY ENGAGE IN ACQUISITIONS, AND WE MAY BE UNABLE TO SUCCESSFULLY INTEGRATE
ANY NEW OPERATIONS, TECHNOLOGIES, PRODUCTS OR PERSONNEL.
Recently, the telecommunications industry has experienced substantial
mergers and acquisitions activity. We may in the future engage in acquisitions
of product lines, technologies and businesses. We currently have no commitments
or agreements with respect to any such acquisition. In the event that such an
acquisition does occur, because of the small size of our management team, we may
be particularly vulnerable if we are unable to effectively assimilate
operations, technologies, products and personnel or if our management's
attention is diverted from other business concerns.
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 have the effect of delaying or preventing a change in our control or
discouraging 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. Upon completion of this offering, our executive officers, directors
and principal stockholders and their affiliates will own 21,621,964 shares or
approximately 73.7% of the outstanding shares of 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. For information about the ownership of common stock by our
executive officers, directors and principal stockholders, see "Principal
Stockholders".
13
<PAGE> 16
WE EXPECT TO EXPERIENCE VOLATILITY IN OUR STOCK PRICE WHICH COULD NEGATIVELY
AFFECT YOUR INVESTMENT.
Prior to this offering, you could not buy or sell our common stock
publicly. An active public market for our common stock may not develop or be
sustained after this offering. 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:
- our loss of a major customer;
- the addition or the departure of key personnel;
- actual or anticipated variations in our quarterly operating results;
- 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;
- sales by us or our current stockholders of common stock or other
securities;
- 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 current stockholders 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 after this offering 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. See "Management -- Stock Plans" and "Shares Eligible for
Future Sale".
14
<PAGE> 17
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus, including the sections entitled "Prospectus Summary",
"Risk Factors", "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business", contains forward-looking statements.
These statements relate to future events or our future financial performance,
and involve known and unknown risks and uncertainties that may cause our actual
results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by these forward-looking statements. These
risks include those listed under "Risk Factors" and elsewhere in this
prospectus. In some cases, you can identify forward-looking statements by
terminology such as "may", "will", "should", "expects", "intends", "plans",
"anticipates", "believes", "estimates", "predicts", "potential", "continue", or
the negative of these terms or other comparable terminology. These statements
are only predictions. Actual events or results may differ materially. In
evaluating these statements, you should specifically consider various factors,
including the risks outlined under "Risk Factors".
USE OF PROCEEDS
We estimate that our net proceeds from the sale of the 3,000,000 shares of
common stock we are offering will be approximately $43.4 million, or $50.1
million if the underwriters exercise in full their option to purchase additional
shares in the offering. These estimates are calculated based on an assumed
initial public offering price of $16.00 per share and after deducting the
underwriting discount and estimated offering expenses payable by us.
We expect to use the net proceeds from this offering for general corporate
purposes, including working capital and capital expenditures. We may use a
portion of the net proceeds to acquire or invest in complementary businesses,
technologies, product lines or products. We have no current plans, agreements or
commitments with respect to any acquisitions or investments, and are not engaged
in any negotiations with respect to any acquisitions or investments. Pending use
of the net proceeds of this offering, we intend to invest the net proceeds in
short-term, investment-grade securities.
DIVIDEND POLICY
We have never declared or paid cash dividends on our common stock or other
securities. We currently expect to retain future earnings, if any, for use in
the operation and expansion of our business and do not anticipate paying any
cash dividends in the foreseeable future.
15
<PAGE> 18
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1999:
- on an actual basis;
- on a pro forma basis to reflect the automatic conversion of our
outstanding preferred stock into common stock upon the closing of the
offering; and
- on a pro forma as adjusted basis to reflect the issuance and conversion
of 90,000 shares of Series A Preferred Stock upon the assumed exercise of
a warrant that would otherwise expire upon the closing of this offering
for a total cash exercise price of $45,000 and the sale of the 3,000,000
shares of common stock in this offering at an assumed initial public
offering price of $16.00 per share after deducting an assumed
underwriting discount and estimated offering expenses payable by us.
You should read this information together with our financial statements and
the notes thereto appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
DECEMBER 31, 1999
----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------- --------- -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Long-term obligations under capital leases, net of current
portion................................................. $ 260 $ 260 $ 260
------- ------- -------
Stockholders' equity:
Convertible preferred stock, $0.001 par value,
15,577,000 shares authorized; 14,856,930 shares
issued and outstanding actual; none, pro forma or pro
forma as adjusted.................................... 15 -- --
Common stock, $0.001 par value, 40,000,000 shares
authorized; 11,406,912 shares issued and outstanding
actual; 26,263,842 shares issued and outstanding pro
forma; 29,353,842 shares issued and outstanding pro
forma as adjusted.................................... 11 26 29
Additional paid-in capital................................ 26,498 26,498 69,980
Deferred stock compensation............................... (9,701) (9,701) (9,701)
Accumulated deficit....................................... (4,932) (4,932) (4,932)
------- ------- -------
Total stockholders' equity.............................. 11,891 11,891 55,376
------- ------- -------
Total capitalization............................ $12,151 $12,151 $55,636
======= ======= =======
</TABLE>
The outstanding share information in the table above excludes:
- 3,339,212 shares of common stock issuable upon exercise of options
outstanding under our 1998 stock plan at a weighted average exercise
price of $2.65 per share;
- 803,376 shares available for future issuance under our 1998 stock plan;
- 5,000,000 shares available for issuance under our 2000 stock plan;
- 500,000 shares available for issuance under our 2000 employee stock
purchase plan; and
- 45,000 shares issuable upon exercise of an outstanding warrant.
16
<PAGE> 19
DILUTION
If you invest in our common stock, your interest will be diluted to the
extent of the difference between the initial public offering price per share of
our common stock and the pro forma as adjusted net tangible book value per share
of our common stock after this offering. Net tangible book value per share
represents the amount of our total tangible assets less total liabilities,
divided by the pro forma number of shares of common stock outstanding. Dilution
in net tangible book value per share represents the difference between the
amount per share paid by purchasers of shares of common stock in this offering
and the net tangible book value per share of common stock immediately after the
completion of this offering.
Our pro forma net tangible book value at December 31, 1999, after giving
effect to the issuance of 90,000 shares of Series A Preferred Stock upon the
assumed cash exercise of a warrant that would otherwise expire upon the closing
of this offering and the automatic conversion of all outstanding shares of our
preferred stock into 14,856,930 shares of common stock upon the closing of this
offering, was $11.9 million, or $0.45 per share of common stock. After giving
effect to the sale of the 3,000,000 shares of common stock in the offering, our
pro forma net tangible book value at December 31, 1999 would be $55.4 million,
or $1.89 per share. This calculation is based on an assumed initial public
offering price of $16.00 per share and subtracts an assumed underwriting
discount and estimated offering expenses. This represents an immediate increase
in the pro forma net tangible book value of $1.44 per share to existing
stockholders and an immediate dilution of $14.11 per share to new investors.
The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $16.00
Pro forma net tangible book value per share at December
31, 1999............................................... $ 0.45
Increase per share attributable to new investors.......... 1.44
------
Pro forma net tangible book value per share after the
offering.................................................. 1.89
------
Dilution per share to new investors......................... $14.11
======
</TABLE>
The following table shows on a pro forma basis at December 31, 1999 the
total number of shares of common stock purchased from us, the total
consideration paid to us and the average price paid per share by existing
stockholders and by new investors purchasing common stock in this offering. The
existing stockholder figures give effect to the issuance of 90,000 shares of
Series A Preferred Stock upon the cash exercise of a warrant and the conversion
of all outstanding shares of convertible preferred stock into common stock.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------ ------------------------- AVERAGE PRICE
NUMBER PERCENTAGE AMOUNT PERCENTAGE PER SHARE
---------- ---------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders... 26,353,842 89.8% $13,263,872 21.7% $ 0.50
New investors........... 3,000,000 10.2 48,000,000 78.3 16.00
---------- -----------
Total......... 29,353,842 100.0% $61,263,872 100.0%
========== ===== =========== =====
</TABLE>
The information in the table above excludes:
- 3,339,212 shares of common stock issuable upon exercise of options
outstanding under our 1998 Stock Plan at a weighted average exercise
price of $2.65 per share;
- 803,376 shares available for future issuance under our 1998 stock plan;
- 5,000,000 shares available for issuance under our 2000 stock plan;
- 500,000 shares available for issuance under our 2000 employee stock
purchase plan; and
- 45,000 shares issuable upon exercise of an outstanding warrant.
17
<PAGE> 20
SELECTED FINANCIAL DATA
The statement of operations data set forth below for the period from
January 2, 1998 (inception) to December 31, 1998 and for the year ended December
31, 1999 and the balance sheet data as of December 31, 1998 and 1999 have been
derived from our financial statements, which have been audited by KPMG LLP,
independent auditors, and are included elsewhere in this prospectus. The
historical results are not necessarily indicative of results to be expected for
any future period. You should read the data presented below in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the financial statements and notes to those statements appearing
elsewhere in this prospectus.
<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 2, 1998
(INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1998 1999
---------------- ------------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues................................................ $ -- $27,196
Cost of revenues............................................ -- 12,359
------- -------
Gross profit................................................ -- 14,837
Operating expenses:
Research and development (exclusive of non-cash
compensation expense of $9 and $1,639 in 1998 and 1999,
respectively).......................................... 3,462 5,731
Sales and marketing (exclusive of non-cash compensation
expense of $17 and $846 in 1998 and 1999,
respectively).......................................... 737 3,912
General and administrative (exclusive of non-cash
compensation expense of $3 and $1,050 in 1998 and 1999,
respectively).......................................... 713 1,559
Amortization of deferred stock compensation............... 29 3,535
------- -------
Total operating expenses.......................... 4,941 14,737
------- -------
Operating income (loss)..................................... (4,941) 100
Interest income (expense) and other, net.................... 193 180
------- -------
Income (loss) before income tax expense..................... $(4,748) $ 280
------- -------
Income tax expense.......................................... 1 463
------- -------
Net loss.................................................... $(4,749) $ (183)
======= =======
Basic and diluted net loss per share(1)..................... $ (3.97) $ (0.04)
======= =======
Shares used in computing basic and diluted net loss per
share..................................................... 1,195 4,237
======= =======
Pro forma basic and diluted net loss per share(1)........... $ (0.38) $ (0.01)
======= =======
Shares used in computing pro forma basic and diluted net
loss per share............................................ 12,449 18,946
======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1999
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $1,338 $ 8,063
Working capital............................................. 960 10,969
Total assets................................................ 1,970 19,257
Long-term obligations under capital leases, net of current
portion................................................... 270 260
Total stockholders' equity.................................. 1,226 11,891
</TABLE>
- -------------------------
(1) See Note 2 of our Notes to Financial Statements for information concerning
the computation of the shares used to compute net loss per share and pro
forma net loss per share.
18
<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Financial Data" and our financial statements and the related notes
included elsewhere in this prospectus. This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results could differ
materially from those anticipated in the forward-looking statements as a result
of a number of factors, including the risks discussed in "Risk Factors" and
elsewhere in this prospectus.
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. Currently, all of our product sales and service
arrangements provide for pricing and payment in U.S. dollars.
We sell our products to 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.
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. This subcontracting arrangement includes material
procurement, board level assembly, final assembly, test 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. These long lead times
have in the past, and may in the future, cause us to attempt to
19
<PAGE> 22
mitigate these lead times by purchasing inventories of some parts ourselves. Any
subsequent 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 1998, we recorded total deferred stock compensation of approximately
$195,000 in connection with stock and stock options granted during 1998 at
prices subsequently deemed to be below fair value on the date of grant. Options
granted are typically subject to a four year vesting period. Stock options
issued prior to this offering have been exercisable immediately by cash payment
of the exercise price and are generally subject to our right to repurchase the
stock at the original exercise price, which lapses ratably over a four year
period. 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 $29,000 of deferred stock compensation in the year ended
December 31, 1998, leaving approximately $166,000 to be amortized over the
remaining vesting periods. In 1999, we recorded approximately $13.1 million in
additional deferred stock compensation for stock options granted during 1999 at
prices subsequently deemed to be below fair value on the date of grant. We
amortized a total of approximately $3.5 million of deferred stock compensation
in the year ended December 31, 1999.
RESULTS OF OPERATIONS
NET REVENUES
The quarter ended March 31, 1999 was our first quarter of revenue. Net
revenues were $27.2 million for the year ended December 31, 1999, due to sales
of our CX100.
COST OF REVENUES
Cost of revenues includes amounts paid to A-Plus Manufacturing and related
overhead expenses. Cost of revenues for the year ended December 31, 1999 was
$12.4 million, due to the commencement of manufacturing and sales of our CX100.
Because we did not generate any revenues during the year ended December 31,
1998, we incurred no cost of revenues for that period.
RESEARCH AND DEVELOPMENT
Research and development expenses, net of non-cash compensation expense of
$1.6 million in 1999, 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 for the year ended December 31, 1999 were $5.7 million,
an increase of $2.3 million over the comparable period of 1998. The increase was
due primarily to a significant increase in personnel and related costs
associated with new product development, verification testing, certification and
compliance testing
20
<PAGE> 23
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 of
$846,000 in 1999, consist primarily of salaries, commissions, and related
expenses for personnel engaged in marketing, sales and customer support
functions, as well as costs associated with trade shows, promotional activities
and public relations. Sales and marketing expenses for the year ended December
31, 1999 were $3.9 million, an increase of $3.2 million over the comparable
period of 1998. This increase was primarily due to an increase in the number of
sales and marketing personnel, increased 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
of $1.1 million in 1999, consist primarily of salaries and related expenses for
executive, finance, accounting, facilities and human resources personnel,
professional fees, and costs associated with expanding our information systems.
General and administrative expenses for the year ended December 31, 1999 were
$1.6 million, an increase of $846,000 over the comparable period of 1998. This
increase was primarily due to an increase in the number of general and
administrative personnel, increased facilities costs, and increased legal and
accounting 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 the growth of our business, expanding our
information infrastructure and our operation as a public company.
AMORTIZATION OF DEFERRED STOCK COMPENSATION
In connection with the grant of stock options to employees, we recorded
amortization of deferred stock compensation of approximately $3.5 million for
the year ended December 31, 1999. We recorded amortization of deferred stock
compensation of $29,000 during the comparable period of 1998. The increase in
deferred stock compensation expense was attributable primarily to increased
option grants in 1999 relative to 1998. These additional option grants resulted
from our accelerated hiring activities, which corresponded to the first shipment
of our products in early 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 income of $193,000 for the year ended December 31, 1998 and net
interest income of $180,000 for the year ended December 31, 1999. The change
from the year ended December 31, 1998 was primarily due to a decrease in
interest income earned on proceeds from issuances of our preferred stock and an
increase in interest charges on capital lease obligations.
INCOME TAX EXPENSE
Income tax expense for 1998 was comprised of minimum state taxes, and for
the year ended December 31, 1999 was comprised of federal and minimum state
taxes.
As of December 31, 1998, we had net operating loss carryforwards and tax
credits for federal income tax purposes of approximately $3.0 million and for
state income tax purposes of approximately $1.3 million. These net operating
loss carryforwards and tax credits were used to reduce income subject to income
taxes in 1999.
21
<PAGE> 24
Federal and California tax laws impose substantial restrictions on the
utilization of net operating loss and credit carryforwards in the event of an
ownership change for tax purposes, as defined in Section 382 of the Internal
Revenue Code. The issuance of Series A convertible preferred stock on January
13, 1998 resulted in such a change. As a result the loss and credit
carryforwards as of January 13, 1998 of approximately $105,600 are subject to an
annual limitation approximating $300,000. The net operating losses incurred from
January 14, 1998 to December 31, 1998 are not subject to an annual limitation
and were utilized to offset taxable income in 1999.
As of December 31, 1999, the Company has research and other credit
carryforwards for federal income tax purposes of approximately $17,000 available
to reduce future income taxes. The federal research credit carryforwards expire
in 2019. We have recorded these research and other credit carryforwards,
together with other temporary differences as deferred tax assets and have
established a full valuation allowance for them as their realization is
uncertain.
22
<PAGE> 25
QUARTERLY RESULTS OF OPERATIONS
The following table presents our operating results for each of the four
quarters in the year ended December 31, 1999. The information for each of these
quarters is unaudited and has been prepared on the same basis as our audited
financial statements appearing elsewhere in this prospectus. In the opinion of
management, all necessary adjustments, consisting only of normal recurring
adjustments, have been included to present fairly the unaudited quarterly
operating results. The operating results set forth below should be read together
with our audited financial statements and the related notes appearing elsewhere
in this prospectus. These operating results do not necessarily indicate what our
results of operations will be in any future period. Accordingly, we believe that
quarter to quarter comparisons of our operating results are not necessarily
meaningful and are not a good indication of our future performance.
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1999 1999 1999 1999
--------- -------- ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues............................. $ 952 $ 4,719 $9,033 $12,492
Cost of revenues......................... 576 2,510 3,834 5,439
------- ------- ------ -------
Gross profit............................. 376 2,209 5,199 7,053
------- ------- ------ -------
Operating expenses:
Research and development, exclusive of
non-cash compensation expense....... 830 1,023 1,756 2,122
Sales and marketing, exclusive of
non-cash compensation expense....... 508 821 1,100 1,483
General and administrative, exclusive
of non-cash compensation expense.... 191 308 444 616
Amortization of deferred stock
compensation........................ 97 1,137 877 1,424
------- ------- ------ -------
Total operating expenses....... 1,626 3,289 4,177 5,645
------- ------- ------ -------
Operating income (loss) ................. (1,250) (1,080) 1,022 1,408
Interest income (expense) and other,
net.................................... 42 41 29 68
------- ------- ------ -------
Income (loss) before income tax
expenses............................... (1,208) (1,039) 1,051 1,476
Income tax expense....................... -- -- 63 400
------- ------- ------ -------
Net income (loss)........................ $(1,208) $(1,039) $ 988 $ 1,076
======= ======= ====== =======
AS A PERCENTAGE OF NET REVENUES:
Net revenues............................. 100.0% 100.0% 100.0% 100.0%
Cost of revenues......................... 60.5 53.2 42.4 43.5
------- ------- ------ -------
Gross profit............................. 39.5 46.8 57.6 56.5
------- ------- ------ -------
Operating expenses:
Research and development, exclusive of
non-cash compensation expense....... 87.2 21.7 19.4 17.0
Sales and marketing, exclusive of
non-cash compensation expense....... 53.3 17.4 12.2 11.9
General and administrative, exclusive
of non-cash compensation expense.... 20.1 6.5 4.9 4.9
Amortization of deferred stock
compensation........................ 10.2 24.1 9.7 11.4
------- ------- ------ -------
Total operating expenses....... 170.8 69.7 46.2 45.2
------- ------- ------ -------
Operating income (loss).................. (131.3) (22.9) 11.4 11.3
Interest income (expense) and other,
net.................................... 4.4 0.9 0.3 0.5
------- ------- ------ -------
Income (Loss) before income taxes........ (126.9) (22.0) 11.7 11.8
Income tax expense....................... -- -- 0.7 3.2
------- ------- ------ -------
Net income (loss)........................ (126.9) (22.0) 11.0 8.6
======= ======= ====== =======
</TABLE>
23
<PAGE> 26
Net revenues increased in each of the quarters in the year ended December
31, 1999. These quarterly increases were primarily due to the introduction and
increasing unit sales of our CX100. Because we are dependent on a limited number
of customers, we expect to experience volatility in our revenues relating to the
budgeting cycles of our customers and the telecommunications industry in
general.
Cost of revenues increased in each quarter in the year ended December 31,
1999 as a result of increased unit sales. Gross profit increased in each quarter
in the year ended December 31, 1999 due to increases in the volume of sales and
the realization of associated economies of scale. We expect that the average
selling price and gross margins for our products will decline over time. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview".
Research and development expenses, exclusive of non-cash compensation
expense of $29,000, $200,000, $549,000 and $861,000 in the first through fourth
quarters of 1999, increased due to the addition of personnel and costs incurred
in the development of new products. We expect that in the future costs
associated with new product development, particularly prototyping and compliance
testing, may cause research and development expenses to increase significantly
as a percentage of revenues in a particular quarter.
Sales and marketing expenses, exclusive of non-cash compensation expense of
$62,000, $107,000, $257,000 and $420,000 in the first through fourth quarters of
1999, increased primarily due to the hiring of additional sales personnel,
higher commission expense resulting from increased unit sales, customer support,
marketing programs and tradeshows.
General and administrative expenses, exclusive of non-cash compensation
expense of $6,000, $830,000, $71,000 and $143,000 in the first through fourth
quarters of 1999, increased primarily due to the addition of personnel and
increased accounting and consulting activities.
Amortization of deferred stock compensation for the quarter ended June 30,
1999 includes a compensation expense of:
- $445,000 related to the issuance of Series B Preferred Stock to an
advisory board member at a price below the deemed fair value of the
preferred stock; and
- $383,669 related to immediately vested common stock options granted at
exercise prices below the deemed fair value of the common stock.
We plan to significantly increase our operating expenses to fund greater
levels of research and development, expand our sales and marketing operations
and broaden our customer support capabilities. We also plan to expand our
general and administrative functions to address the increased reporting and
other administrative demands which will result from this offering and the
increasing size of our business.
As a result of our limited operating history, we cannot accurately forecast
operating expenses based on historical results. Accordingly, we base our
expenses in part on future revenue projections. Most of our expenses are fixed
in nature, and we may not be able to quickly reduce spending if revenues are
lower than we have projected. Our ability to forecast our quarterly sales
accurately is limited, which makes it difficult to predict the quarterly
revenues that we will recognize. We expect that our business, operating results
and financial condition would be harmed if our revenues do not meet projections.
Our quarterly results of operations may fluctuate from quarter to quarter
due to a number of factors, including the following:
- demand for the CX100;
- the timing of sales of the CX100;
24
<PAGE> 27
- the timing of product acceptance by some of our customers;
- new product introductions by our competitors;
- changes in our pricing policies or the pricing policies of our
competitors;
- our ability to develop, introduce and ship new products and product
enhancements that meet customer requirements in a timely manner;
- our ability to obtain sufficient supplies of sole or limited source
components;
- increases in the prices of the components we purchase;
- our ability to plan, attain and maintain production volumes and quality
levels for our products;
- prototype expenses; and
- costs related to acquisitions of technology or businesses.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations primarily through private
sales of approximately $12.0 million of convertible preferred stock and
approximately $1.2 million of common stock as well as through capital leases for
computers, office equipment, software and furniture.
We used $4.3 million in cash from operations in the period from inception
to December 31, 1998, primarily due to our net loss of $4.7 million, partially
offset by non-cash charges. We generated $328,000 in cash from operations in the
year ended December 31, 1999. This resulted from increases in accrued expenses
and other liabilities, deferred revenue, customer deposits and non cash charges
offset by increases in accounts receivable and inventory balances.
We used $222,000 in cash from investing activities in the period from
inception to December 31, 1998 and used $715,000 in cash from investing
activities in the year ended December 31, 1999, for acquisition of property and
equipment. We generated $5.9 million in cash in the period from inception to
December 31, 1998 and $7.1 million in cash in the year ended December 31, 1999,
from financing activities, primarily from private sales of convertible preferred
stock and issuances of common stock. We have used leases to partially finance
capital purchases of computer equipment. We had $399,000 in capitalized lease
obligations outstanding at December 31, 1998, and $489,000 at December 31, 1999.
These amounts represent our payment obligations to the equipment lessor which,
because of their nature, have been capitalized and reflected as a liability on
our balance sheet, to be repaid over a period of three years from lease
inception.
At December 31, 1999, cash and cash equivalents totaled $8.1 million, an
increase of $6.7 million from December 31, 1998. The increase was due to the
receipt of $6.2 million from the sale of convertible preferred stock in January
1999 and $328,000 in cash generated from operations, partially offset by cash
used in investing activities.
Our capital requirements depend on numerous factors, including:
- timing and amount of sales of our products;
- market acceptance of our products;
- the resources we devote to developing, marketing, selling and supporting
our products; and
- the timing and extent of establishing international operations.
We expect to devote substantial capital resources to continue our research
and development efforts, to hire and expand our sales, support, marketing and
product development organizations, to expand marketing programs, and for other
general corporate activities. We believe that our current cash balances will be
sufficient to fund our operations for at least the next 12 months. In addition
we believe the net proceeds of this offering will improve our long-term
liquidity by providing us with
25
<PAGE> 28
substantial working capital. We currently expect to fund our business
principally from cash generated from operations and do not anticipate any need
to raise additional capital in the foreseeable future. Nevertheless, we may in
the future experience one or more quarters in which our revenues are less than
expected, resulting in operating cash flow deficiencies. In that event, the
proceeds of this offering would be used to fund our operations. If any downturn
in our business were severe or sustained, of if changes in our business
strategies resulted in alternative uses of these proceeds, we could require
additional financing. Any additional funding, if needed, may not be available on
terms acceptable to us or at all.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not currently transact business in any foreign countries or
currencies and have therefore not engaged in any currency hedging activities to
date. We do not use derivative financial instruments for speculative trading
purposes and to date have not been a party to any financial instruments or
contracts that expose us to material market risk.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards, or SFAS, No. 133, "Accounting for Derivative
Instruments and Hedging Activities". The new standard establishes accounting and
reporting standards for derivative instruments, including derivative instruments
embedded in other contracts, and for hedging activities. SFAS 133 will be
effective for the Company's fiscal year ended December 31, 2001. We do not
expect SFAS 133 to have a material effect on our financial position or results
of operations.
YEAR 2000 COMPLIANCE
THE YEAR 2000 PROBLEM
The year 2000 computer problem refers to the potential for system and
processing failures of date-related data as a result of computer-controlled
systems using two digits rather than four to define the applicable year. For
example, computer programs that have time-sensitive software may recognize a
date represented as "00" as the year 1900 rather than the year 2000.
READINESS OF OUR PRODUCTS
We have designed the CX100 for use in the year 2000 and beyond and believe
it is year 2000 compliant. Since January 1, 2000, we have not received any
reports of CX100 malfunctions related to Year 2000 issues. However, a
programming error that has not yet been discovered could result in the CX100
failing to be year 2000 compliant, in which case, our business would suffer. We
represent to our customers that upon notification of any year 2000 problems with
our products, we will remedy it by product repair or replacement.
Our products are generally integrated into larger networks involving
sophisticated hardware and software products supplied by other vendors. The
networks to which our products are connected may have problems with year 2000
issues, since these networks incorporate hardware and software products supplied
by other companies. Each of our customers' networks involves different
combinations of third party products. We cannot evaluate whether all of their
products are year 2000 compliant. We may face claims based on year 2000 problems
in other companies' products or based on issues arising from the integration of
multiple products within the overall network. To date, we have not become aware
of any year 2000 problems associated with the integration of our products with
third-party products. We could experience problems in the future, however, based
on problems that have not yet been discovered. We may in the future be required
to defend our products in legal proceedings that could be expensive regardless
of the merits of these claims.
26
<PAGE> 29
READINESS OF OUR SYSTEMS AND FACILITIES
We completed our systems updates and upgrades of non-ready systems prior to
December 31, 1999 and have not experienced any material problems since January
1, 2000. Systems include internal hardware and software as well as external
services provided by other companies, including contract manufacturing, product
development, information processing and facility services. We are not currently
aware of any unresolved year 2000 problems relating to any of our internal
systems but could discover problems in the future. If our suppliers, vendors,
major distributors, partners, customers, service providers, contract
manufacturer, or applications service provider fail to correct their year 2000
problems, these failures could interrupt our normal business activities. If a
year 2000 problem occurs, it may be difficult to determine which party's
products have caused the problem. These failures could interrupt our operations
and damage our relationships with our customers. We have contacted A-Plus
Manufacturing and AristaSoft to determine whether their systems are year 2000
compliant. Both have reported that their internal systems are year 2000
compliant and that they have not experienced any material problems since January
1.
COST OF PRODUCT AND INTERNAL SYSTEMS PREPARATION
Based on our assessment and experience to date, we do not expect the total
cost of year 2000 remediation to be material to our business. We have not
developed, and have no plans to develop, a contingency plan to address
situations that may result if we experience year 2000 problems.
YEAR 2000 RISK
An internal or external business disruption caused by the year 2000 issue
could interrupt our operations and damage our relationships with our customers.
An internal disruption unique to us could give a comparative advantage to our
competitors. Any failure of our internal systems and critical external services
resulting from year 2000 issues could delay order processing, issuing invoices
or development and shipment of products. The cost of recovery from failures
could be significant and result in lost revenues.
Our customers' purchasing plans could be affected by year 2000 issues if
they need to expend significant resources to fix their existing systems. This
situation could divert funds and resources otherwise available for new product
purchase.
We are unable to determine at this time whether undiscovered year 2000
problems will occur in the future and will have a material impact on our
business, results of operations or financial condition. We are also unable to
determine the costs and consequences to us of year 2000 failures we, our
vendors, customers or manufacturing contractors experience due to the scope and
complexity of the manner in which these failures may manifest. In particular, it
is difficult to assess the readiness of external service providers, including
utilities, government entities and other vendors. However, a reasonable worst
case scenario might include:
- delay or loss of revenues;
- cancellation of customer orders;
- diversion of development resources;
- damage to our reputation;
- increased maintenance and warranty costs; or
- litigation costs.
Any of these effects could harm our business, financial condition and results of
operations.
27
<PAGE> 30
BUSINESS
OVERVIEW
We are a leading provider of products that enable local exchange carriers
to rapidly deploy and efficiently maintain DSL services. The Copper CrossConnect
CX100, our first product, is currently being installed in telephone company
central offices by competitive local exchange carriers to speed their deployment
of DSL services. The CX100 product family enables the rapid and efficient
deployment of high-speed digital services on existing copper telephone lines.
INDUSTRY BACKGROUND
INCREASING NEED FOR HIGH SPEED ACCESS
Internet content and the number of users accessing the Internet are
expected to continue to grow rapidly. International Data Corporation projects
the number of worldwide users accessing the Internet to grow from approximately
142 million in 1998 to more than 500 million by 2003. In addition, content is
becoming more data-intensive as websites increasingly offer streaming video and
audio, animation and software downloads. As more users access more Internet
content, the ability to connect to the Internet at high speeds is becoming more
important. To remain competitive, businesses are using high-speed connections to
access and provide information via the Internet, conduct transactions with
customers and suppliers, and communicate more effectively with remote employees.
Consumers are also increasingly accessing the Internet to communicate, collect
and publish data-intensive information, conduct retail purchases and access
online entertainment.
To meet this demand, a growing number of local exchange carriers are
increasingly offering high-speed Internet access and other services, often over
existing telephone lines. These existing lines, commonly referred to as the
local loop, extend from telephone companies' central offices out to businesses
and residences. The local loop is part of analog telephone networks developed
and deployed over the last 100 years to carry voice traffic. Local exchange
carriers are taking advantage of the underutilized capacity of this telephone
network infrastructure to deliver high-speed Internet connections to businesses
and residences.
EMERGING DSL SERVICES AND LOCAL EXCHANGE CARRIERS
A growing number of local exchange carriers are deploying DSL to offer
high-speed, cost-effective, access services on existing copper lines. Because
DSL networks reuse the existing copper lines extending from telephone companies'
central offices to businesses and residences, they are less expensive to deploy
than alternative access technologies. In addition, significant portions of the
cost of a DSL network can be deferred until subscribers are added, reducing the
initial fixed cost of the network. Other advantages of DSL include the ability
to leverage more of the underutilized capacity of the telephone line, offer
multiple services on the same line and operate as a dedicated, always-on
service, not requiring subscribers to initiate a dial-up connection each time
the service is used. Challenges to providing DSL service generally include the
difficulty in identifying, installing and determining the quality of a
particular line, and the expense of deploying and maintaining DSL service.
However, we believe the benefits of DSL technology are compelling, and that a
growing number of local exchange carriers will deploy DSL instead of
alternatives such as cable modems, wireless or satellite technology.
In the mid-to-late 1990's, various competitive dynamics prompted local
exchange carriers to target either the consumer or business market segments
using DSL technology. Cable operators, such as AT&T@Home and RoadRunner, began
delivering high-speed consumer services, prompting the incumbent local exchange
carriers to respond by accelerating their investments in DSL technologies. An
incumbent local exchange carrier is a communications company that held an
exclusive license to offer local telephone services prior to the
Telecommunications Act of 1996. Examples include the regional Bell operating
companies. To date, incumbent local exchange carriers have generally focused
28
<PAGE> 31
their DSL deployments on the consumer segment by using versions of DSL that work
in conjunction with existing analog voice services as well as the associated
line maintenance procedures. However, these consumer-oriented versions of DSL
typically have limitations that make them unattractive for businesses. We
believe many incumbent local exchange carriers will gradually convert their
existing local loop equipment from analog to digital to deliver more competitive
business services as well as voice services in a more cost-effective manner.
Deregulation under the Telecommunications Act of 1996 enabled new
companies, known as competitive local exchange carriers, to provide competing
services. It also eliminated a substantial barrier to competitive local exchange
carriers by allowing access to the incumbent local exchange carriers' facilities
in order to utilize the existing local loop network infrastructure. Many of
these competitive local exchange carriers are new companies without a
significant installed base of traditional analog voice equipment and as a result
are aggressively deploying modern DSL equipment and implementing new line
maintenance procedures in the incumbent carriers' facilities. This has enabled a
growing number of competitive local exchange carriers to use the local loop to
offer competitively priced, high-speed services to business customers.
The primary alternative methods of providing high-speed Internet access
include cable modems, wireless technology and satellite technologies. Cable
modem service targets the residential market and theoretically can provide
faster download speeds than DSL, if access is provided over a line with a single
user. However, because of the cable modems' method of data transmission and
cable layout patterns, all cable modem users in a particular neighborhood share
the same bandwidth, and download speeds slow as the number of users in that
neighborhood increases. Both wireless and satellite technologies enable users to
transmit and receive information using radio frequencies at transmission speeds
close or comparable to DSL transmission speeds; however, neither technology has
yet achieved widespread acceptance, and neither technology can make use of the
existing physical infrastructure that the incumbent local exchange carriers have
developed and maintained. Technology for providing high-speed data services is
rapidly evolving, however, and our success will depend upon DSL technology
remaining competitive with these and other emerging technologies.
29
<PAGE> 32
DSL LINE INSTALLATION AND MAINTENANCE
Competitive local exchange carriers gain access to the local loop and
deploy DSL by leasing space in an incumbent local exchange carrier's central
office, installing network equipment in this space and leasing specific copper
telephone lines to connect subscribers. Incumbent local exchange carriers must
connect copper lines as requested from the competitive local exchange carriers'
leased space to subscriber locations, a process that tends to be labor
intensive. When a competitive local exchange carrier orders a line from their
equipment to the subscriber's site, the incumbent local exchange carrier's
personnel must manually complete one or more connections. These include
connections inside the central office, at the subscriber's site and possibly at
various points throughout the local loop.
The following diagram illustrates a typical network configuration and
installation procedures for competitive local exchange carrier DSL deployment.
LOGO
DSL DEPLOYMENT CHALLENGES
Despite the new revenue opportunity DSL provides for local exchange
carriers, there are several major challenges in deploying and maintaining a new
DSL infrastructure that have slowed deployment. The challenges include:
DSL INSTALLATION IS DIFFICULT, EXPENSIVE AND LABOR INTENSIVE. DSL
installation requires one or more connections to the copper line in a process
that uses manual labor and hand-held test tools. A common problem that arises
with local exchange carriers deploying DSL is human error in installing the
copper line. To ensure that the line has been correctly connected, technicians
rely on standard analog voice tools that attach to the copper lines at any point
in order to correctly identify the line. This technique relies upon incumbent
local exchange carrier voice equipment that generates audible dial tones as well
as an audible identification code associated with a particular line. Since a
competitive local exchange carrier's DSL lines are not connected to this voice
equipment, an audible dial tone is not available. Without this line
identification information, connections are often performed incorrectly at one
or more of the various points throughout the network. Discovering and correcting
these mistakes by dispatching service personnel into the field is costly and
leads to delays in establishing service.
30
<PAGE> 33
DSL SERVICES ARE DEPENDENT ON COPPER LINE LENGTH AND QUALITY. DSL operates
at higher frequencies than traditional analog voice service and is therefore
more dependent on the length and quality of the copper line and more easily
affected by electrical interference. Because various devices connected to, or
faults occurring on, the copper line can cause problems for DSL, they must be
identified in advance so that the line can be properly prepared for DSL service.
In addition, a greater range of frequencies must be monitored to fully qualify
the line and detect electrical interference. For local exchange carriers to
efficiently maintain DSL services, they must be able to qualify and monitor
copper lines. To date, a significant amount of on-site labor and expensive
hand-held test equipment has been required to install, qualify, maintain and
troubleshoot lines for DSL.
DSL MAINTENANCE IS COMPLEX. Because DSL runs on the local loop, DSL
networks require local exchange carriers to deploy DSL equipment in a large
number of central offices in order to provide service in a broad geographic
region. One necessary piece of equipment is known as a DSL access multiplexer,
which receives signals from multiple DSL connections and puts the signals on a
larger, high-speed transmission line. Local exchange carriers must sometimes
send technicians to individual central offices to reconnect lines, to correct
equipment failures or to change subscriber services. For example, in the event
of a DSL access multiplexer failure, the local exchange carrier would need to
either replace the defective equipment or manually reconnect the subscriber
lines around the failure. These on-site service calls to the central office can
be costly and lead to delays in service availability. Given the rapid and
wide-scale deployment of DSL technology and the need for guaranteed levels of
service, local exchange carriers are increasingly automating and remotely
managing activities related to DSL deployment and maintenance.
NEED FOR A PURPOSE-BUILT SOLUTION
Given the historically exclusive use of the copper local loop
infrastructure by incumbent local exchange carriers for voice traffic, most
equipment vendors have focused on the needs of the incumbent local exchange
carriers and their traditional analog voice services. These vendors have not
developed products optimized for the unique requirements of competitive local
exchange carriers and new digital services. Traditional systems, often based on
proprietary software, are difficult and expensive to integrate with new DSL
equipment and modern operational support systems. We believe widespread
deployment of competitive DSL services requires new infrastructure equipment
with standard interfaces providing for the automation and remote management of
line installation, qualification and maintenance that would otherwise be
manually implemented.
THE TURNSTONE SOLUTION
Our Copper CrossConnect CX100 product family improves the efficiency of
installing and managing DSL services while delivering the high levels of
reliability and scalability needed in a large, complex network. We believe that
our CX100 product family is the first solution designed and built specifically
to enable local exchange carriers deploying DSL to automate and remotely control
the installation, qualification and maintenance of copper telephone lines in a
local loop. Our CX100 product family consists of the Copper CrossConnect CX100
and associated modules and the CrossWorks suite of software applications. The
CX100 product family is designed specifically to enable the rapid and efficient
deployment of high-speed digital services on the existing local loop. The CX100
is typically deployed between one or more DSL access multiplexers and the copper
subscriber lines. Additional modules can be added to the CX100 over time as
subscriber count increases and as more modules are added to DSL access
multiplexers. The CX100 enables local exchange carriers to remotely qualify,
manage and control the copper lines. CrossWorks can operate independently or be
integrated with a local exchange carrier's operational support system, enhancing
efficiency and scalability.
31
<PAGE> 34
The benefits of our solution include:
RAPID AND EFFICIENT DSL DEPLOYMENT. Our CX100 enables carriers to remotely
perform line qualification, testing and maintenance on any line connected
through the system. Accurate line qualification and testing enable local
exchange carriers to rapidly and efficiently deploy DSL services. The CX100
provides local exchange carriers with critical testing capabilities, including
traditional tests performed on analog lines as well as advanced tests that are
appropriate for DSL network environments. Our customers can remotely confirm if
a particular copper line is properly connected into the central office, and
whether it can support a specific type and speed of DSL service prior to
deploying field personnel for installation at the subscriber site. The CX100 can
also generate audible tones on any set of lines, providing field personnel with
a convenient mechanism for ensuring lines are correctly connected during DSL
installation. These features are also useful for performing fault isolation and
maintenance on DSL subscriber lines after service is installed and operational.
IMPROVED NETWORK RELIABILITY. The CX100 improves network reliability and
availability by providing local exchange carriers with remote service
modification and restoration capabilities, enabling local exchange carriers to
offer guaranteed levels of service. For example, in the event of a DSL access
multiplexer failure, our customers can rapidly restore services by remotely
reconnecting the affected lines around the problem, a process we call protection
switching. Carriers can also use the protection switching capability to remotely
modify a customer's service type quickly and cost effectively. The ability to
remotely modify a customer's services is useful for handling unforeseen
installation problems or responding quickly to service change requests without
the requirement for costly on-site labor.
AUTOMATED OPERATIONS. Our CrossWorks software operates in conjunction with
the CX100 to automate the collection, analysis and archiving of information
regarding subscribers, line assignments, test histories and other information.
Raw test data can be automatically gathered at programmed intervals and
analyzed, generating pass/fail notifications based on user-defined thresholds
for particular services. All of the information is automatically stored and is
available for future troubleshooting or trend analysis. CrossWorks also includes
automated network administration capabilities such as software upgrades, backups
and alarm tracking. CrossWorks may be integrated with service providers'
existing operational support systems using open, standard interfaces or operated
as a stand-alone application.
COMPATIBLE WITH ALL SERVICES AND PLATFORMS. The CX100 is designed to be
compatible with all types of local loop services and all types of DSL access
multiplexers. A single CX100 may be deployed with multiple DSL access
multiplexers from a variety of vendors, including Alcatel, Cisco, Copper
Mountain, Lucent, Nokia and Paradyne. With our solution in place, local exchange
carriers can deploy next-generation equipment to support emerging DSL services
as well as leverage existing investments in networking equipment that support
more traditional services.
STRATEGY
Our objective is to be the leading provider of products to enable local
exchange carriers to automate and remotely control the installation,
qualification and maintenance of copper telephone lines for DSL service. Key
elements of our strategy include:
INCREASE PENETRATION IN THE COMPETITIVE LOCAL EXCHANGE CARRIER MARKET. Our
initial target customers are competitive local exchange carriers specifically
focused on offering DSL services to business users. We expect that our target
market will grow as new competitive local exchange carriers emerge and as
established competitive local exchange carriers supplement their existing
services with DSL service offerings for businesses. We believe our early success
with competitive local exchange carriers such as BlueStar, Covad Communications,
DSL.net, Jato Communications, Network Access Solutions and Rhythms
NetConnections Inc. will better enable us to market to other competitive local
exchange carriers as they deploy DSL.
32
<PAGE> 35
PENETRATE NEW MARKETS AS THEY EMERGE. We believe incumbent local exchange
carriers and local exchange carriers in other countries will gradually convert
their installed base of analog, voice equipment to more efficient DSL equipment
due to superior economics, demand for new services and continued deregulation.
We intend to add features to our existing products to make our solutions more
attractive to incumbent local exchange carriers and local exchange carriers in
other countries. We plan to expand our sales, marketing and support capabilities
to meet the growing demand for high-speed access solutions and increase our
brand recognition both domestically and internationally.
ENHANCE PRODUCT OFFERINGS. We believe that our core product offerings can
be enhanced to offer better value to existing and new customers and plan to
continue adding features and functionality to increase the utility and
applicability of our product offerings. Since our products have been deployed by
a number of our customers, we have developed an understanding of the challenges
facing these carriers, which better enables us to design additional features and
capabilities into the CX100 product family. We expect to invest significant
development resources in the areas of service qualifications, network
management, operational support system interfaces and manufacturing cost
reductions. In addition, we plan to seek regulatory approvals and certifications
so that our products may be deployed outside the United States.
DEVELOP RELATIONSHIPS WITH ORIGINAL EQUIPMENT MANUFACTURERS. Although we
primarily market our products through our direct sales force, we believe
original equipment manufacturer relationships can enhance our market position
and make us a more attractive vendor to a broader base of customers. We have
formed an original equipment manufacturer relationship with Lucent Technologies,
who has chosen to resell the CX100 as a co-branded system. We expect this
relationship to expand our distribution and customer support capacity globally
as well as satisfy the equipment financing requirements of certain customers. In
the future, we expect to develop other original equipment manufacturer
relationships in order to penetrate additional customer segments or market our
products in international markets.
LEVERAGE RELATIONSHIPS WITH COMPLEMENTARY EQUIPMENT VENDORS. The CX100 is
compatible with a variety of DSL equipment as well as analog telephone
equipment. The CX100 may be used with multiple DSL access multiplexers from a
number of vendors, including Alcatel, Cisco, Copper Mountain, Lucent, Nokia and
Paradyne. Because our solution is complementary to DSL access multiplexers, we
believe DSL access multiplexer vendors are likely to recommend our products to
their customers. We intend to make our product an attractive complement to all
DSL access multiplexer vendors and to further encourage joint sales and
marketing activities. We are also working with vendors of hand-held line test
equipment in order to provide more sophisticated capabilities.
OUTSOURCE MANUFACTURING. We outsource manufacturing of our products
including material procurement, board level assembly, final assembly, test and
shipment to our customers. We use automated design, manufacturing and test
processes to minimize cycle times and improve product quality. We believe that
continuing this arrangement will lower our manufacturing costs, provide us with
more flexibility to scale our operations to meet changing demand and allow us to
focus our engineering resources on new product development and product
enhancements.
33
<PAGE> 36
PRODUCTS
The CX100 is typically deployed in a telephone company's central office
between one or more DSL access multiplexers and the copper subscriber lines.
CX100 modules may be added over time as subscriber count increases and as more
DSL access multiplexer modules are added. With the CX100 our customers can
remotely qualify and monitor copper lines as well as verify connections to
subscriber sites. We also offer a suite of software modules, called CrossWorks,
which enables our customers to more efficiently control the CX100, enhancing
remote or automated management of the local loop. We expect that these core
technologies will serve as the basis for future generations of products.
Pictured below is the CX100 deployed in the telephone company's central
office.
LOGO
COPPER CROSSCONNECT CX100. The CX100 is a modular product designed for
central office environments and is compliant with network equipment building
standards. The base system, which depends on customer configuration, typically
consists of one CX100 chassis, one P100 module that provides the management and
control functions of the CX100 and one or more L140 modules that provide access
to copper telephone lines. The base system is installed and fully cabled in a
central office, with additional modules added over time as subscriber count
increases and as more DSL access multiplexer modules are added. All modules may
be inserted or removed while the system is operational and are automatically
recognized and inventoried by the system upon insertion. All modules, indicators
and switches are accessible from the front of the system, consistent with
current industry practices. The CX100 supports dual 48-volt power feeds. In the
event of loss of power, the CX100 maintains all connections with no loss of
subscriber service. The CX100 chassis is available in
34
<PAGE> 37
19 and 23 inch configurations. The 19 inch version supports 425 lines, and the
23 inch version supports 550 lines. The following modules are currently
available:
P100. The P100 module provides management and control functions for the
system and has line qualification functionality. The P100 supports Ethernet,
serial port or dial-up modem access for management, as well as access for
interfacing to external test gear.
L140. The L140 module provides access to the P100 and connections for up to
25 copper lines. L140 module may be added over time as subscriber count
increases and as more DSL access multiplexer modules are added.
M101. The M101 module provides a six-port Ethernet hub and four contacts
for monitoring physical alarms in central offices. This optional module provides
a convenient management connectivity solution between multiple network products
within the central office.
CROSSWORKS. CrossWorks is a suite of software products that enable service
providers to automate physical management of a large volume of copper lines when
using CX100 systems.
The following diagram shows how our CrossWorks software interfaces with a
competitive local exchange carrier's operational support system.
LOGO
CrossWorks employs a client-server architecture that offers flexible
integration with existing operations and support systems. The CrossWorks server,
which performs most of the automation work, can be accessed via standard
interfaces, such as common object request broker architecture, commonly known as
CORBA, JAVA, remote method indication, commonly known as RMI, simple network
management protocol, commonly known as SNMP, or distributed component object
model, commonly known as DCOM, allowing a service provider to use its own user
interface. Alternatively, a service provider can use CrossWorks as a standalone
client-server application. With either of these approaches, CrossWorks is
designed to interface with the service provider's existing database through a
standard application programming interface. These options are designed to
provide the
35
<PAGE> 38
service provider with automated system capabilities while leveraging its
existing operational support systems infrastructure.
The CrossWorks suite consists of the following modules:
- CROSSTEST for line qualification and line history tracking;
- CROSSSCOPE for frequency analysis of local loops;
- CROSSCONFIG for comprehensive network configuration and administration of
multiple CX100s; and
- CROSSVIEW for basic management of individual CX100s.
CUSTOMERS
In the year ended December 31, 1999, customers who accounted for more than
$100,000 of revenue included Bluestar Communications, Covad Communications,
DSL.net, Jato Communications, MCI Worldcom, MGC Communications, Network Access
Solutions, Network Plus, Nokia, Primary Networks and Rhythms NetConnections. As
of December 31, 1999, we had shipped over 2,500 CX100 systems. In the year ended
December 31, 1999, Rhythms NetConnections accounted for approximately 41% of our
revenues, Network Access Solutions accounted for approximately 19% of our
revenues, and Covad Communications accounted for approximately 11% of our
revenues. In addition, our non-exclusive original equipment manufacturer
relationship with Lucent Technologies accounted for 15% of our revenues. We have
no long-term contracts with any of our customers, and they may reduce or
discontinue their purchases at any time.
SALES AND MARKETING
We sell and market our products through our direct sales force and an
indirect channel.
DIRECT SALES. Our direct sales effort in North America is directed by four
regional sales managers. To date, our direct sales efforts have been primarily
focused on competitive local exchange carriers deploying DSL, and we expect to
target other local exchange carriers who deploy DSL in the future. We plan to
expand our direct sales organization internationally in the future. We also have
eight systems engineers who support our regional sales managers and work with
customers' engineering and operations personnel to improve their ability to use
and integrate our products. Direct sales accounted for approximately 85% of our
revenues for the year ended December 31, 1999.
INDIRECT SALES. We have entered into an original equipment manufacturer
agreement with Lucent Technologies, a leader in the global telecommunications
equipment market. Under this agreement, we co-brand the CX100 with Lucent, which
resells the CX100 products. Lucent offers DSL access equipment and services,
including vendor financing, which facilitate the sale of our products and
services. Lucent generally provides first level support for our products to its
customers. Our agreement allows Lucent to sell our product on a worldwide,
nonexclusive basis. Under our agreement, Lucent provides monthly, nonbinding,
twelve-month forecasts of Lucent's anticipated orders. The contract contains no
minimum purchase requirements and is terminable by Lucent at any time. Products
are shipped against individual purchase orders. The agreement expires in August
2002 but may be renewed by agreement of both parties for an additional twelve
month period.
Our marketing organization is responsible for sales support, product
presentations, documentation and pricing, as well as new product and feature
definition. Our marketing organization also performs activities such as
marketing communications, marketing research, trademark administration and other
support functions.
36
<PAGE> 39
CUSTOMER SERVICE AND SUPPORT
We believe a high level of continuing service and support is critical to
our long-term success. We offer comprehensive hardware and software maintenance
and support programs for our products. The majority of our service and support
activities are related to training, troubleshooting and network management.
These services are provided by telephone, email and directly at customer
locations using personnel from our customer support group. We also offer various
training courses for our direct customers and original equipment manufacturers.
RESEARCH AND DEVELOPMENT
We have assembled a team of highly skilled engineering professionals who
are experienced at designing data networking equipment and network management
software. Our engineering personnel have expertise in a number of fields,
including digital loop carrier design, voice and data switching technology,
local loop equipment design and operations support systems. During the year
ended December 31, 1999, we spent $5.7 million on research and development. As
of December 31, 1999, we had a total of 33 employees engaged in research and
development.
We believe that our future success depends on our continued ability to
adapt to the rapidly changing local loop market, to maintain our expertise in
loop management and to continue anticipating and satisfying our customers'
evolving needs. We continually review and evaluate technological and regulatory
changes affecting the local exchange carrier market and seek to offer products
and capabilities that solve customers' operational challenges and improve their
efficiency.
Through our research and development efforts, we created our CrossWorks
suite of software products that enable more efficient integration of our CX100
systems' functions into our customers' operations support systems. We believe
that our extensive experience designing and implementing high-quality network
components has enabled us to develop high-value integrated systems solutions.
We are currently investing significant resources in operational support
systems interfaces and capabilities, automated testing, new modules optimized
for specific applications and support for additional industry standards,
including international compliance testing for our products.
COMPETITION
The market for telecommunications equipment is highly competitive. A number
of companies that have traditionally produced products for analog voice networks
market products that compete with ours. These companies include: Harris
Corporation, Hekimian Laboratories, Hewlett-Packard Company, Inrange
Technologies Corporation, Lucent Technologies, Nortel Networks, Teradyne
Corporation and Tollgrade Communications. In addition, a number of smaller
companies are expected to introduce products that will compete with ours.
We also compete with DSL equipment providers including Lucent, Nortel,
Nokia and Alcatel, who have announced plans to incorporate competitive features
and functionality into their DSL access multiplexers. 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.
Remaining competitive in our markets will require a continued high level of
investment in research and development, marketing, and customer service. The
principal competitive factors in our market include:
- speed of new product introductions to market;
- depth of product functionality;
- ease of installation, integration and use;
- system reliability and performance;
37
<PAGE> 40
- price and financing terms;
- technical support and customer service;
- size and stability of the vendor's operations; and
- compliance with government and industry standards.
Due to the rapidly evolving markets in which we compete, additional
competitors with significant market presence and financial resources, including
other large telecommunications equipment manufacturers, may enter our markets,
thereby further intensifying competition. We may not have sufficient resources
to continue to make the investments or achieve the technological advances
necessary to compete successfully.
The markets for high-speed telecommunications products are characterized by
rapid technological developments, frequent enhancements to existing products and
new product introductions, changes in end user requirements and evolving
industry standards. The emerging nature of these products and services and their
rapid evolution requires us to continually improve the performance, features and
reliability of our products, particularly in response to competitive product
offerings. Current or future competitors may foresee the course of market
developments more accurately than we do and may introduce products incorporating
superior or alternative technologies that could render our products obsolete.
Our products are primarily used in DSL-based service applications that use
copper lines. Numerous other high-speed access technologies, including cable
modems, satellite technology and wireless technologies compete with DSL-based
services. These competing technologies may ultimately prove to be superior to
DSL-based services and reduce or eliminate the demand for our products. The
properties of copper lines limit the speed and distance over which data can be
transmitted. Service levels degrade as distance from the central switching
station increases. Other competing technologies, such as wireless and cable, are
not subject to such limitations. Our products may become obsolete as a result of
the development of competing technologies that are more reliable, faster and
less expensive than DSL.
MANUFACTURING
Our manufacturing operation is entirely outsourced. We have entered into an
agreement with A-Plus Manufacturing, under which we subcontract manufacturing of
our products. A-Plus Manufacturing, located in San Jose, California, is an
established contract manufacturer with ISO 9002 and Telecordia, formerly
Bellcore, certifications. These certifications relate to the manufacturer's
compliance with industry standards for quality control procedures and
telecommunications products. This subcontracting arrangement includes material
procurement, board level assembly, final assembly, test and shipment to our
customers. We utilize automated design, manufacturing and test processes to
minimize cycle times and improve product quality. We design and implement all of
the tests that are required to meet internal and external quality standards, and
routinely monitor product quality via on-site inspections. This arrangement
provides us with the following benefits:
- we operate without substantial space dedicated to manufacturing
operations;
- we conserve a significant portion of the working capital that would be
required for funding inventory; and
- we can more easily adjust manufacturing volumes to meet changes in
demand.
A combination of standard parts and components are used, which are
generally available from more than one vendor, and a number of key components
are purchased from sole or limited source vendors for which alternative sources
are not currently available. There are no guaranteed supply arrangements with
these suppliers, and we or our contract manufacturer may fail to obtain these
supplies in a timely manner in the future. Delivery delays, supply interruptions
or the discontinuation of these components could result in delays or reduction
in product shipments and
38
<PAGE> 41
revenues. 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 12 suppliers.
All of these components are critical to the production of our products, and
competition exists with other manufacturers for these key components. While
alternative suppliers may be available, we must first identify these suppliers
and qualify them. Qualifying additional suppliers is time-consuming and
expensive. We cannot be certain that we will be able to qualify or identify
alternative suppliers in a timely fashion, or at all. In addition, our contract
manufacturer may not be able to obtain sufficient quantities of these components
from existing or future suppliers on the same or substantially the same terms as
are currently available. Consolidations involving suppliers could further reduce
the number of alternatives and affect the cost of components. An increase in the
cost of components could make our products less competitive and result in lower
margins.
Financial or other difficulties faced by these suppliers or significant
changes in market demand for these components could limit the availability of
these components. Any interruption or delay in the supply of any of these
components, or the inability to obtain these components from alternate sources
at acceptable prices and within a reasonable amount of time, would adversely
affect our ability to meet scheduled product deliveries to our customers, cause
us to lose sales to existing and future customers and harm our operating results
and financial condition.
In addition, lead times for some of the materials and components we use are
very long and depend on factors such as the specific supplier, contract terms
and demand for each component at given time. Our contract manufacturer also may
experience shortages of components from time to time, which also could delay the
manufacturing of our products. Additionally, long lead times for some materials
and components have in the past, and may in the future, cause us to attempt to
mitigate these lead times by purchasing inventories of some parts ourselves,
increasing our costs and risk of obsolescence. If we 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.
INTELLECTUAL PROPERTY
We rely on a combination of copyright, trademark, trade secret and other
intellectual property law, nondisclosure agreements and other protective
measures to protect our proprietary rights. We have filed one patent application
to date. We attempt to protect our intellectual property rights by limiting
access to the distribution of our software, documentation and other proprietary
information. 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. Other parties may independently develop competing
technology. Attempts may be made to copy aspects of our products or to obtain
and use information that we regard as proprietary. We presently have no patents
and no patent applications. 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 may be challenged by third parties. Any failure
to adequately protect our proprietary rights could result in our competitors
offering similar products, potentially resulting in loss of a competitive
advantage and decreased revenues.
We employ a variety of intellectual property in the development and
manufacturing of our products. We believe that the loss of all or a substantial
portion of our intellectual property rights could have a material adverse effect
on our results of operations. Our intellectual property protection measures
might not be sufficient to prevent misappropriation of our technology. In
addition, the laws of many foreign countries do not protect our intellectual
properties to the same extent as the laws of the United States. From time to
time, we may desire or be required to renew or to obtain licenses
39
<PAGE> 42
from others in order to further develop and market commercially viable products
effectively. Any necessary licenses might not be available on reasonable terms.
To date, we have not been notified that our products infringe the
proprietary rights of third parties, but in the future third parties might claim
infringement by us with respect to our current or future products. These claims
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.
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. As a result, our operating results could
suffer and our financial condition could be harmed.
We have registered Turnstone Systems and the Turnstone Systems logo as
trademarks. Copper CrossConnect CX100 is also our trademark. Each trademark,
trade name or service mark of any other company appearing in this prospectus
belongs to its holder.
EMPLOYEES
As of December 31, 1999, we had a total of 73 employees, all of whom were
based in the United States. Of the total, 33 were engaged in research and
development, 19 were engaged in sales, marketing and customer support, 12 were
engaged in operations, and 9 were in administration and finance. None of our
employees is subject to a collective bargaining agreement and we believe that
our relations with our employees are good.
FACILITIES
As of December 31, 1999, our principal administrative, sales, marketing and
research and development facility occupied approximately 20,300 square feet in
Mountain View, California under a sublease that expires in September 2002. We
have sales offices throughout the United States, including regional sales
offices in Colorado, Illinois, Massachusetts and Virginia. We expect to require
additional office space within the next 12 months.
LEGAL PROCEEDINGS
We are not a party to any material legal proceedings.
40
<PAGE> 43
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth information with respect to our executive
officers and directors as of December 31, 1999.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Richard N. Tinsley(1)............. 35 President, Chief Executive Officer and Director
P. Kingston Duffie(1)............. 39 Chief Technology Officer and Director
M. Denise Savoie.................. 44 Chief Financial Officer and Vice President, Business
Operations
Eric J. Andrews................... 34 Vice President, Marketing
Michael A. Crumlin................ 38 Vice President, Sales and Customer Service
John Loiacono IV.................. 36 Vice President, Business Development
Catherine Millet.................. 47 Vice President, Engineering
Shames S. Panahi.................. 41 Vice President, Operations
Robert J. Finocchio, Jr.(2)....... 48 Director
John K. Peters(3)................. 51 Director
Andrew W. Verhalen(2)............. 43 Director
Geoffrey Y. Yang(3)............... 40 Director
</TABLE>
- -------------------------
(1) Member of Stock Option Grant Committee
(2) Member of Audit Committee
(3) Member of Compensation Committee
RICHARD N. TINSLEY cofounded Turnstone Systems in January 1998 and has
served as President and Chief Executive Officer and as a director since that
time. From August 1997 to December 1997, Mr. Tinsley was a consultant to the
venture capital firms Institutional Venture Partners and Benchmark Capital
Partners. From September 1993 to August 1997, Mr. Tinsley held various positions
at Newbridge Networks, a designer and manufacturer of networking products, most
recently as Vice President and General Manager, VIVID Business Unit. Mr. Tinsley
holds an M.B.A from the University of Dallas and a B.S. in electrical
engineering from Rensselaer Polytechnic Institute.
P. KINGSTON DUFFIE cofounded Turnstone Systems in January 1998 and has
served as Chief Technology Officer and as a director since that time. From
January 1998 to April 1999, he also served as Vice President, Engineering. From
August 1997 to January 1998, Mr. Duffie was a consultant to Institutional
Venture Partners and Matrix Partners. From May 1997 to July 1997, Mr. Duffie was
Assistant Vice President, Engineering, Data Communications division, for Ascend
Communications, a developer and manufacturer of wide area networking equipment.
From March 1993 until April 1997, Mr. Duffie was Chief Technology Officer at
Whitetree, Inc., a developer and manufacturer of high-speed switching products,
which was acquired by Ascend Communications in April 1997. From April 1994 until
August 1996, he also served as Vice President, Engineering of Whitetree. Mr.
Duffie holds an M.S. in electrical engineering from McGill University in
Montreal and a B.Sc. (Eng.) in engineering physics from Queen's University in
Kingston, Ontario.
M. DENISE SAVOIE cofounded Turnstone Systems in January 1998 and has served
as Chief Financial Officer and Vice President of Business Operations since that
time. From May 1997 to December 1997, Ms. Savoie worked as an independent
consultant. From May 1993 until May 1997, Ms. Savoie served as Vice President of
Business Operations and Chief Financial Officer at Whitetree. Ms. Savoie holds a
B.A. in economics from the University of Michigan and a B.A. in art from Whitman
College.
ERIC J. ANDREWS joined Turnstone Systems in February 1998 and has served as
Vice President, Marketing since that time. From April 1993 to January 1998, Mr.
Andrews held various marketing positions at Newbridge Networks, most recently as
Assistant Vice President of Marketing, VIVID Business Unit. Mr. Andrews holds an
M.S. and a B.S. in computer science and electrical engineering from the
Massachusetts Institute of Technology.
41
<PAGE> 44
MICHAEL A. CRUMLIN joined Turnstone Systems in March 1999 and has served as
Vice President, Sales and Customer Service since that time. From August 1998 to
February 1999, Mr. Crumlin was Vice President of Business Development for
e.spire Communications, a provider of integrated communications services. From
November 1996 to August 1998, Mr. Crumlin was Director of Marketing of Yurie
Systems, a manufacturer of telecommunications equipment, which was acquired by
Lucent Technologies, a provider of communications and networking products, in
May 1998. From April 1995 to August 1996, Mr. Crumlin was a co-founder and
Director of Marketing & Business Development of TSI TelSys, a developer of
satellite data processing systems. Mr. Crumlin holds an M.B.A from the Harvard
University Graduate School of Business and a B.S. in engineering from the United
States Military Academy at West Point.
JOHN LOIACONO IV joined Turnstone Systems in September 1999 and has served
as Vice President, Business Development since that time. From September 1994 to
September 1999, Mr. Loiacono was Director of Systems Engineering, Europe,
Middle-East, Africa at Bay Networks, Inc., a provider of internetworking
solutions, which was acquired by Nortel Networks, a supplier of
telecommunications equipment products, in August 1998. Mr. Loiacono holds a B.S.
in computer science from California State University - San Francisco.
CATHERINE MILLET joined Turnstone Systems in April 1999 and has served as
Vice President, Engineering since that time. From December 1997 to April 1999,
Ms. Millet held various senior management positions at Advanced Fibre
Communications, a designer and manufacturer of multi-service access solutions
for telecommunications providers, most recently as Vice President of
Engineering. From September 1994 to December 1997, Ms. Millet held various
senior management positions at DSC Communications, a provider of
telecommunications products, most recently as Vice President of Advanced
Planning. Ms. Millet holds an M.S.E.E from the Ecole Superieure d' Electricite
in Paris.
SHAMES S. PANAHI joined Turnstone Systems in February 1998 and has served
as Vice President, Operations since that time. From October 1995 to June 1997,
Ms. Panahi was Director of Manufacturing at Whitetree. From June 1992 to October
1995, Ms. Panahi was Manufacturing Engineering Manager at Adaptive/Network
Equipment Technologies, a designer and manufacturer of wide area networks. Ms.
Panahi holds a B.S. in industrial engineering from Northwestern University.
ROBERT J. FINOCCHIO, JR. has been a director of Turnstone Systems since
September 1999. He has served as Chairman of the Board of Informix Corporation,
a provider of database systems, since July 1997 and served as President and
Chief Executive Officer of Informix from July 1997 to July 1999. From December
1988 until April 1997, Mr. Finocchio was employed with 3Com Corporation, a
global data networking company, where he held various positions, most recently
serving as President, 3Com Systems. Mr. Finocchio also serves as a director of
Latitude Communications, a teleconferencing company, and Echelon Corporation, a
developer of open, interoperable control networks. Mr. Finocchio is also a
Regent of Santa Clara University. Mr. Finocchio holds an M.B.A. from the Harvard
University Graduate School of Business and a B.S. in economics from Santa Clara
University.
JOHN K. PETERS has been a director of Turnstone Systems since June 1999.
From July 1995 to present Mr. Peters has held the position of Executive Vice
President as well as various other senior management positions at Concentric
Network Corporation, a provider of Internet protocol-based network services.
From February 1993 to July 1995, Mr. Peters served as President of Venture
Development Consulting, a consulting firm specializing in new communications and
information services. Mr. Peters holds an M.B.A. from the Stanford University
Graduate School of Business and a B.S. in Statistics from Stanford University.
ANDREW W. VERHALEN has been a director of Turnstone Systems since January
1998. Mr. Verhalen has been a partner of Matrix Partners, a venture capital
firm, since April 1992. He also serves on the board of directors of Alteon
WebSystems, a provider of Internet infrastructure solutions, Copper Mountain, a
supplier of digital subscriber line-based communications products, Phone.com, a
provider of Internet-based services for wireless telephones, and Watchguard
Technologies, a provider
42
<PAGE> 45
of Internet security systems. Mr. Verhalen holds M.B.A, Masters of Engineering
and B.S.E.E. degrees from Cornell University.
GEOFFREY Y. YANG has been a director of Turnstone Systems since January
1998. Since June 1989, Mr. Yang has been a general partner of Institutional
Venture Partners, a venture capital firm. He has also been a Managing Director
of Redpoint Ventures, a venture capital firm, since October 1999. Mr. Yang is a
director of MMC Networks, Inc., a developer of network processors, Ask Jeeves,
Inc., a provider of natural-language question answering services on the
Internet, and TiVo, a provider of personalized television services. Mr. Yang
holds an M.B.A. from the Stanford University Graduate School of Business, a
B.S.E. in Information Systems Engineering from Princeton University and a B.A.
in economics from Princeton University.
Upon completion of the offering, our bylaws will provide that executive
officers are appointed by the board of directors and serve for periods as
determined by the board of directors. Ms. Savoie is married to Mr. Duffie's
brother. There are no other family relationships among any of our directors,
officers or key employees.
BOARD OF DIRECTORS
Upon completion of this offering, our bylaws will provide for a board of
directors consisting of six members. Our certificate of incorporation will
provide for a classified board of directors consisting of three classes of
directors, each serving staggered three-year terms. As a result, a portion of
our board of directors will be elected each year. To implement the classified
structure, prior to the consummation of the offering, two of the nominees to the
board of directors will be elected to terms expiring at the first annual meeting
of stockholders after the closing of this offering, two will be elected to terms
expiring at the second annual meeting of stockholders after the closing of this
offering, and two will be elected to terms expiring at the third annual meeting
of stockholders after the closing of this offering. Thereafter, each class of
directors will be elected for three-year terms. Messrs. Tinsley and Duffie have
been designated Class I Directors, whose term will expire at the annual meeting
of stockholders held in 2000. Messrs. Verhalen and Yang have been designated
Class II Directors, whose term will expire at the annual meeting of stockholders
held in 2001. Messrs. Peters and Finocchio have been designated Class III
Directors, whose term will expire at the annual meeting of stockholders held in
2002. This classification of the board of directors may delay or prevent a
change in control of our company or in our management. See "Description of
Capital Stock -- Antitakeover Effects of Provisions of Our Charter Documents".
BOARD COMMITTEES
We established an audit committee in October 1999. The audit committee
consists of Messrs. Verhalen and Finocchio, who have comprised the committee
since its inception. The audit committee reviews our internal accounting
procedures and consults with and reviews the services provided by our
independent accountants.
We established a compensation committee in March 1999. The compensation
committee consists of Messrs. Peters and Yang. Mr. Yang has served on the
committee since its inception, and Mr. Peters has served as a member since
October 1999. Mr. Verhalen was a member from inception of the committee until
October 1999. The compensation committee reviews and recommends to the board of
directors the compensation of all of our officers and directors, including stock
compensation and loans, and establishes and reviews general policies relating to
the compensation and benefits of our employees.
We established a stock option grant committee in March 1999. The stock
option grant committee consists of Messrs. Duffie and Tinsley, who have
comprised the committee since its inception. The board of directors delegated
the stock option grant committee the authority to act as administrator of the
1998 stock plan solely for the purpose of granting stock options to new and
current employees within Board-approved guidelines, including those set forth in
the 1998 and 2000 stock plans. The
43
<PAGE> 46
stock option grant committee is not authorized to grant stock options to our
directors or executive officers.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to establishing the compensation committee, the board of directors as
a whole performed the functions delegated to the compensation committee. No
interlocking relationship exists between any member of our board of directors or
our compensation committee and any member of the board of directors or
compensation committee of any other company.
DIRECTOR COMPENSATION
We do not currently compensate our directors in cash for their service as
members of the board of directors, although they are reimbursed for certain
expenses in connection with attendance at board of director and committee
meetings. Under our 1998 stock plan, which will terminate upon completion of
this offering, nonemployee directors are eligible to receive stock option grants
at the discretion of the board of directors. We have previously granted options
to Messrs. Peters and Finocchio. These grants are described under the caption
"Certain Transactions -- Stock Option Grants to Directors". Upon completion of
this offering, under our 2000 Stock Plan, nonemployee directors will receive
automatic annual nondiscretionary stock option grants of 10,000 shares and will
also be eligible to receive additional stock option grants at the discretion of
the board of directors. Also, each person who joins our board of directors as a
nonemployee director after the completion of this offering will be automatically
granted an option to purchase up to 30,000 shares under the 2000 stock plan. For
further information regarding the provisions of the 1998 Stock Plan and the 2000
stock plan, please refer to the discussion under the caption "Incentive Stock
Plans".
LIMITATIONS ON LIABILITY AND INDEMNIFICATION
Upon completion of the offering, our certificate of incorporation will
limit the liability of directors to the fullest extent permitted by Delaware
law. Delaware law provides that directors of a corporation will not be
personally liable for monetary damages for breach of their fiduciary duties as
directors, except liability for:
- a breach of their duty of loyalty to the corporation or its stockholders;
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
- any transaction from which the director derived an improper personal
benefit.
The limitation of liability does not apply to liabilities arising under the
federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission.
Upon completion of this offering, our certificate of incorporation will
provide that we will indemnify our directors, officers and employees to the
fullest extent permitted by law. We believe that indemnification under our
bylaws covers at least negligence and gross negligence on the part of
indemnified parties. Our bylaws will also permit us to secure insurance on
behalf of any officer, director, employee or other agent for any liability
arising out of his or her actions in their capacity as an officer, director,
employee or other agent, regardless of whether we would have the power to
indemnify him or her under Delaware law.
In addition, we have entered into agreements to indemnify our directors and
executive officers. These agreements provide for indemnification of our
directors and executive officers for judgments, fines, settlement amounts and
certain expenses, including attorneys' fees incurred by the director or
executive officer in any action or proceeding. We believe that these provisions
and agreements are necessary to attract and retain qualified persons as
directors and executive officers.
44
<PAGE> 47
The limited liability and indemnification provisions in our certificate of
incorporation and bylaws may discourage stockholders from bringing a lawsuit
against our directors for breach of their fiduciary duty and may reduce the
likelihood of derivative litigation against our directors and officers, even
though a derivative action, if successful, might otherwise benefit us and our
stockholders. A stockholder's investment in us may be adversely affected to the
extent we pay the costs of settlement or damage awards against our directors and
officers under these indemnification provisions.
At present, there is no pending litigation or proceeding involving any of
our directors, officers or employees in which indemnification is sought, nor are
we aware of any threatened litigation that may result in claims for
indemnification.
EXECUTIVE COMPENSATION
The following table indicates the compensation earned for services rendered
to Turnstone Systems in all capacities for the fiscal year ended December 31,
1999 by our Chief Executive Officer and our next most highly compensated
executive officers who earned more than $100,000 during the fiscal year.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES
--------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITIONS SALARY BONUS OPTIONS COMPENSATION
---------------------------- --------- -------- ------------ ---------------
<S> <C> <C> <C> <C>
Richard N. Tinsley.................. $191,265 $114,759 -- $ --
President and Chief Executive
Officer
P. Kingston Duffie.................. 153,461 57,548 -- --
Chief Technology Officer
Eric J. Andrews..................... 143,230 53,711 -- --
Vice President, Marketing
M. Denise Savoie.................... 143,230 53,711 -- --
Chief Financial Officer and
Vice President, Business
Operations
Michael A. Crumlin.................. 118,076 138,388 385,000 14,055(1)
Vice President, Sales and
Customer Service
</TABLE>
- -------------------------
(1) Represents $14,055 in relocation expenses.
OPTION GRANTS IN LAST FISCAL YEAR
The following table provides information relating to stock options granted
to each of the executive officers named in the compensation table above during
the fiscal year ended December 31, 1999. All of these options were granted under
our 1998 stock plan and have a term of 10 years, subject to earlier termination
in the event the optionee's services to us cease.
The exercise prices of the options we grant are equal to the fair market
value of our common stock, as determined by our board of directors, on the date
of grant. The exercise price may be paid by cash or check.
Under our 1998 stock plan, in the event of an acquisition of Turnstone
Systems by merger or asset purchase, the vesting of each outstanding option
listed below will accelerate to the extent that it would have been vested on the
date twelve months following the effectiveness of the acquisition.
45
<PAGE> 48
Furthermore, if the acquiring corporation fails to assume or substitute the
remaining unvested options, then all of the option shares will become
immediately vested. See "-- Incentive Stock Plans -- 1998 Stock Plan".
The potential realizable value is calculated by assuming that the price of
our common stock increases from the assumed initial public offering price of
$16.00 per share at assumed rates of stock appreciation of 5% and 10%,
compounded annually over the 10 year term of the option, and subtracting from
that result the total option exercise price. These assumed appreciation rates
comply with the rules of the Securities and Exchange Commission and do not
represent our prediction of the performance of our stock price.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
PERCENT OF VALUE AT ASSUMED ANNUAL
NUMBER OF TOTAL OPTIONS RATES OF
SECURITIES GRANTED TO STOCK APPRECIATION
UNDERLYING EMPLOYEES EXERCISE FOR OPTION TERM
OPTIONS DURING PRICE PER EXPIRATION -------------------------
NAME GRANTED PERIOD SHARE DATE 5% 10%
---- ---------- ------------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Richard N. Tinsley...... -- --% $ -- -- $ -- $ --
P. Kingston Duffie...... -- -- -- -- -- --
Eric J. Andrews......... -- -- -- -- -- --
M. Denise Savoie........ -- -- -- -- -- --
Michael A. Crumlin...... 285,000 9.27 0.50 3/9/09 7,285,259 11,684,966
</TABLE>
AGGREGATE OPTION EXERCISES AND OPTION VALUES
The following table provides information relating to option exercises by
the executive officers named in the summary compensation table during the fiscal
year ended December 31, 1999, and the number and value of vested and unvested
options held by those executive officers as of December 31, 1999.
The "Value Realized" and the "Value of Unexercised In-the-Money Options at
December 31, 1999" are based upon a value of $16.00 per share, the assumed
initial public offering price, minus the per share exercise price, multiplied by
the number of shares underlying the option.
Options granted under our 1998 stock plan are immediately exercisable for
all the option shares, but we may repurchase, at the original exercise price,
any shares purchased under such options if the optionee's service relationship
with us terminates before the shares are vested. The 1998 stock plan will
terminate upon the closing of this offering, and no further option grants will
be made under this
46
<PAGE> 49
plan. Options granted under the 2000 stock plan, which will become effective
upon the closing of this offering, will not be exercisable prior to vesting.
OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
SHARES UNDERLYING VALUE OF UNEXERCISED
VALUE UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
SHARES REALIZED AT AT
ACQUIRED ON FOR DECEMBER 31, 1999 DECEMBER 31, 1999
EXERCISE OF EXERCISED -------------------- ---------------------
NAME OPTIONS OPTIONS VESTED UNVESTED VESTED UNVESTED
---- ------------ ------------ -------- --------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Richard N. Tinsley........... -- $ -- -- -- $ -- $ --
P. Kingston Duffie........... -- -- -- -- -- --
Eric J. Andrews.............. -- -- -- -- -- --
M. Denise Savoie............. -- -- -- -- -- --
Michael A. Crumlin(1)........ 142,500 2,208,750 -- 142,500 -- 2,208,750
</TABLE>
- -------------------------
(1) All shares acquired by Mr. Crumlin were unvested as of December 31, 1999 and
subject to an option in favor of Turnstone Systems to repurchase unvested
shares at their original purchase price in the event of a termination of Mr.
Crumlin's employment.
CHANGE OF CONTROL AGREEMENTS
Our 1998 stock plan and our 2000 stock plan provide, under some
circumstances, for accelerated vesting upon a change of control of Turnstone
Systems. The terms of this accelerated vesting are disclosed in detail below
under "Incentive Stock Plans".
In January 1998, Richard N. Tinsley and P. Kingston Duffie each purchased
3,027,145 shares of our common stock, and M. Denise Savoie purchased 2,421,210
shares of our common stock under founders' restricted stock purchase agreements.
These agreements contain vesting provisions that give us the option to
repurchase unvested shares at the original purchase price if the purchaser's
service to the company is terminated. Upon a change of control of Turnstone, in
each case, 75% of their shares that have not yet vested will vest and will no
longer be subject to repurchase by us. If his or her employment with the
surviving corporation is terminated within twelve months following the change of
control, then all of his or her shares that have not yet vested will vest and
will no longer be subject to repurchase. Each month, 1/48 of the total shares
purchased by each of these individuals becomes vested. All of Mr. Tinsley's
shares and all of Mr. Duffie's shares will be fully vested on October 1, 2001.
All of Ms. Savoie's shares will be fully vested on January 19, 2002.
INCENTIVE STOCK PLANS
1998 STOCK PLAN
Our 1998 stock plan was adopted by our board of directors in January 1998
and subsequently approved by our stockholders. Our 1998 stock plan provides for
the grant of incentive stock options, nonstatutory stock options, or stock
purchase rights to employees, directors and consultants. A total of 7,074,000
shares of common stock have been reserved for issuance under the 1998 stock
plan.
As of December 31, 1999, options to purchase 3,339,212 shares of common
stock were outstanding and 803,376 shares were available for future grant. Upon
completion of this offering, the 1998 stock plan will terminate, no further
option grants will be made under the 1998 stock plan, and any shares reserved
but not yet issued under the 1998 stock plan will be available for grant under
the 2000 stock plan.
Our board of directors administers the 1998 stock plan and may determine
the terms of options granted, including the exercise price, the number of shares
subject to individual option awards and the vesting period of the options. The
board of directors has delegated responsibility for approving option grants to
non-officer employees to the stock option grant committee. These grants must be
47
<PAGE> 50
within guidelines prescribed by the board of directors. Grants to executive
officers or directors, however, require approval of the board of directors. The
exercise price of incentive stock option grants to employees cannot be lower
than 100% of the fair market value of the common stock on the date of grant. In
the case of incentive stock options granted to employees who are holders of more
than 10% of our voting power, the exercise price cannot be less than 110% of the
fair market value. The term of an incentive stock option cannot exceed ten
years, and the term of an incentive stock option granted to a holder of more
than 10% of our voting power cannot exceed five years. Nonstatutory options
granted to an employee, consultant or director who, at the time of grant, holds
stock representing more than ten percent of the voting power of our capital
stock, must have an exercise price of least 110% of the fair market value on the
date of grant. Nonstatutory options granted to any other employee, consultant or
director must have an exercise price of at least 85% of the fair market value on
the date of grant. Stock purchase rights may be issued either alone, in addition
to, or in tandem with other awards granted under the 1998 stock plan and/or cash
awards made outside of the 1998 stock plan. Options and stock purchase rights
granted under our 1998 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 2.1% of the shares subject to the option each
month thereafter. The board of directors may amend or terminate the 1998 stock
plan at any time as long as the amendment or termination does not impair the
rights of plan participants with respect to outstanding options under the 1998
stock plan.
Option agreements under the 1998 stock plan between Turnstone Systems and
each optionholder allow optionholders to purchase shares issuable under their
option agreements before the shares have vested. All unvested shares issued
under this early exercise provision are subject to repurchase by us at the
original exercise price. All stock certificates representing exercised but
unvested shares are held in escrow until the shares have vested.
In the event we are acquired in a merger or asset purchase, each
outstanding option and stock purchase right granted under the 1998 stock plan
will vest to the extent that the option or stock purchase right would have been
vested on the date twelve months following the effectiveness of the acquisition,
and the successor corporation will assume or substitute an equivalent option for
each outstanding option under the 1998 stock plan. In the event that the
successor corporation refuses to assume or issue an equivalent option for each
outstanding option, these options will become fully vested. Following an
assumption or substitution in connection with a merger, if the successor
corporation terminates an optionholder's status as an employee or consultant,
other than for cause, within twelve months following the merger, then the
optionholder's options will become fully vested. Furthermore, in event of a
merger, options or stock purchase rights held by an outside director will become
fully vested.
2000 STOCK PLAN
Our 2000 stock plan was adopted by our board of directors in November 1999.
It will become effective upon the effectiveness of this offering. The 2000 stock
plan provides for the grant of incentive stock options, nonstatutory stock
options and stock purchase rights to employees, directors and consultants. The
2000 stock plan also provides for nondiscretionary grants of nonstatutory
options to outside directors. Under this nondiscretionary grant mechanism, each
outside director will receive an option to purchase 30,000 shares of our common
stock at the time he or she first becomes a director. This initial grant will
vest over three years in three equal annual installments. In addition, beginning
with the 2001 annual meeting of stockholders, each outside director who has
served as a director for at least the six preceding months will receive an
option to acquire an additional 10,000 shares. Each of these incremental option
grants will vest in full one year after all options previously granted to the
director have fully vested. All options granted to outside directors under this
nondiscretionary grant mechanism will have an exercise price equal to the fair
market value of our common stock on the date of grant.
48
<PAGE> 51
A total of 5,000,000 shares of common stock have been reserved for issuance
under the 2000 stock plan. No shares or options have been issued under the 2000
Stock Plan prior to this offering. An annual increase in the share reserve will
be added on the first day of our fiscal year, beginning in 2001, equal to the
lesser of:
- 5,000,000 shares;
- 6% of the outstanding shares on that date; or
- a lesser amount determined by the board of directors.
Our board of directors will administer the 2000 stock plan and will
determine the terms of options granted, including the exercise price, the number
of shares subject to individual option awards and the vesting period of options.
The exercise price of incentive stock option grants to employees cannot be lower
than 100% of the fair market value on the date of grant and, in the case of
incentive stock options granted to employees who are holders of more than 10% of
our voting power, not less than 110% of the fair market value. The exercise
price of options granted to outside directors will be 100% of the fair market
value on the date of grant. The term of an incentive stock option cannot exceed
ten years, and the term of an incentive stock option granted to a holder of more
than 10% of our voting power cannot exceed five years. Stock purchase rights may
be issued either alone, in addition to, or in tandem with other awards granted
under the 2000 stock plan and/or cash awards made outside of the 2000 stock
plan. Options and stock purchase rights granted under our 2000 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
2.1% of the shares subject to the option each month thereafter.
If we are acquired in a merger or asset purchase, each outstanding option
and stock purchase right granted under the 2000 stock plan will vest to the
extent that such option or stock purchase right would have been vested on the
date twelve months following the effectiveness of the acquisition, provided the
successor corporation assumes or substitutes an equivalent option for each
outstanding option. However, if the successor corporation refuses to assume or
issue an equivalent option for each outstanding option, the options will become
fully vested and exercisable. Following an assumption or substitution in
connection with a merger, if the successor corporation terminates an
optionholder's status as an employee or consultant other than for cause within
twelve months following such merger, then the optionholder's options will become
fully vested. Furthermore, in event of a merger, options or stock purchase
rights held by an outside director will vest fully.
2000 EMPLOYEE STOCK PURCHASE PLAN
Our 2000 employee stock purchase plan was adopted by our Board of Directors
in November 1999. It will become effective upon the effectiveness of this
offering. The 2000 employee stock purchase plan provides our employees with an
opportunity to purchase our common stock through accumulated payroll deductions.
A total of 500,000 shares of common stock has been reserved for issuance under
the 2000 employee stock purchase plan, none of which has been issued prior to
this offering. An annual increase in the share reserve under the 2000 employee
stock purchase plan will be added on the first day of our fiscal year, beginning
in 2001, equal to the lesser of:
- 750,000 shares;
- 2% of the outstanding shares on that date; or
- a lesser amount determined by the board of directors.
The 2000 employee stock purchase plan will be administered by our board of
directors or by a committee appointed by the board of directors. The 2000
employee stock purchase plan will permit eligible employees to purchase common
stock through payroll deductions of up to 15% of an employee's base compensation
on each pay day during the offering period. However, no employee may purchase
more than 1,000 shares in any six-month purchase period. Moreover, an employee
may
49
<PAGE> 52
not purchase more than $25,000 worth of stock, determined at the fair market
value of the shares at the time the option is granted, in one calendar year.
Employees employed by us on a given enrollment date are eligible to participate
during that offering period, provided they remain employed by us for the
duration of that offering period.
Unless the board of directors or its committee determines otherwise, the
2000 employee stock purchase plan will be implemented in a series of overlapping
offering periods, each approximately twenty-four months in duration. However,
the first offering period will be approximately 27 months in duration, ending on
the last trading day on or before October 31, 2001. Offering periods contain
four consecutive, six-month purchase periods, and will begin on the first
trading day on or after May 1 and November 1 of each year and terminate on the
last trading day in the period twenty-four months later.
The first purchase period will commence on the date upon which the
registration statement, of which this prospectus is a part, is declared
effective by the Securities and Exchange Commission and terminate on the last
trading day in the period ending October 31, 2000. If we are acquired, offering
and purchase periods then in progress will be shortened and all options
automatically exercised.
The price at which common stock will be purchased under the 2000 employee
stock purchase plan is equal to 85% of the fair market value of our common stock
on the first day of the applicable offering period or the last day of the
applicable purchase period, whichever is lower. Employees may end their
participation in the offering period at any time, and participation
automatically ends on termination of employment.
The board of directors may amend or terminate the 2000 employee stock
purchase plan at any time as long as the amendment or termination does not
impair vesting rights of plan participants. The 2000 employee stock purchase
plan will terminate in January 2010, unless terminated earlier in accordance
with its provisions.
50
<PAGE> 53
CERTAIN TRANSACTIONS
The following is a description of transactions since inception in January
1998 to which we have been a party, in which the amount involved in the
transaction exceeds $60,000 and in which any director, executive officer or
holder of more than 5% of our capital stock had or will have a direct or
indirect material interest other than compensation arrangements which are
otherwise required to be described under "Management".
COMMON STOCK
On January 2, 1998, we issued 3,027,145 shares of common stock to P.
Kingston Duffie, one of our founders and directors and our Chief Technical
Officer; 2,421,210 shares of common stock to M. Denise Savoie, one of our
founders and our Chief Financial Officer; and 3,027,145 shares of common stock
to Richard N. Tinsley, one of our founders and directors and our President and
Chief Executive Officer, in each case at a price per share of $0.001. All these
shares were issued under founders' restricted stock purchase agreements and are
subject to a right of repurchase by Turnstone Systems, which lapses at a monthly
rate of 1/48 of the total shares purchased by each individual over a period of
four years. Mr. Duffie's and Mr. Tinsley's shares will become fully vested on
October 1, 2001, and Ms. Savoie's shares will become fully vested on January 19,
2002. Vesting is subject to acceleration upon a change of control involving a
merger, sale of all or substantially all of our assets or a shift in 50% or more
of the voting power of our capital stock. Our repurchase rights lapse
immediately after a change of control with respect to 75% of the shares then
subject to the repurchase right. Our repurchase rights lapse with respect to all
remaining unvested shares if the individual is constructively terminated or
terminated without cause within twelve months after the change in control.
PREFERRED STOCK
The following table summarizes the sales of preferred stock to our
executive officers, directors and principal stockholders, and persons and
entities associated with them, since our inception. Each share of Series A
Preferred Stock and Series B Preferred Stock automatically converts into one
share of common stock upon the closing of this offering. See "Principal
Stockholders" for a summary of the affiliations of each of the persons and
entities described below.
<TABLE>
<CAPTION>
TOTAL VALUE OF
SERIES A SERIES B PREFERRED STOCK
PREFERRED STOCK PREFERRED STOCK PURCHASED
--------------- --------------- ---------------
<S> <C> <C> <C>
Date of sale..................................... January 1998 January 1999
Price per share.................................. $ 0.50 $ 1.95
Entities associated with our directors
Entities Associated with Institutional Venture
Partners.................................... 4,800,000 1,213,882 $4,767,070
Entities Associated with Matrix Partners....... 4,800,000 1,213,882 4,767,070
Entities Associated with Benchmark Capital....... 1,900,000 480,496 1,886,967
</TABLE>
Andrew W. Verhalen, one of our directors, is a general partner of Matrix
Partners, one of our investors. Geoffrey Y. Yang, another director, is a general
partner of Institutional Venture Partners. The entities associated with
Benchmark Capital own more than 5% of our capital stock.
STOCK OPTION GRANTS TO DIRECTORS
We have granted options to purchase a total of 200,000 shares of our common
stock with a total exercise price of $870,000 to two of our directors in
connection with the services they provide to us as members of our board of
directors. Neither of these directors is an employee of Turnstone Systems or is
affiliated with any of our principal stockholders. We believe that granting
stock options to these outside directors helps us to attract and retain
qualified directors.
51
<PAGE> 54
In June 1999, we granted to John K. Peters an option to purchase 40,000
shares of our common stock under our 1998 stock plan at a per-share exercise
price of $1.75, the fair market value of a share of our common stock as
determined by the board of directors on the date of the grant. The option was
fully vested at the time of grant. Mr. Peters exercised the entire option in
June 1999.
In September 1999, we granted to Mr. Peters an option to purchase 60,000
shares under our 1998 stock plan at a per-share exercise price of $5.00, the
fair market value of a share of our common stock as determined by the board of
directors on the date of the grant. The option is subject to vesting over a four
year period. None of these shares will vest during the twelve months after the
grant date. The shares will begin vesting on the first anniversary of the date
of grant on a monthly basis thereafter until all the shares are vested. The
stock option agreement between Turnstone Systems and Mr. Peters provides for the
early exercise of the option, and Mr. Peters exercised the entire option in
September 1999. Under the 1998 stock plan, if Mr. Peters' service as a director
is terminated, any unvested shares are subject to repurchase by us at the
original per-share purchase price.
In September 1999, we granted to Robert J. Finocchio, Jr. a stock option to
purchase 100,000 shares under our 1998 stock plan at a per-share exercise price
of $5.00, the fair market value of a share of our common stock on the date of
the grant. The option is subject to vesting over a four year period, with an
equal portion of the shares subject to the option vesting each month until all
the shares are vested. The stock option agreement between Turnstone Systems and
Mr. Finocchio provides for the early exercise of the option. Mr. Finocchio has
not exercised any of the shares subject to this stock option.
INDEMNIFICATION
We have entered into indemnification agreements with each of our directors
and executive officers. These indemnification agreements require us to indemnify
our directors and officers to the fullest extent permitted by Delaware law. See
"Management -- Limitations on Liability and Indemnification".
52
<PAGE> 55
PRINCIPAL STOCKHOLDERS
The following table provides information relating to the beneficial
ownership of our common stock by each of the following as of December 31, 1999
and after completion of this offering:
- each stockholder who owns at least 5% of our common stock;
- each of the executive officers named in the summary compensation table
and each of our directors; and
- all of our directors and executive officers as a group.
Beneficial ownership is determined based on the rules of the Securities and
Exchange Commission. The column entitled "Number of Shares Beneficially Owned"
excludes the number of shares of common stock subject to options held by that
person that are currently exercisable or that will become exercisable within 60
days after December 31, 1999. The number of shares subject to options that each
beneficial owner has the right to acquire within 60 days of December 31, 1999
are listed separately under the column entitled "Number of Shares Underlying
Options Beneficially Owned." These shares are not deemed outstanding for
purposes of computing the percentage ownership of any other person. Unless
otherwise indicated in the footnotes, these stockholders have sole voting or
investment power with respect to all shares, subject to applicable community
property laws.
The number and percentage of shares beneficially owned are based on
- 26,353,842 shares outstanding as of December 31, 1999, including the
assumed exercise for cash of a warrant to purchase 90,000 shares; and
- the issuance of 3,000,000 shares in connection with this offering in this
offering.
<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE OF
SHARES SHARES
NUMBER OF UNDERLYING BENEFICIALLY OWNED
SHARES OPTIONS --------------------
BENEFICIALLY BENEFICIALLY BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED OWNED OFFERING OFFERING
------------------------------------ ------------ ------------ -------- --------
<S> <C> <C> <C> <C>
Institutional Venture Partners(1).......... 6,013,882 -- 22.8% 20.5%
3000 Sand Hill Road
Building 2, Suite 290
Menlo Park, California 94025
Matrix Partners(2)......................... 6,013,882 -- 22.8 20.5
Bay Colony Corporate Center
1000 Winter Street, Suite 4500
Waltham, Massachusetts 02451
Benchmark Capital Partners(3).............. 2,380,496 -- 9.0 8.1
2480 Sand Hill Road
Suite 200
Menlo Park, California 94025
Andrew W. Verhalen(4)...................... 6,013,882 -- 22.8 20.5
Geoffrey Y. Yang(5)........................ 6,013,882 -- 22.8 20.5
P. Kingston Duffie(6)...................... 3,007,145 -- 11.4 10.2
Richard N. Tinsley(7)...................... 3,012,345 -- 11.4 10.3
M. Denise Savoie(8)........................ 2,391,210 -- 9.1 8.1
Eric J. Andrews(9)......................... 632,500 -- 2.4 2.2
Michael A. Crumlin(10)..................... 142,500 142,500 1.1 1.0
John K. Peters(11)......................... 100,000 -- * *
Robert J. Finocchio, Jr.................... -- 100,000 * *
All directors and officers as a group (12
persons)(12)............................. 21,621,964 1,114,000 82.8 74.6
</TABLE>
53
<PAGE> 56
- -------------------------
* Represents beneficial ownership of less than 1%.
(1) Includes 5,595,719 shares held by Institutional Venture Partners VII, L.P.,
117,850 shares held by Institutional Venture Management VII, L.P., 178,925
shares held by IVP Founders Fund I, L.P., and 121,388 shares held by IVP
Broadband Fund L.P. Geoffrey Y. Yang, a director of Turnstone Systems, is a
general partner of Institutional Venture Management VII, the general
partner of Institutional Venture Partners VII. The other general partners
of Institutional Venture Management VII are Samuel D. Colella, Reid W.
Dennis, Mary Jane Elmore, Norman A. Fogelsong, Ruthann Quindlen, L. James
Strand, William P. Tai and T. Peter Thomas.
(2) Includes 5,412,493 shares held by Matrix Partners V, L.P. and 601,389
shares held by Matrix V Entrepreneurs Fund, L.P. Andrew Verhalen, a
director of Turnstone Systems, is a managing member of Matrix V Management
Co., L.L.C., the general partner of each entity. Mr. Verhalen has sole
voting and dispositive power over the shares held by the entities
associated with Matrix Partners. Mr. Verhalen disclaims beneficial
ownership of the shares held by the entities associated with Matrix
Partners, except to the extent of his pecuniary interest as a general
partner.
(3) Includes 1,614,548 shares held by Benchmark Capital Partners II, L.P.,
170,927 shares held by Benchmark Founders' Fund II, L.P., 87,401 shares
held by Benchmark Founders' Fund II-A, L.P., 27,124 shares held by
Benchmark Members' Fund, L.P., and 480,496 shares held by Benchmark Capital
Partners II, L.P. as nominee for Benchmark Capital Partners II, L.P.,
Benchmark Founders' Fund II, L.P., Benchmark Founders' Fund II-A, L.P. and
Benchmark Members' Fund, L.P. The general partners of Benchmark Capital
Partners are David M. Beirne, Bruce W. Dunlevie, J. William Gurley, Kevin
R. Harvey, Robert C. Kagle, Andrew S. Rachleff and Steve M. Spurlock.
(4) Includes 6,013,882 shares held by entities affiliated with Matrix Partners.
Mr. Verhalen is a managing member of Matrix V Management Co., L.L.C., the
general partner of the entities associated with Matrix Partners. Mr.
Verhalen disclaims beneficial ownership of the shares held by the entities
associated with Matrix Partners, except to the extent of his pecuniary
interest as a general partner.
(5) Includes 6,013,882 shares held by entities affiliated with Institutional
Venture Partners, of which Mr. Yang is a general partner. Mr. Yang
disclaims beneficial ownership of the shares held by the entities
affiliated with Institutional Venture Partners, except to the extent of his
pecuniary interest as a general partner.
(6) Includes 1,387,442 shares subject to repurchase as of December 31, 1999 by
Turnstone Systems upon a termination of employment.
(7) Includes 1,387,442 shares subject to repurchase as of December 31, 1999 by
Turnstone Systems upon a termination of employment.
(8) Includes 1,261,047 shares subject to repurchase as of December 31, 1999 by
Turnstone Systems upon a termination of employment.
(9) Includes 342,604 shares subject to repurchase as of December 31, 1999 by
Turnstone Systems upon a termination of employment. Mr. Andrews acquired
all of these shares upon the exercise of a stock option.
(10) All of these shares, which Mr. Crumlin acquired upon the exercise of a
stock option, were subject to repurchase as of December 31, 1999 by
Turnstone Systems upon a termination of employment.
(11) Includes 60,000 shares subject to repurchase as of December 31, 1999 upon a
termination of status as a director. Mr. Peters acquired all of the shares
upon the exercise of a stock option.
(12) Includes a total of 4,777,973 shares subject to repurchase as of December
31, 1999 by Turnstone Systems upon a termination of employment.
54
<PAGE> 57
DESCRIPTION OF CAPITAL STOCK
GENERAL
Upon completion of this offering, we will be 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. Immediately after this offering,
based on shares outstanding as of December 31, 1999, we estimate there will be
approximately 26,353,842 shares of common stock outstanding, 3,339,212 shares of
common stock will be issuable upon exercise of outstanding options assuming
there are no additional option grants after December 31, 1999 and that no shares
of preferred stock will be issued and outstanding.
The figure for outstanding shares of common stock upon completion of this
offering reflects the issuance and conversion into common stock of 90,000 shares
of Series A Preferred Stock in connection with the assumed exercise for cash of
a warrant.
Upon completion of this offering, our certificate of incorporation and
bylaws will contain provisions that are intended to enhance the likelihood of
continuity and stability in the composition of the board of directors and which
may have the effect of delaying, deferring, or preventing a future takeover or
change in control of Turnstone Systems unless such takeover or change in control
is approved by our board of directors.
COMMON STOCK
Holders of common stock are entitled to one vote per share on all matters
to be voted upon by the stockholders. Holders of common stock do not have
cumulative voting rights, and therefore, holders of a majority of the shares
voting for the election of directors can elect all of the directors. If this
occurs, the holders of the remaining shares will not be able to elect any
directors.
Holders of our common stock are entitled to receive any dividends that our
board of directors may declare from funds legally available for distribution. We
have never declared or paid cash dividends on our capital stock and expect to
retain future earnings, if any, for use in the operation and expansion of our
business. As a result, we do not anticipate paying any cash dividends in the
foreseeable future. In addition, we may in the future enter into agreements with
lenders that could prohibit our paying cash dividends. In the event of
liquidation, dissolution or winding up of Turnstone, the holders of common stock
are entitled to share ratably in all assets legally available for distribution
after payment of all debts and other liabilities and subject to the prior rights
of any holders of preferred stock then outstanding. Holders of common stock have
no preemptive or other subscription or conversion rights. There are no
redemption or sinking fund provisions applicable to the common stock.
PREFERRED STOCK
Effective upon the closing of this offering, we will be authorized to issue
5,000,000 shares of undesignated preferred stock. The board of directors has the
authority without any further stockholder vote to issue the preferred stock in
one or more series and to fix the price and rights of the preferred stock. The
issuance of preferred stock, while providing desirable flexibility in connection
with possible acquisitions and other corporate purposes, could have the effect
of delaying, deferring or preventing a change in control of Turnstone. It could
also adversely affect the market price of our common stock and the voting and
other rights of the holders of our common stock. We have no current plans to
issue any shares of preferred stock.
WARRANTS
As of December 31, 1999, there were warrants outstanding to purchase
135,000 shares of Series A Preferred Stock.
55
<PAGE> 58
Comdisco, a provider of equipment leasing and financing services, holds a
warrant to purchase 90,000 shares of Series A Preferred Stock that will expire
on the effectiveness of our initial public offering. We have presumed this
warrant will be exercised prior to the closing of this offering. The Comdisco
warrant is exercisable at a price of $0.50 per share and may be exercised on a
cash or cashless basis. In order to effect a cashless exercise, Comdisco would
surrender the right to acquire shares under the warrant with a fair market value
equal to the aggregate exercise price of the shares being exercised. For
purposes of determining our outstanding capitalization in this prospectus, we
have assumed that Comdisco will exercise its warrant for cash in connection with
the offering.
Silicon Valley Bank holds a warrant to purchase 45,000 shares of Series A
Preferred Stock, which expires on June 1, 2003. The exercise price for this
warrant is $0.50 per share. The exercise price for the warrant issued to Silicon
Valley Bank is payable by cash, cancellation of indebtedness or a combination of
the two.
REGISTRATION RIGHTS
Set forth below is a summary of the registration rights of the holders of
our Series A Preferred Stock and Series B Preferred Stock, each of which will
convert into common stock immediately prior to the consummation of this
offering.
DEMAND REGISTRATION. Beginning six months following the closing date of the
initial public offering of our common stock, the holders of registration rights
may request that we register shares of common stock subject to our right, upon
the advice of our underwriters, to reduce the number of shares proposed to be
registered. In order to exercise these rights, at least 66 2/3% of the holders
of registrable securities must make the request for registration, and these
holders must request registration of at least 33 1/3% of the registrable
securities then outstanding. We are obligated to effect only two registrations
under this provision. If shares requested to be included in a registration must
be excluded due to market factors, as determined by the managing underwriter,
the shares registered on behalf of the selling stockholders will be allocated
among all holders of shares with rights to be included in the registration on
the basis of the number of shares with such rights held by such stockholders.
PIGGYBACK REGISTRATION RIGHTS. Holders of registration rights have
unlimited rights to request that shares be included in any company-initiated
registration of common stock other than registrations of employee benefit plans
or relating to this offering or business combinations subject to Rule 145 under
the Securities Act. The underwriters may, for marketing reasons, limit the
shares requested to be registered on behalf of all stockholders having the right
to request inclusion in such registration. In addition, we have the right to
terminate any registration we initiated prior to its effectiveness regardless of
any request for inclusion by any stockholders.
FORM S-3 REGISTRATIONS. After we have qualified for registration on Form
S-3, which will not be available until at least 12 months after we become a
public reporting company, holders of registration rights may request in writing
that we effect an unlimited number of registrations of such shares on Form S-3
if the gross offering price of the shares to be so registered in each such
registration exceeds $1,000,000. We are not obligated to effect a registration
on Form S-3 prior to expiration of 90 days following effectiveness of the most
recent registration requested by the holders.
TRANSFERABILITY. The registration rights are transferable upon notice by
the holder to us of the transfer, provided that the transferee or assignee is an
affiliate or constituent partner of the transferor or assignor, or the
transferee or assignee acquires at least 500,000 shares, and assumes the rights
and obligations of the transferor for such shares.
TERMINATION. The registration rights will terminate for holders of less
than 500,000 shares at such time after this offering as the registrable shares
held by that holder may be sold within any three-month period under Rule 144 of
the Securities Act of 1933. For holders of 500,000 or more shares, the
registration rights will terminate on the first to occur of three years after
the date we
56
<PAGE> 59
become subject to the reporting requirements of Section 12 of the Exchange Act,
and the date on which the holder may sell all its shares under Rule 144.
ANTITAKEOVER EFFECTS OF PROVISIONS OF OUR CHARTER DOCUMENTS
Some of the provisions of our certificate of incorporation and bylaws that
will become effective upon the completion of this offering could make the
following more difficult:
- acquisition of Turnstone Systems by means of a tender offer;
- acquisition of Turnstone Systems by means of a proxy contest or
otherwise; or
- the removal of our incumbent officers and directors.
These provisions, summarized below, are generally expected to discourage
coercive takeover practices and inadequate takeover bids. These provisions are
also designed to encourage persons seeking to acquire control of Turnstone
Systems to first negotiate with our board. We believe that the benefits of
increased protection resulting from our potential ability to negotiate with the
proponent of an unfriendly or unsolicited proposal to acquire or restructure
Turnstone Systems outweigh the disadvantages of discouraging these proposals
because we believe that the negotiation of these proposals could result in an
improvement of their terms.
ELECTION AND REMOVAL OF DIRECTORS. Upon completion of this offering, our
board of directors will be divided into three classes. The directors in each
class will serve for a three-year term, one class being elected each year by our
stockholders. This system of electing and removing directors may tend to
discourage a third party from making a tender offer or otherwise attempting to
obtain control of Turnstone Systems because it generally makes it more difficult
for stockholders to replace a majority of the directors. See
"Management -- Board of Directors" for a further discussion of the structure of
the Board of Directors.
STOCKHOLDER MEETINGS. Upon completion of this offering, under our bylaws,
only the board of directors, the chairman of the board, the president and chief
executive officer may call special meetings of stockholders.
REQUIREMENTS FOR ADVANCE NOTIFICATION OF STOCKHOLDER NOMINATIONS AND
PROPOSALS. Upon completion of this offering, our bylaws will contain advance
notice procedures with respect to stockholder proposals and the nomination of
candidates for election as directors, other than nominations made by or at the
direction of the board of directors or a committee of the board.
ELIMINATION OF CUMULATIVE VOTING. Upon completion of this offering, our
certificate of incorporation and bylaws will not provide for cumulative voting
in the election of directors.
UNDESIGNATED PREFERRED STOCK. The authorization of undesignated preferred
stock makes it possible for the board of directors to issue preferred stock with
voting or other rights or preferences that could impede the success of any
attempt to change control of Turnstone Systems. These and other provisions may
have the effect of deferring hostile takeovers or delaying changes in control or
management of Turnstone.
AMENDMENT OF CHARTER PROVISIONS. The amendment of the above provisions
relating to the election and removal of directors and stockholder meetings will
require approval by holders of at least 66 2/3% of the outstanding common stock.
EFFECT OF DELAWARE ANTITAKEOVER STATUTE
We are subject to Section 203 of the Delaware General Corporation Law which
regulates corporate acquisitions. Section 203 generally prevents Delaware
corporations, including those whose securities are listed for trading on the
Nasdaq National Market, from engaging in a business combination with any
interested stockholder for three years following the date that such stockholder
became an interested stockholder. A business combination includes, among other
things, a merger or
57
<PAGE> 60
consolidation involving Turnstone Systems and the interested stockholder and the
sale of more than 10% of our assets. Generally, an interested stockholder is any
entity or person beneficially owning 15% or more of our outstanding voting stock
and any entity or person affiliated with or controlling or controlled by such
entity or person. A Delaware corporation may opt out of Section 203 with an
express provision in its original certificate of incorporation or an express
provision in its certification of incorporation or bylaws resulting from
amendments approved by the holders of at least a majority of the corporation's
outstanding voting shares. We have not opted out of Section 203.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is BankBoston, N.A.
and can be contacted by phone at (781) 575-3400.
58
<PAGE> 61
SHARES ELIGIBLE FOR FUTURE SALE
Immediately prior to this offering, there was no public market for our
common stock. Future sales of substantial amounts of common stock in the public
market could adversely affect the market price of our common stock.
Upon completion of this offering, assuming no exercise of the underwriters'
overallotment option, we will have outstanding 26,353,842 shares of common
stock, assuming the issuance of 3,000,000 shares of common stock offered hereby,
the exercise for cash of a warrant to acquire 90,000 shares of our capital stock
that would otherwise expire upon this offering and no other exercise of
outstanding options or warrants after December 31, 1999. Of these shares, the
3,000,000 shares sold in the offering will be freely tradable without
restriction or further registration under the Securities Act. However, if shares
are purchased by affiliates, as that term is defined in Rule 144 under the
Securities Act, their sales of shares would be subject to certain limitations
and restrictions that are described below.
The remaining 26,353,842 shares of common stock held by existing
stockholders were issued and sold by Turnstone Systems in reliance on exemptions
from the registration requirements of the Securities Act. Of these shares,
26,353,842 shares will be subject to lock-up agreements described below on the
effective date of the offering. On the effective date of the offering, all
shares that would otherwise be eligible for sale under Rule 144(k) will be
subject to lock-up agreements with the underwriters. Upon expiration of the
lock-up agreements 180 days after the date of this prospectus, 22,525,701 shares
will become eligible for sale, subject in most cases to the limitations of Rule
144, and 3,828,141 shares held by our employees will remain unavailable for sale
until the expiration of repurchase rights held by us. In addition, Silicon
Valley Bank could exercise its warrant for 45,000 shares of our capital stock
and holders of stock options could exercise such options and sell certain of the
shares issued upon exercise as described below.
<TABLE>
<CAPTION>
APPROXIMATE SHARES
THAT BECOME
ELIGIBLE FOR SALE
RELEVANT DATE ON RELEVANT DATE COMMENT
- --------------------------------------- ------------------ ------------------------------------------
<S> <C> <C>
On Effective Date...................... 3,000,000 Shares sold in the offering
90 Days after Effective Date........... -- Freely tradable shares saleable under Rule
144(k) that are not subject to the
lock-up.
May 15, 2000........................... 2,587,547 10% of shares subject to lock-up released;
shares saleable under Rules 144 and 701.
3 days after results for the fiscal
quarter ended June 30, 2000 are
released............................. 5,338,360 Additional 25% of shares subject to
lock-up released; shares saleable under
Rules 144 and 701.
180 Days after date of prospectus...... 14,599,794 Lock-up on remaining shares released;
shares saleable under Rules 144 and 701.
</TABLE>
As of December 31, 1999, assuming the exercise of the Comdisco warrant for
90,000 shares of our capital stock, there was one other warrant outstanding for
the purchase of 45,000 shares of our capital stock at a per share exercise price
of $0.50 per share. The warrant held by Comdisco must be exercised prior to the
effectiveness of this offering, or it will expire. The other outstanding warrant
is not required to be exercised in connection with this offering although the
holder could elect to do so. In addition, there were a total of 3,339,212 shares
of common stock subject to outstanding options under our 1998 stock plan, all of
which are subject to lock-up agreements. Immediately after the completion of the
offering, we intend to file registration statements on Form S-8 under the
Securities
59
<PAGE> 62
Act to register all of the shares of common stock issued or reserved for future
issuance under our 1998 stock plan, the 2000 stock plan, and 2000 employee stock
purchase plan. On the date 180 days after the date of this prospectus, a total
of 445,560 shares of common stock subject to outstanding options will be vested.
After the effective dates of the registration statements on Form S-8, shares
purchased upon exercise of options granted pursuant to the 1998 stock plan, the
2000 stock plan, and 2000 employee stock purchase plan generally would be
available for resale in the public market.
Our officers, directors and stockholders have agreed not to sell or
otherwise dispose of any of their shares for the time periods described above.
Goldman Sachs & Co., however, may in its sole discretion, at any time without
notice, release all or any portion of the shares subject to lock-up agreements.
RULE 144
All of the securities we have issued prior to the completion of this
offering are restricted securities which cannot be freely sold or transferred.
In general, under Rule 144 as currently in effect, beginning 90 days after the
effective date of the registration statement of which this prospectus is a part,
a person who has beneficially owned restricted shares of our common stock for at
least one year would be entitled to sell, within any three-month period, a
number of shares that does not exceed the greater of
- 1% of the number of shares of common stock then outstanding, which will
equal approximately 293,539 shares immediately after this offering; or
- the average weekly trading volume of our common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to such sale.
Sales under Rule 144 are also subject to certain other requirements
regarding the manner of sale, notice filing and the availability of current
public information about us.
RULE 144(k)
Under Rule 144(k), a person who is not deemed to have been one of our
affiliates at any time during the 90 days preceding a sale, and who has
beneficially owned the restricted shares proposed to be sold for at least two
years, including the holding period of any prior owner other than an affiliate,
is entitled to sell restricted shares without complying with the manner of sale,
notice filing, volume limitation or notice provisions of Rule 144. Therefore,
unless otherwise restricted, these shares may be sold immediately upon the
completion of this offering.
RULE 701
In general, under Rule 701, any of our employees, directors, officers,
consultants or advisors who purchases restricted shares from us in connection
with a compensatory stock or option plan or other written agreement before the
effective date of the offering is entitled to resell such shares 90 days after
the effective date of this offering in reliance on Rule 144, without having to
comply with certain restrictions, including the holding period, contained in
Rule 144.
The SEC has indicated that Rule 701 will apply to typical stock options
granted by an issuer before it becomes subject to the reporting requirements of
the Securities Exchange Act of 1934, along with the shares acquired upon
exercise of such options, including exercises after the date of this prospectus.
Securities issued in reliance on Rule 701 are restricted securities and, subject
to the contractual restrictions described above, beginning 90 days after the
date of this prospectus, may be sold by persons other than affiliates, as
defined in Rule 144, subject only to the manner of sale provisions of Rule 144
and by affiliates under Rule 144 without compliance with its one year minimum
holding period requirement.
60
<PAGE> 63
UNDERWRITING
Turnstone Systems and the underwriters for the offering named below have
entered into an underwriting agreement with respect to the shares being offered.
Subject to certain conditions, each underwriter has severally agreed to purchase
the number of shares indicated in the following table. Goldman, Sachs & Co.,
Dain Rauscher Incorporated and BancBoston Robertson Stephens Inc. are the
representatives of the underwriters.
<TABLE>
<CAPTION>
Number of
Underwriters Shares
------------ ---------
<S> <C>
Goldman, Sachs & Co. .......................................
Dain Rauscher Incorporated..................................
FleetBoston Robertson Stephens Inc. ........................
--------
Total.............................................
========
</TABLE>
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional 450,000
shares from Turnstone Systems to cover such sales. They may exercise that option
for 30 days. If any shares are purchased under this option, the underwriters
will severally purchase shares in approximately the same proportion as set forth
in the table above.
The following tables show the per share and total underwriting discounts
and commissions to be paid to the underwriters by Turnstone Systems. Such
amounts are shown assuming both no exercise and full exercise of the
underwriters' option to purchase additional shares.
<TABLE>
<CAPTION>
Paid by Turnstone Systems
----------------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share................................................... $ $
Total....................................................... $ $
</TABLE>
Shares sold by the underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $ per share from the initial public offering price. Any such
securities dealers may resell any shares purchased from the underwriters to
certain other brokers or dealers at a discount of up to $ per share from the
initial public offering price. If all the shares are not sold at the initial
offering price, the representatives may change the offering price and the other
selling terms.
Turnstone Systems and its directors, officers and significant stockholders
have agreed with the underwriters not to dispose of or hedge any of their common
stock or securities convertible into or exchangeable for shares of common stock
during the period from the date of this prospectus continuing through the date
180 days after the date of this prospectus, except with the prior written
consent of the representatives and except as described in "Shares Eligible for
Future Sale". This agreement does not apply to any existing employee benefit
plans. See "Shares Eligible for Future Sale" for a discussion of certain
transfer restrictions.
Prior to the offering, there has been no public market for our common
stock. The initial public offering price was negotiated among Turnstone Systems
and the representatives. Among the factors considered in determining the initial
public offering price of the shares, in addition to prevailing market
conditions, were Turnstone Systems' historical performance, estimates of the
business potential and earnings prospects of Turnstone Systems, an assessment of
Turnstone Systems' management and the consideration of the above factors in
relation to market valuation of companies in related business.
61
<PAGE> 64
The common stock will be quoted on the Nasdaq National Market under the
symbol "TSTN".
In connection with the offerings, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. Stabilizing
transactions consist of certain bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offering is in progress.
The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of such underwriter in stabilizing or short covering
transactions.
These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
The underwriters do not expect sales to discretionary accounts to exceed
five percent of the total number of shares offered.
A prospectus in electronic format may be made available on the web sites
maintained by one or more underwriters. The underwriters may agree to allocate a
number of shares to underwriters for sale to their online brokerage account
holders. Internet distributions will be allocated by the lead managers to
underwriters that may make Internet distributions on the same basis as other
allocations.
Turnstone Systems estimates that its share of the total expenses of the
offering, excluding underwriting discounts and commissions, will be
approximately $1,200,000.
Turnstone Systems has agreed to indemnify the several underwriters against
certain liabilities, including liabilities under the Securities Act of 1933.
62
<PAGE> 65
VALIDITY OF COMMON STOCK
The validity of the common stock offered hereby will be passed upon for us
by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California, and for the underwriters by Sullivan & Cromwell, Los Angeles,
California. Thomas C. DeFilipps, a member of Wilson Sonsini Goodrich & Rosati,
is Secretary of Turnstone Systems. As of the date of this prospectus, WS
Investment Company 97B and WS Investment Company 98B, each an investment
partnership composed of certain current and former members of and persons
associated with Wilson Sonsini Goodrich & Rosati, Professional Corporation, in
addition to certain current individual members of Wilson Sonsini Goodrich &
Rosati, Professional Corporation, beneficially own an aggregate of 125,290
shares of preferred stock which will automatically convert into our common stock
upon the close of this offering.
EXPERTS
The financial statements of Turnstone Systems, Inc. as of December 31, 1998
and 1999, and for the period from January 2, 1998 (inception) to December 31,
1998 and the year ended December 31, 1999, have been included herein and in the
registration statement in reliance on the report of KPMG LLP, independent
auditors, appearing elsewhere herein, and upon the authority of that firm as
experts in accounting and auditing.
WHERE YOU MAY FIND ADDITIONAL INFORMATION
We filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act for the shares of common stock in
this offering. This prospectus does not contain all of the information in the
registration statement and the exhibits and schedule that were filed with the
registration statement. For further information with respect to Turnstone
Systems and our common stock, we refer you to the registration statement and the
exhibits and schedule that were filed with the registration statement. A copy of
the registration statement and the exhibits and schedule that were filed with
the registration statement may be inspected without charge at the public
reference facilities maintained by the Securities and Exchange Commission in
Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of all or
any part of the registration statement may be obtained from the SEC upon payment
of the prescribed fee. You may call the Securities and Exchange Commission at
1-800-SEC-0330 for further information on the operation of the public reference
facilities. The Securities and Exchange Commission maintains a World Wide Web
site that contains reports, proxy and information statements and other
information regarding registrants that file electronically with the Securities
and Exchange Commission. The address of the site is http://www.sec.gov.
Upon completion of this offering, Turnstone Systems will become subject to
the information and periodic reporting requirements of the Securities Exchange
Act of 1934, and, in accordance with the requirements of the Securities Exchange
Act of 1934, will file periodic reports, proxy statements and other information
with the Securities and Exchange Commission. These periodic reports, proxy
statements and other information will be available for inspection and copying at
the regional offices, public reference facilities and web site of the Securities
and Exchange Commission referred to above.
We intend to send to our stockholders annual reports containing audited
financial statements for each fiscal year and quarterly reports containing
unaudited interim financial statements for the first three quarters of each
fiscal year.
63
<PAGE> 66
TURNSTONE SYSTEMS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-2
Balance Sheets.............................................. F-3
Statements of Operations.................................... F-4
Statements of Stockholders' Equity.......................... F-5
Statements of Cash Flows.................................... F-6
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE> 67
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Turnstone Systems, Inc.
We have audited the accompanying balance sheets of Turnstone Systems, Inc.
(the Company), as of December 31, 1998 and 1999, and the related statements of
operations, stockholders' equity, and cash flows for the period from January 2,
1998 (inception) to December 31, 1998 and the year ended December 31, 1999.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Turnstone Systems, Inc. as
of December 31, 1998 and 1999, and the results of its operations and its cash
flows for the period from January 2, 1998 (inception) to December 31, 1998 and
the year ended December 31, 1999, in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
Mountain View, California
January 6, 2000
F-2
<PAGE> 68
TURNSTONE SYSTEMS, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, 1999
DECEMBER 31, ------------------------------
1998 ACTUAL PRO FORMA
------------ ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $1,338 $ 8,063 $ 8,063
Accounts receivable, net of allowance for doubtful
accounts and sales returns of $0 and $276 at December
31, 1998 and 1999, respectively....................... -- 6,439 6,439
Inventory................................................ -- 2,939 2,939
Prepaid expenses and other current assets................ 96 599 599
------ ------- -------
Total current assets............................. 1,434 18,040 18,040
Property and equipment net................................. 508 1,085 1,085
Other assets............................................... 28 132 132
------ ------- -------
Total assets..................................... $1,970 $19,257 $19,257
====== ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current obligations under capital leases................. $ 129 $ 229 $ 229
Accounts payable......................................... 182 783 783
Accrued compensation and benefits........................ 129 920 920
Customer deposits........................................ -- 1,328 1,328
Other current liabilities and accrued expenses........... 34 1,679 1,679
Deferred revenue......................................... -- 2,132 2,132
------ ------- -------
Total current liabilities........................ 474 7,071 7,071
Long-term obligations under capital leases, net of current
portion.................................................. 270 260 260
Other long-term liabilities................................ -- 35 35
------ ------- -------
Total liabilities................................ 744 7,366 7,366
------ ------- -------
Commitments
Stockholders' equity:
Convertible preferred stock Series A, $0.001 par value,
12,100 shares authorized; 11,680 shares issued and
outstanding at December 31, 1998 and 1999,
respectively; aggregate liquidation preference of
$5,840 (Pro forma -- no shares outstanding)........... 12 12 --
Convertible preferred stock Series B, $0.001 par value, 0
and 3,477 shares authorized; 0 and 3,177 shares issued
and outstanding at December 31, 1998 and 1999,
respectively; aggregate liquidation preference of
$6,195 (Pro forma -- no shares outstanding)........... -- 3 --
Common stock, $0.001 stated value, 40,000 shares
authorized; 10,162 and 11,407 shares issued and
outstanding at December 31, 1998 and 1999,
respectively (pro forma -- 26,264 shares
outstanding);......................................... 10 11 26
Additional paid-in capital............................... 6,119 26,498 26,498
Deferred stock compensation.............................. (166) (9,701) (9,701)
Accumulated deficit...................................... (4,749) (4,932) (4,932)
------ ------- -------
Total stockholders' equity....................... 1,226 11,891 11,891
------ ------- -------
Total liabilities and stockholders' equity....... $1,970 $19,257 $19,257
====== ======= =======
</TABLE>
See accompanying notes to financial statements
F-3
<PAGE> 69
TURNSTONE SYSTEMS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1998 1999
------- -------
<S> <C> <C>
Net revenues................................................ $ -- $27,196
Cost of revenues............................................ -- 12,359
------- -------
Gross profit................................................ -- 14,837
Operating expenses:
Research and development (Exclusive of non-cash
compensation expense of $9 and $1,639 in 1998 and 1999,
respectively).......................................... 3,462 5,731
Sales and marketing (Exclusive of non-cash compensation
expense of $17 and $846 in 1998 and 1999,
respectively).......................................... 737 3,912
General and administrative (Exclusive of non-cash
compensation expense of $3 and $1,050 in 1998 and 1999,
respectively).......................................... 713 1,559
Amortization of deferred stock compensation............... 29 3,535
------- -------
Total operating expenses.......................... 4,941 14,737
------- -------
Operating income (loss)..................................... (4,941) 100
------- -------
Interest income............................................. 205 225
Interest and other expense.................................. (12) (45)
------- -------
Total interest and other income................... 193 180
------- -------
Income (loss) before income tax expense..................... (4,748) 280
Income tax expense.......................................... 1 463
------- -------
Net loss.................................................... $(4,749) $ (183)
======= =======
Basic and diluted net loss per share........................ $ (3.97) $ (0.04)
======= =======
Weighted-average shares outstanding used in computing basic
and diluted net loss per share............................ 1,195 4,237
======= =======
</TABLE>
See accompanying notes to financial statements
F-4
<PAGE> 70
TURNSTONE SYSTEMS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL TOTAL
--------------- --------------- PAID-IN DEFERRED STOCK ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION DEFICIT EQUITY
------ ------ ------ ------ ---------- -------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of restricted common
stock to founders................. -- $-- 8,475 $ 8 $ -- $ -- $ -- $ 8
Issuance of Series A preferred
stock, net of issuance costs.... 11,680 12 -- -- 5,801 -- -- 5,813
Issuance of common stock pursuant
to stock plans to employees and
consultants..................... -- -- 1,687 2 83 -- -- 85
Issuance of convertible preferred
stock warrants.................. -- -- -- -- 40 -- -- 40
Deferred stock compensation....... -- -- -- -- 195 (195) -- --
Amortization of deferred stock
compensation.................... -- -- -- -- -- 29 -- 29
Net loss.......................... -- -- -- -- -- -- (4,749) (4,749)
------ --- ------ --- ------- -------- ------- -------
Balance at December 31, 1998...... 11,680 12 10,162 10 6,119 (166) (4,749) 1,226
Issuance of Series B preferred
stock, net of issuance costs.... 3,177 3 -- -- 6,171 -- -- 6,174
Issuance of common stock pursuant
to stock plans to employees and
consultants..................... -- -- 1,245 1 1,138 -- -- 1,139
Deferred stock compensation....... -- -- -- -- 13,070 (13,070) -- --
Amortization of deferred stock
compensation.................... -- -- -- -- -- 3,535 -- 3,535
Net loss.......................... -- -- -- -- -- -- (183) (183)
------ --- ------ --- ------- -------- ------- -------
Balance at December 31, 1999...... 14,857 $15 11,407 $11 $26,498 $ (9,701) $(4,932) $11,891
====== === ====== === ======= ======== ======= =======
</TABLE>
See accompanying notes to financial statements
F-5
<PAGE> 71
TURNSTONE SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1998 1999
---------- ----------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................... $ (4,749) $ (183)
Adjustments to reconcile net loss to net cash
provided/(used) in operating activities:
Depreciation........................................... 108 312
Amortization of deferred stock compensation............ 29 3,535
Common stock issued for services....................... 2 13
Provision for doubtful accounts and sales returns...... -- 276
Changes in assets and liabilities:
Accounts receivable.................................. -- (6,715)
Inventory............................................ -- (2,939)
Prepaid expenses and other current assets............ (56) (503)
Accounts payable..................................... 182 601
Accrued compensation and benefits.................... 129 791
Accrued expenses, other current and long-term
liabilities......................................... 34 1,680
Deferred revenue..................................... -- 2,132
Customer Deposits.................................... 1,328
-------- --------
Net cash provided/(used) in operating
activities...................................... (4,321) 328
INVESTING ACTIVITIES
Acquisition of property and equipment....................... (194) (611)
Increase in other assets.................................... (28) (104)
-------- --------
Net cash used in investing activities............. (222) (715)
FINANCING ACTIVITIES
Net proceeds from issuance of convertible preferred stock... 5,813 6,174
Proceeds from issuance of common stock...................... 91 1,126
Principal payments of capital lease obligations............. (23) (188)
-------- --------
Net cash provided by financing activities......... 5,881 7,112
-------- --------
Net increase in cash and cash equivalents................... 1,338 6,725
Cash and cash equivalents at beginning of period............ -- 1,338
-------- --------
Cash and cash equivalents at end of period.................. $ 1,338 $ 8,063
======== ========
Supplemental disclosures of cash flow information:
Cash paid for interest.................................... $ -- $ 31
Noncash investing and financing activities:
Equipment purchases under capital leases............. $ 422 $ 278
Deferred stock compensation.......................... $ 195 $ 13,070
Convertible preferred stock warrant issuances........ $ 40 $ --
</TABLE>
See accompanying notes to financial statements
F-6
<PAGE> 72
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1999
1. THE COMPANY
Turnstone Systems, Inc. (the Company) has been engaged in the development
and marketing of the Copper CrossConnect(TM) family of products, which enable
the automation and remote management of line installation, qualification and
maintenance. The Company commenced the commercial sale of its products in the
first quarter of 1999.
During 1998, the Company was considered to be in the development stage as
the Company was engaged primarily in obtaining financing and personnel and in
developing its products.
The Company was incorporated on January 2, 1998. The period from this date
to December 31, 1998 is referred to in the accompanying financial statements and
notes as "1998" or the "Year ended December 31, 1998".
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
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
December 31, 1998 and 1999 consist primarily of money market funds.
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, which approximates amortized cost for debt securities.
INVENTORIES
Inventories consist of finished products which a third party manufactures
for the Company. Component parts inventory held and owned by a third party
manufacturer is not included in the Company's inventory balance, while finished
products held by a third party manufacturer are included in the Company's
inventory balance once testing is complete and title passes to the Company.
Inventories are stated at the lower of cost (determined by the first-in,
first-out method) or market. Under the contract with the third-party
manufacturer, the Company has liability for inventories of component parts which
become excess or obsolete to the manufacturer as a result of certain Company
actions, including the effect of product design changes. As of December 31, 1999
the Company had no reserves for excess or obsolete inventory.
LONG-LIVED ASSETS
Property and equipment are stated at cost. Depreciation of property and
equipment is computed using the straight-line method over the estimated useful
lives of the respective assets or, if shorter, the lease terms for assets
acquired under capital leases. Useful lives and lease terms generally have been
three years.
The Company evaluates long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired,
F-7
<PAGE> 73
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999
the impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets.
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 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 in respect of
the comprehensive maintenance program 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, SOP 98-4, Deferral of Effective Date of SOP 97-2,
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.
RESEARCH AND DEVELOPMENT COSTS
Development costs incurred in the research and development of new products
and enhancements to existing products are expensed as incurred until the product
has been completed, tested and is ready for commercial manufacturing. To date,
hardware development projects have been completed concurrent with the
establishment of commercial manufacturing and accordingly no costs have been
capitalized. To date, software development projects have been completed
concurrent with the establishment of technological feasibility in the form of a
working model and, accordingly, no costs have been capitalized.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company uses the intrinsic value method in accordance with Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees,
to account for employee stock-based compensation. Accordingly, compensation cost
is recorded on the date of grant to the extent the fair value of the underlying
share of common stock exceeds the exercise price for a stock option or the
purchase price for a share of common stock. The compensation cost is amortized
as a charge against income on an accelerated basis over the vesting terms of
stock options in accordance with Financial Accounting Standards Board (FASB)
Interpretation No. 28. Pursuant to SFAS No. 123, the Company discloses the
pro-forma effect of using the fair value method of accounting for employee
stock-based compensation arrangements.
Stock-based awards granted to non-employees are measured using the fair
value method in accordance with SFAS No. 123 at the date of grant or the vesting
date, if different than the grant date. The associated expense is recognized by
the Company over the period the services are performed by the non-employee.
F-8
<PAGE> 74
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999
INCOME TAXES
The Company uses the asset and liability method of accounting for income
taxes. Under the asset and liability method, deferred tax assets and liabilities
are recognized for the estimated future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the statement of operations in the period
that includes the enactment date. A valuation allowance is established when
necessary to reduce deferred tax assets to the amounts expected to be recovered.
COMPREHENSIVE LOSS
The Company has no significant components of other comprehensive loss, and,
accordingly, the comprehensive loss is the same as net loss for the periods
presented.
NET LOSS PER SHARE
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock excluding shares of restricted stock subject
to repurchase summarized below. Dilutive net loss per share is computed using
the weighted-average number of shares of common stock outstanding and, when
dilutive, potential shares of restricted common stock subject to repurchase,
common stock from options and warrants using the treasury stock method and from
convertible securities using the "as-if converted basis". Potential common
shares that could dilute earnings per share in future periods but which have
been excluded from the determination of diluted net loss per share because the
effect of such shares would have been anti-dilutive are as follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1998 1999
------ ------
<S> <C> <C>
Shares issuable under stock options......................... 1,500 3,339
Shares of restricted stock subject to repurchase
Founders.................................................. 6,155 4,036
Other employees........................................... 1,664 1,633
Shares issuable pursuant to warrants to purchase convertible
preferred stock........................................... 135 135
Shares of convertible preferred stock on an
"as-if-converted" basis................................... 11,680 14,857
------ ------
21,134 24,000
====== ======
</TABLE>
The weighted-average exercise price of stock options outstanding was $0.07
and $2.65 for the years ended December 31, 1998 and 1999, respectively. The
weighted-average purchase price of shares of common stock subject to the
Company's right of repurchase was $0.001 for each period for shares issued to
the Company's founders and was $0.05 and $0.63 for the years ended December 31,
1998 and 1999, respectively for shares issued to other employees. The exercise
price of warrants to purchase shares of convertible preferred stock is $0.50 for
each period. Each share of Series A and Series B convertible preferred stock is
convertible into one share of common stock.
F-9
<PAGE> 75
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999
FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
The carrying values of the Company's financial instruments, consisting of
cash and cash equivalents, accounts receivable, accounts payable and obligations
under capital leases, approximate fair values.
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist primarily of cash, cash equivalents and
accounts receivable. The Company's cash and cash equivalents are maintained with
three highly accredited financial institutions. To reduce credit risk with
respect to accounts receivable, the Company performs ongoing evaluations of the
financial condition of its customers. The Company does not require collateral
from its customers. As of December 31, 1999, three of the Company's customers
accounted for 30%, 24%, and 18% of the accounts receivable balance,
respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of expenses during the reporting period.
Actual results could differ from these estimates.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. The Company is required to adopt SFAS No.
133 as amended by SFAS No. 137, in 2001. SFAS No. 133 establishes methods of
accounting for derivative financial activities related to those instruments as
well as to other activities. To date, the Company has not entered into any
derivative financial instruments or hedging activities.
INITIAL PUBLIC OFFERING AND UNAUDITED PRO FORMA BALANCE SHEET
In November 1999, the Board of Directors authorized the filing of a
registration statement with the SEC that would permit the Company to sell shares
of the Company's common stock in connection with a proposed initial public
offering (IPO).
Pro forma basic and diluted net loss per share data assuming conversion of
the shares of Series A and Series B convertible preferred stock into shares of
common stock had occurred at the beginning of the period (or date of issuance if
later) are as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1998 1999
------- -------
<S> <C> <C>
Pro forma net loss.......................................... $(4,749) $ (183)
Pro forma basic and diluted net loss per share.............. $ (0.38) $ (0.01)
======= =======
Shares used in calculation of pro forma basic and diluted
net loss per share........................................ 12,449 18,946
======= =======
</TABLE>
F-10
<PAGE> 76
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1998 1999
---- ------
<S> <C> <C>
Furniture and fixtures...................................... $ 93 $ 261
Computer equipment and software............................. 444 1,011
Test equipment.............................................. 79 233
---- ------
616 1,505
Less accumulated depreciation and amortization.............. 108 420
---- ------
$508 $1,085
==== ======
</TABLE>
Property and equipment includes assets under capital leases of $447,000
less accumulated depreciation of $93,000 at December 31, 1998 and $725,000 less
accumulated depreciation of $229,000 at December 31, 1999.
4. INCOME TAXES
Income tax expense consists of the following (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1999
------------ -------------
<S> <C> <C>
Current:
Federal............................................... $ -- $ 456
State................................................. 1 7
---- ------
Total current tax expense.......................... 1 463
---- ------
Deferred:
Federal............................................... -- --
State................................................. -- --
---- ------
Total deferred tax expense......................... -- --
---- ------
Total income tax expense........................... $ 1 $ 463
==== ======
</TABLE>
Income tax expense differs from the amounts computed by applying the U.S.
federal income tax rate of 34% to pretax income (loss) as a result of the
following (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1999
------------ -------------
<S> <C> <C>
Federal tax at statutory rate........................... $(1,614) $ 95
State taxes, net of federal income tax benefit.......... 1 8
Research and development credits........................ -- (157)
Permanent differences -- primarily nondeductible
compensation.......................................... 2 1,266
Temporary differences not benefitted.................... 484 379
Net operating losses (utilized) not benefited........... 1,128 (1,128)
------- -------
Total income tax expense.............................. $ 1 $ 463
======= =======
</TABLE>
F-11
<PAGE> 77
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999
The types of temporary differences that give rise to significant portions
of the Company's deferred tax assets and liabilities consist of the following
(in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1999
------------ -------------
<S> <C> <C>
Deferred tax assets:
Accruals and reserves................................. $ 24 $ 276
State income taxes.................................... -- 4
Plant and equipment................................... 23 36
Startup costs......................................... 814 640
Deferred revenues..................................... -- 222
Net operating loss and credit carryforwards........... 1,410 17
------- -------
Gross deferred tax assets.......................... 2,271 1,195
Valuation allowance..................................... (2,271) (1,195)
------- -------
Net deferred tax assets............................ $ -- $ --
======= =======
</TABLE>
Management has established a valuation allowance for the portion of
deferred tax assets for which realization is uncertain. The change in the
valuation allowance for deferred tax assets as of December 31, 1998 and 1999 was
an increase of $2,271,000 and a decrease of $1,076,000, respectively.
As of December 31, 1999, the Company has research and other credit
carryforwards for federal income tax purposes of approximately $17,000,
available to reduce future income taxes. The federal research credit
carryforwards expire in 2019.
Federal and California tax laws impose substantial restrictions on the
utilization of net operating loss and credit carryforwards in the event of an
"ownership change" for tax purposes, as defined in Section 382 of the Internal
Revenue Code. The issuance of Series A convertible preferred stock on January
13, 1998 resulted in such a change. As a result, the annualized loss and credit
carryforwards as of January 13, 1998 of approximately $100,000 and $5,600,
respectively, are subject to an annual limitation approximating $300,000. The
net operating losses incurred from January 14, 1998 to December 31, 1998 are not
subject to an annual limitation.
5. BANK LINE OF CREDIT
On June 1, 1998, the Company entered into a $900,000 line of credit
agreement with a bank. Borrowings under the line of credit bear interest at the
bank's prime rate and are collateralized by certain assets of the Company other
than intellectual property. On December 1, 1999, the line of credit expired and
it was not renewed by the Company. There have been no borrowings under this
agreement.
In connection with the line of credit agreement, the Company issued to the
bank warrants to purchase 45,000 shares of Series A convertible preferred stock
at an exercise price of $0.50 per share. The warrants are exercisable through
June 1, 2008. No warrants have been exercised as of December 31, 1999. The fair
value of the warrants was determined to be $13,000, calculated using the
Black-Scholes option pricing model, using the following assumptions: no
dividends; contractual term of five years; risk-free interest rate of 5.5%; and
expected volatility of 65%. The fair value of the warrants has been recorded as
additional paid-in capital and is being amortized as interest expense over the
term of the line of credit agreement.
F-12
<PAGE> 78
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999
6. LEASE OBLIGATIONS AND COMMITMENTS
In July 1998, the Company entered into an leasing agreement with a
financing company which allows the Company through October 29, 1999,
subsequently extended to April 29, 2000 to draw up to $900,000 for the lease of
hardware and $600,000 for the lease of software. The leases are accounted for as
capital leases. The lease obligations under this agreement are repayable in 36
equal monthly installments of principal plus interest commencing on the
individual lease inception dates and are secured by the leased assets.
In connection with the equipment leasing agreement, the Company issued to
the financing company warrants to purchase 90,000 shares of Series A convertible
preferred stock at a price of $0.50 per share. The warrants expire on July 30,
2003 or upon the effectiveness of the Company's initial public offering, if
earlier. No warrants have been exercised as of December 31, 1999. The fair value
of the warrants was determined to be $27,000, calculated using the Black-Scholes
option pricing model, using the following assumptions: no dividends; contractual
term of five years; risk-free interest rate of 5.5%; and expected volatility of
65%. The fair value of the warrants has been recorded as additional paid-in
capital and is being amortized as interest expense over the term of the lease
agreement.
The Company is also obligated under certain noncancelable operating leases
for office space, which requires the Company to pay related property taxes and
normal maintenance. The leases expire in 2002 and 2003.
Future minimum payments required under capital and operating leases as of
December 31, 1999 are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING CAPITAL OPERATING
DECEMBER 31, LEASES LEASES
------------ ------- ---------
<S> <C> <C>
2000........................................................ $255 567
2001........................................................ 231 567
2002........................................................ 41 320
2003........................................................ -- 12
---- ------
Total future minimum lease payments......................... 527 $1,466
======
Less imputed interest....................................... 38
----
Present value of future minimum lease payments under capital
leases.................................................... 489
Less current portion........................................ 229
----
Long-term portion........................................... $260
====
</TABLE>
In September 1999, the Company entered into a noncancelable operating
sublease of a facility the Company previously occupied. Payments to be received
under this sublease are as follows: 2000 -- $193,000; 2001 -- $199,000;
2002 -- $205,000; and 2003 -- $17,000.
7. STOCKHOLDERS' EQUITY
CONVERTIBLE PREFERRED STOCK
In 1998, the Company issued 11,680,000 shares of Series A convertible
preferred stock at a price of $0.50 per share for cash proceeds of $5,813,000,
net of issuance costs of $27,000.
In 1999, the Company issued 3,176,930 shares of Series B convertible
preferred stock at a price of $1.95 per share for cash proceeds of $6,174,000,
net of issuance costs of $21,000. Amortization
F-13
<PAGE> 79
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999
of deferred stock compensation in the year ended December 31, 1999 includes
$445,000 of compensation related to the issuance of Series B convertible
preferred stock to an Advisory Board member at a price less than deemed fair
value and which were fully vested at the date of issuance.
The rights, preferences, and privileges of the holders of Series A and
Series B convertible preferred stock are as follows:
- - each share of Series A and Series B preferred stock is convertible into one
share of common stock, subject to certain antidilution provisions.
- - shares of Series A and Series B preferred stock automatically convert to
common stock on the earlier of consummation of an underwritten initial public
offering in which the aggregate proceeds are at least $10,000,000 or $1.50 per
share offering; or the date specified by written consent or agreement of at
least two-thirds of the Series A and Series B stockholders. Holders of Series
A and Series B preferred stock are entitled to noncumulative annual dividends
of $0.04 per share and $0.16 per share, respectively, if and when declared by
the Company's Board of Directors.
- - Series A and Series B preferred stock votes equally with the shares of common
stock on an "as-if-converted" basis, but also has class voting rights as
provided by law and in the Certificate of Incorporation.
- - holders of Series A and Series B preferred stock have a liquidation preference
of $0.50 per share and $1.95 per share, respectively, plus all declared but
unpaid dividends.
COMMON STOCK
In 1998, the Company issued 8,475,500 shares of restricted common stock to
the three founding members of the Company at a price of $0.001 per share. The
shares are subject to a right of repurchase by the Company, which lapses monthly
over four year periods ending in October 2001 and January 2002, or on the
occurrence of a change of control event. Upon termination of employment, the
Company may repurchase all unvested shares at $0.001 per share. The Company
maintains a right of first refusal with respect to restricted common stock.
1998 STOCK PLAN
The 1998 Stock Plan permits the Company to grant employees, outside
directors, and consultants qualified stock options, nonstatutory stock options
or stock purchase rights to purchase shares of the Company's common stock.
Options generally vest 25% with respect to the number granted upon the first
anniversary date of the option grant and the remainder vest in equal monthly
installments over the 36 months thereafter. Options are exercisable immediately.
Shares issued upon exercise of non-vested stock options are subject to the
Company's right to repurchase at the original exercise price. The Company's
repurchase right lapses in accordance with the vesting schedule for the stock
options. At December 31, 1998 and 1999 1,664 and 1,633 shares, respectively,
resulting from the early exercise of options were subject to repurchase at a
weighted average exercise price of $0.05 and $0.63 respectively.
Under the 1998 Stock Plan, the Company issued 22,690 shares of common stock
in 1998 and 15,534 shares in 1999 in exchange for consulting services. The
aggregate estimated fair value of these shares and the resulting expense was
$2,000 for the 1998 issuances and $25,000 for the 1999 issuances.
In July 1999, the Company approved increases in the number of shares of
Common Stock reserved for issuance under the Company's 1998 Stock Plan from
5,324,000 to 7,074,000 shares.
F-14
<PAGE> 80
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999
A summary of the status of the Company's 1998 Stock Plan is as follows (in
thousands except for per share data):
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
------------------------------------
WEIGHTED- WEIGHTED-
SHARES AVERAGE AVERAGE
AVAILABLE FOR NUMBER EXERCISE GRANT DATE
GRANT OF SHARES PRICE FAIR VALUE
------------- --------- --------- ----------
<S> <C> <C> <C> <C>
Authorized as of January 2, 1998
(inception)................................ 5,324 --
Granted with exercise price:
Less than fair value....................... (520) 520 $0.13 $0.50
Equal to fair value........................ (2,807) 2,807 0.05
Exercised.................................... -- (1,687) 0.05
Canceled..................................... 140 (140) 0.05
------ ------
Balances as of December 31, 1998............. 2,137 1,500 0.07
Authorized................................... 1,750 -- --
Granted with exercise price:
Less than fair value....................... (3,084) 3,084 3.20 $7.30
Exercised.................................... -- (1,245) 0.91
------ ------
Balance as of December 31, 1999.............. 803 3,339 $2.65
====== ======
Options exercisable as of December 31,
1999....................................... 3,339
======
</TABLE>
The following table summarizes information about stock options outstanding
as of December 31, 1999:
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
REMAINING
RANGE OF CONTRACTUAL
EXERCISE NUMBER LIFE
PRICES OUTSTANDING (YEARS)
- ------------- -------------- -----------
(IN THOUSANDS)
--------------
<S> <C> <C>
$ 0.05 - 0.07 841 8.34
0.20 - 0.50 443 9.12
0.95 478 9.32
1.15 - 1.95 214 9.44
2.05 - 3.15 360 9.55
3.65 - 4.15 190 9.65
5.00 100 9.69
6.45 - 7.15 395 9.74
7.65 - 8.90 180 9.83
10.80 138 9.94
-----
3,339
=====
</TABLE>
The Company uses the intrinsic-value method prescribed by APB No. 25 in
accounting for its stock-based compensation arrangements for employees whereby
compensation cost is recognized to the extent the fair value of the underlying
common stock exceeds the exercise price of the stock options at the date of
grant. Deferred stock compensation of $195,000 in 1998 and $13,070,000 in 1999
has been recorded for the excess of the fair value of the common stock
underlying the options at the grant date over the exercise price of the options.
These amounts are being amortized on an accelerated basis over the vesting
period, generally four years, consistent with the method described
F-15
<PAGE> 81
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999
in FASB Interpretation No. 28. Amortization of deferred compensation was $29,000
in 1998 and $3,535,000 in 1999. Had compensation cost for the Company's
stock-based compensation plan been determined consistent with the fair value
approach set forth in SFAS No. 123, the Company's net losses would have been as
follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1999
------------ -----------------
<S> <C> <C>
Net loss -- as reported............................. $(4,749) $ (183)
======= ======
Net loss -- pro forma............................... $(4,750) $ (653)
======= ======
Basic and diluted net loss per share -- as
reported.......................................... $ (3.97) $(0.04)
======= ======
Basic and diluted net loss per share -- pro forma... $ (3.97) $(0.15)
======= ======
</TABLE>
The fair value of options granted are estimated on the date of grant using
the minimum value method with the following weighted-average assumptions: no
dividend yield; risk-free interest rates of 5.12% and 5.38% in 1998 and 1999,
respectively, and an expected life of four years.
2000 EMPLOYEE STOCK PURCHASE PLAN
The Company's Board of Directors adopted the 2000 Employee Stock Purchase
Plan in November 1999. It will become effective upon the effectiveness of this
offering. The 2000 Employee Stock Purchase Plan provides employees the
opportunity to purchase common stock, subject to certain restrictions, through
payroll deductions. A total of 500,000 shares of common stock have currently
been reserved for issuance, with an annual increase for subsequent years, none
of which have been issued prior to this offering. The purchase price per share
will be 85% of the fair market value of the common stock on the first day of the
applicable purchase period or the last day of the applicable purchase period,
whichever is lower.
2000 STOCK PLAN
The Board of Directors adopted the 2000 Stock Plan in November 1999. It
will become effective upon the effectiveness of this offering. The 2000 Stock
Plan provides for the grant of incentive stock options, nonstatutory stock
options, and stock purchase rights to employees, directors and consultants. The
plan also provides for nondiscretionary grants of nonstatutory options to
outside directors. A total of 5,000,000 shares of common stock have been
reserved for issuance under the 2000 Stock Plan with an annual increase in the
share reserve added on the first day of each year, beginning in 2001. Any
options available for grant under the 1998 Stock Plan at the date the 2000 Stock
Plan becomes effective will be transferred to the 2000 Stock Plan.
8. 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). From inception of the Company through
December 31, 1999, the Company
F-16
<PAGE> 82
TURNSTONE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1999
has consisted of one product line. The CEO reviews financial information on an
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.
All of the Company's revenues have been derived from customers located in
the United States and all of the Company's assets are located in the United
States.
For the year ended December 31, 1999, 41%, 19%, 15% and 11% of the
Company's revenues were attributable to four different customers.
F-17
<PAGE> 83
APPENDIX -- DESCRIPTION OF GRAPHICS
Caption and Graphic Description
[INSIDE FRONT COVER]
Caption: The Turnstone Local Loop Management Solution.
Graphic: Illustration of an installation of Turnstone's Copper CrossConnect
CX100. The illustration depicts the CX100 installed within a central office of
an incumbent local exchange carrier in space leased by a competitive local
exchange carrier. The CX100 is installed between the copper telephone lines
leading to DSL subscribers and two DSL access multiplexers. The illustration
also depicts the remote management and operation of the CX100 using Turnstone's
CrossWorks software.
[Page 30]
[Graphic: Diagram depicting deployment of DSL equipment by one or more
competitive local exchange carriers without the CX100. The diagram shows copper
telephone lines running from DSL subscribers to the central office of an
incumbent local exchange carrier. Physical connection points that must be
completed in order for DSL service to function are labeled in the diagram.
Caption: Manual DSL Line Installation and Maintenance]
[Page 34]
[Graphic: Diagram depicting deployment of the CX100 in conjunction with DSL
equipment from one or more competitive local exchange carriers. The diagram
shows copper telephone lines running from DSL subscribers to the central office
of an incumbent local exchange carrier. A picture of the network operations
center of a competitive local exchange carrier with a line to the CX100 depicts
the operation of the CX100 from a remote facility by a competitive local
exchange carrier.
Caption: Deployment of the CX100]
[Page 35]
[Graphic: Diagram depicting the interaction of CrossWorks software with CX100s,
user interfaces and other computer systems. The diagram shows a server running
CrossWorks installed at a network operations center exchanging data with
multiple CX100s in different central offices as well as with a competitive local
exchange carrier's operational support system. The diagram depicts a service
worker accessing CrossWorks via a voice response systems as well as the
graphical computer screens that can be accessed by network operators.
Caption: CrossWorks Architecture]
[INSIDE BACK COVER]
Turnstone Systems, Inc. Logo
<PAGE> 84
TURNSTONE SYSTEMS
[ART WORK]
<PAGE> 85
- ------------------------------------------------------
- ------------------------------------------------------
No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. You must not rely on
any unauthorized information or representations. This prospectus is an offer to
sell only the shares offered hereby, but only under circumstances and in
jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.
-------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary................... 1
Risk Factors......................... 4
Note Regarding Forward-looking
Statements......................... 15
Use of Proceeds...................... 15
Dividend Policy...................... 15
Capitalization....................... 16
Dilution............................. 17
Selected Financial Data.............. 18
Management's Discussion And Analysis
of Financial Condition And Results
of Operations...................... 19
Business............................. 28
Management........................... 41
Certain Transactions................. 51
Principal Stockholders............... 53
Description of Capital Stock......... 55
Shares Eligible For Future Sale...... 59
Underwriting......................... 61
Validity of Common Stock............. 63
Experts.............................. 63
Where You May Find Additional
Information........................ 63
Index To Financial Statements........ F-1
</TABLE>
-------------------------
Through and including , 2000 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to a dealer's obligation to deliver a prospectus when acting
as an underwriter and with respect to an unsold allotment or subscription.
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
3,000,000 Shares
TURNSTONE SYSTEMS, INC.
Common Stock
-------------------------
[Turnstone Systems, Inc. Logo]
-------------------------
GOLDMAN, SACHS & CO.
DAIN RAUSCHER WESSELS
ROBERTSON STEPHENS
Representatives of the Underwriters
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 86
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by Turnstone Systems in
connection with the sale of Common Stock being registered. All amounts are
estimates except the SEC registration fee and the NASD filing fee.
<TABLE>
<S> <C>
SEC registration fee........................................ $ 15,484
NASD filing fee............................................. 6,365
Nasdaq National Market listing fee.......................... 22,250
Printing and engraving costs................................ 300,000
Legal fees and expenses..................................... 400,000
Accounting fees and expenses................................ 400,000
Blue Sky fees and expenses.................................. 20,000
Transfer Agent and Registrar fees........................... 10,000
Miscellaneous expenses...................................... 25,901
----------
Total............................................. $1,200,000
==========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law permits a corporation
to include in its charter documents, and in agreements between the corporation
and its directors and officers, provisions expanding the scope of
indemnification beyond that specifically provided by the current law.
Article XI of Turnstone Systems' Restated Certificate of Incorporation
provides for the indemnification of directors to the fullest extent permissible
under Delaware law.
Article VI of Turnstone Systems' Bylaws provides for the indemnification of
officers, directors and third parties acting on behalf of Turnstone Systems if
such person acted in good faith and in a manner reasonably believed to be in and
not opposed to the best interest of Turnstone Systems, and, with respect to any
criminal action or proceeding, the indemnified party had no reason to believe
his or her conduct was unlawful.
Turnstone Systems has entered into indemnification agreements with its
directors and executive officers, in addition to indemnification provided for in
Turnstone Systems' Bylaws, and intends to enter into indemnification agreements
with any new directors and executive officers in the future.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Since our incorporation in January 1998, we have issued unregistered
securities to a limited number of persons as described below.
None of these transactions involved any underwriters, underwriting
discounts or commissions, or any public offering, and we believe that each
transaction was exempt from the registration requirements of the Securities Act
by virtue of Section 4(2) thereof, Regulation D promulgated thereunder or Rule
701 pursuant to compensatory benefit plans and contracts relating to
compensation as provided under such Rule 701. The recipients of securities in
each such transaction represented their intention to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof, and appropriate legends were affixed to the share
certificates and instruments issued in such transactions. All recipients had
adequate access, through their relationships with Turnstone Systems, to
information about Turnstone Systems.
II-1
<PAGE> 87
1. In January 1998, we issued and sold 8,475,500 shares of common stock to
founders at a purchase price per share of $0.001. These transactions
were exempt from the registration requirements of the Securities Act by
virtue of Section 4(2) in that the shares were issued to our three
founders, each of whom is an officer of the Company.
2. Pursuant to our 1998 Stock Plan, from inception to December 31, 1999 we
issued and sold an aggregate of 2,931,412 shares of common stock to
certain employees, officers, directors and consultants. These
transactions were exempt from the registration requirements of the
Securities Act by virtue of Rule 701.
3. On January 12, 1998 and February 27, 1998, we issued and sold a total of
11,680,000 shares of Series A Preferred Stock to a total of 13 investors
for an aggregate purchase price of $5,840,000. These transactions were
exempt from the registration requirements of the Securities Act by
virtue of Section 4(2) and Regulation D based on the representations of
each of the investors that it was accredited under Rule 501.
4. On June 1, 1998, in connection with a credit facility, we issued to one
party a warrant to purchase 45,000 shares of our Series A Preferred
Stock for an aggregate exercise price of $22,500. This transaction was
exempt from the registration requirements of the Securities Act by
virtue of Section 4(2) in that the issuance was made to an investor
which was a sophisticated financial institution.
5. One July 29, 1998, in connection with certain equipment leases, we
issued to one party a warrant to purchase 90,000 shares of our Series A
Preferred Stock for an aggregate exercise price of $45,000. This
transaction was exempt from the registration requirements of the
Securities Act by virtue of Section 4(2) in that the issuance was made
to an investor, which was a sophisticated financial institution.
6. On January 12, 1999 and June 21, 1999, we issued and sold a total of
3,176,930 shares of Series B Preferred Stock to a total of 12 investors
for an aggregate purchase price of $6,195,013.50. These transactions
were exempt from the registration requirements of the Securities Act by
virtue of Section 4(2) and Regulation D based on the representations of
each of the investors that it was accredited under Rule 501.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- -----------------------
<S> <C>
1.1* Form of Underwriting Agreement
3.1A* Certificate of Incorporation of Turnstone Systems currently
in effect
3.1B* Certificate of Incorporation of Turnstone Systems to be in
effect after the closing of the offering made under this
Registration Statement
3.2A* Bylaws of Turnstone Systems currently in effect
3.2B* Bylaws of Turnstone Systems to be in effect after the
closing of the offering made under this Registration
Statement
4.1 Form of Common Stock certificate
4.2 Registration Rights Agreement, dated January 12, 1998 by and
among Turnstone Systems and certain stockholders of
Turnstone Systems named therein, as amended as of January
12, 1999 and November 21, 1999
4.3* Warrant to purchase shares of Series A Preferred Stock of
Turnstone Systems issued to Silicon Valley Bank
4.4* Form of Founder's Restricted Stock Purchase Agreement
entered into as of January 2, 1998 between Turnstone Systems
and each of P. Kingston Duffie, M. Denise Savoie and Richard
N. Tinsley
</TABLE>
II-2
<PAGE> 88
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- -----------------------
<S> <C>
5.1 Opinion of Wilson Sonsini Goodrich & Rosati, Professional
Corporation
10.1* Form of Indemnification Agreement entered into by Turnstone
Systems with each of its directors and executive officers
10.2* 1998 Stock Plan and forms of agreement thereunder
10.3 2000 Stock Plan and forms of agreement thereunder
10.4* 2000 Employee Stock Purchase Plan and forms of agreement
thereunder
10.5+* Manufacturing Agreement dated as of October 16, 1998,
between Turnstone Systems and A-Plus Manufacturing
Corporation
10.6+* OEM Purchase Agreement, dated effective as of September 1,
1999, between Turnstone Systems and Lucent Technologies
Inc., as amended as of September 28, 1999 and December 9,
1999
10.7* Sublease dated June 16, 1999, between Turnstone Systems and
Finisar Corporation
10.8+ Application Services Agreement, dated effective as of
December 23, 1999, between Turnstone Systems and AristaSoft
Corporation
23.1 Consent of KPMG LLP, independent auditors
23.2 Consent of Counsel (included in Exhibit 5.1)
24.1* Power of Attorney (see page II-4)
27.1 Financial Data Schedule
</TABLE>
- -------------------------
* Previously filed.
+ Confidential treatment requested.
(b) FINANCIAL STATEMENT SCHEDULES
Schedule II -- Valuation and Qualifying Accounts (see pages S-1 and S-2)
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
ITEM 17. UNDERTAKINGS
Turnstone Systems hereby undertakes to provide to the underwriters at the
closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification by Turnstone Systems for liabilities arising
under the Securities Act may be permitted to directors, officers and controlling
persons of Turnstone Systems pursuant to the provisions referenced in Item 14 of
this registration statement or otherwise, Turnstone Systems has been advised
that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act, and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by Turnstone Systems of
expenses incurred or paid by a director, officer, or controlling person of
Turnstone Systems in the successful defense of any action, suit or proceeding)
is asserted by a director, officer or controlling person in connection with the
securities being registered hereunder, Turnstone Systems will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
Turnstone Systems hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by Turnstone Systems pursuant to
II-3
<PAGE> 89
Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to
be part of this registration statement as of the time it was declared
effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-4
<PAGE> 90
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 2 to the Registration Statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in the city of
Mountain View, State of California, on the 10th day of January 2000.
TURNSTONE SYSTEMS, INC.
By: /s/ RICHARD N. TINSLEY
------------------------------------
Richard N. Tinsley
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to the Registration Statement has been signed by the following persons in
the capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ RICHARD N. TINSLEY President, Chief Executive January 10, 2000
- ----------------------------------------------------- Officer and Director
Richard N. Tinsley (Principal Executive Officer)
*P. KINGSTON DUFFIE Chief Technology Officer and January 10, 2000
- ----------------------------------------------------- Director
P. Kingston Duffie
/s/ M. DENISE SAVOIE Chief Financial Officer and January 10, 2000
- ----------------------------------------------------- Vice President, Business
M. Denise Savoie Operations (Principal
Financial and Accounting
Officer)
*ROBERT J. FINOCCHIO, JR. Director January 10, 2000
- -----------------------------------------------------
Robert J. Finocchio, Jr.
*JOHN K. PETERS Director January 10, 2000
- -----------------------------------------------------
John K. Peters
*ANDREW W. VERHALEN Director January 10, 2000
- -----------------------------------------------------
Andrew W. Verhalen
*GEOFFREY Y. YANG Director January 10, 2000
- -----------------------------------------------------
Geoffrey Y. Yang
*By: /s/ RICHARD N. TINSLEY
------------------------------------------------
Attorney-in-Fact
</TABLE>
II-5
<PAGE> 91
TURNSTONE SYSTEMS, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS
CLASSIFICATION BEGINNING OF CHARGED TO BALANCE AT
PERIOD YEAR OPERATIONS WRITE-OFFS END OF YEAR
- -------------------------------- ------------ ---------- ---------- -----------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS
YEAR ENDED:
December 31, 1998............... $ -- $ -- $ -- $ --
December 31, 1999............. -- 76,077 -- 76,077
SALES RETURN RESERVE
YEAR ENDED:
December 31, 1998............. -- -- -- --
December 31, 1999............. -- 200,000 -- 200,000
</TABLE>
S-1
<PAGE> 92
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- -----------------------
<S> <C>
1.1* Form of Underwriting Agreement
3.1A* Certificate of Incorporation of Turnstone Systems currently
in effect
3.1B* Certificate of Incorporation of Turnstone Systems to be in
effect after the closing of the offering made under this
Registration Statement
3.2A* Bylaws of Turnstone Systems currently in effect
3.2B* Bylaws of Turnstone Systems to be in effect after the
closing of the offering made under this Registration
Statement
4.1 Form of Common Stock certificate
4.2 Registration Rights Agreement, dated January 12, 1998 by and
among Turnstone Systems and certain stockholders of
Turnstone Systems named therein, as amended as of January
12, 1999 and November 19, 1999
4.3* Warrant to purchase shares of Series A Preferred Stock of
Turnstone Systems issued to Silicon Valley Bank
4.4* Form of Founder's Restricted Stock Purchase Agreement
entered into as of January 2, 1998 between Turnstone Systems
and each of P. Kingston Duffie, M. Denise Savoie and Richard
N. Tinsley
5.1 Opinion of Wilson Sonsini Goodrich & Rosati, Professional
Corporation
10.1* Form of Indemnification Agreement entered into by Turnstone
Systems with each of its directors and executive officers
10.2* 1998 Stock Plan and forms of agreement thereunder
10.3 2000 Stock Plan and forms of agreement thereunder
10.4* 2000 Employee Stock Purchase Plan and forms of agreement
thereunder
10.5+* Manufacturing Agreement dated as of October 16, 1998,
between Turnstone Systems and A-Plus Manufacturing
Corporation
10.6+* OEM Purchase Agreement, dated effective as of September 1,
1999, between Turnstone Systems and Lucent Technologies
Inc., as amended as of September 28, 1999 and December 9,
1999
10.7* Sublease dated June 16, 1999, between Turnstone Systems and
Finisar Corporation
10.8+ Application Services Agreement, dated effective as of
December 23, 1999, between Turnstone Systems and AristaSoft
Corporation
23.1 Consent of KPMG LLP, independent auditors
23.2 Consent of Counsel (included in Exhibit 5.1)
24.1* Power of Attorney (see page II-4)
27.1 Financial Data Schedule
</TABLE>
- -------------------------
* Previously filed.
+ Confidential treatment requested.
<PAGE> 1
EXHIBIT 4.1
COMMON SHARES
COMMON SHARES
TST
THIS CERTIFICATE IS TRANSFERABLE IN
RIDGEFIELD PARK, NJ OR NEW YORK, NY
CUSIP 900423 10 4
SEE REVERSE FOR CERTAIN DEFINITIONS
TURNSTONE SYSTEMS, INC.
INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE
This Certifies that
is the record holder of
FULLY PAID AND NON-ASSESSABLE SHARES OF THE COMMON STOCK, PAR VALUE $.001 PER
SHARE, OF
Turnstone Systems, Inc., transferable only on the books of the Corporation by
the holder hereof in person or by duly authorized Attorney upon surrender of
this Certificate properly endorsed. This Certificate is not valid unless
countersigned and registered by the Transfer Agent and Registrar. In Witness
Whereof, the Corporation has caused this Certificate to be executed and attested
to by the manual or facsimile signatures of its duly authorized officers, under
a facsimile of its corporate seal to be affixed hereto. Dated:
SECRETARY
CHIEF EXECUTIVE OFFICER
COUNTERSIGNED AND REGISTERED:
BankBoston, N.A.
TRANSFER AGENT AND REGISTRAR
BY
AUTHORIZED SIGNATURE
<PAGE> 2
TURNSTONE SYSTEMS, INC.
Upon request the Corporation will furnish any holder of shares of Common Stock
of the Corporation, without charge, with a full statement of the powers,
designations, preferences, and relative, participating, optional or other
special rights of any class or series of capital stock of the Corporation, and
the qualifications, limitations or restrictions of such preferences and/or
rights.
The following abbreviations, when used in the inscription on the face of this
certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
TEN COM -
TEN ENT -
JT TEN -
as tenants in common
as tenants by the entireties
as joint tenants with right of
survivorship and not as tenants
in common
UNIF GIFT MIN ACT-D......................Custodian......................
(Cust) (Minor)
under Uniform Gifts to Minors Act...............................................
(State)
Additional abbreviations may also be used though not in the above list.
For value received, hereby sell, assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE OF ASSIGNEE)
Shares
of Common Stock represented by the within Certificate, and do hereby irrevocably
constitute and appoint
Attorney
to transfer the said stock on the books of the within named Corporation with
full power of substitution in the premises.
Dated
In presence of
X
<PAGE> 3
X
NOTICE:
THE SIGNATURE TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME AS WRITTEN UPON
THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR
ENLARGEMENT OR ANY CHANGE WHATEVER.
Signature(s) Guaranteed
By
THE SIGNATURE(S) MUST BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS,
STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEMBERSHIP IN
AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE
17Ad-15.
<PAGE> 1
Exhibit 4.2
AMENDMENT NO. 2 TO REGISTRATION RIGHTS AGREEMENT
This Amendment No. 2 (the "Amendment") to Registration Rights Agreement
dated as of January 12, 1998 (the "Rights Agreement") and amended by Amendment
No. 1 to Registration Rights Agreement dated as of January 12, 1999, is made and
entered into as of November 21, 1999 pursuant to Section 19 of the Rights
Agreement by and among Turnstone Systems, Inc., a Delaware corporation, and the
purchasers of the Company's Series A Preferred Stock pursuant to the Series A
Preferred Stock Purchase Agreement dated January 12, 1998 (the "Series A
Purchasers") and the purchasers of the Company's Series B Preferred Stock
pursuant to the Series B Preferred Stock Purchase Agreements dated January 12,
1999 and June 21, 1999 (the "Series B Purchasers" and together with the Series A
Purchasers, the "Preferred Holders"). Capitalized terms used in this Amendment
that are not otherwise defined herein shall have the respective meanings
assigned to them in the Rights Agreement.
RECITALS
WHEREAS, Section 6(a) of the Rights Agreement grants the Preferred Holders
the right to include their Registrable Securities in any registration by the
Company of its securities, for its own account or the account of a security
holder or holders exercising their demand registration rights, other than
registrations relating solely to employee benefit plans or registrations
relating solely to transactions pursuant to Rule 145 promulgated under the
Securities Act, and Section 19 of the Rights Agreement permits amendment thereof
by written consent of the Company and holders of 66-2/3% of the outstanding
shares of Registrable Securities; and
WHEREAS, the Preferred Holders and the Company wish to enter this Amendment
to amend and waive their registration rights under Section 6(a).
NOW, THEREFORE, the parties hereto hereby agree as follows:
AGREEMENT
1. Section 6(a) of the Rights Agreement is hereby amended and restated to
read as follows:
Notice of Registration. If the Company shall determine to register any of
its securities, either for its own account or the account of a security holder
or holders exercising their respective demand registration rights, other than
(i) a registration relating solely to employee benefit plans; (ii) a
registration relating solely to a transaction pursuant to Rule 145 promulgated
under the Securities Act; or (iii) the initial public offering of the Company's
common stock, the Company will:
(x) promptly give to each Holder written notice thereof; and
(y) include in such registration (and any related qualification under blue
sky laws or other compliance), and in any underwriting involved therein, all the
Registrable Securities specified in a written request or requests, made within
30 days after receipt of such written notice from the Company, by any Holder or
Holders.
<PAGE> 2
2. Section 6(b) of the Rights Agreement is hereby amended to delete the
following of phrase at the end of the first sentence (such that the first
sentence shall now end immediately before such phrase):
", provided that in the case of the Company's initial public offering,
the managing underwriter shall include in such offering at least 25%
of the Registrable Securities requested to be included in such
offering"
3. Except as expressly set forth in this Amendment, the Rights Agreement
shall continue in full force and effect in accordance with its terms.
4. This Amendment may be executed in one or more counterparts, each of
which shall be deemed an original, but all of which together shall constitute
one and the same instrument. This Amendment shall be governed by and construed
and enforced in accordance with the laws of the State of California, without
reference to the conflict of laws provisions thereof.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
2
<PAGE> 3
IN WITNESS WHEREOF, the parties hereto have caused this AMENDMENT NO. 2 TO
REGISTRATION RIGHTS AGREEMENT to be executed as of the date first above written.
"COMPANY" TURNSTONE SYSTEMS
A DELAWARE CORPORATION
By: /s/ RICHARD N. TINSLEY
-------------------------------------
Name: Richard N. Tinsley
-----------------------------------
Title: CEO
-----------------------------------
"PREFERRED HOLDERS" MATRIX PARTNERS V, L.P.
By: Matrix V Management Company, L.L.C.
Its General Partner
/s/ ANDREW W. VERHALEN
-----------------------------------------
By: Andrew W. Verhalen, Member
MATRIX PARTNERS
ENTREPRENEURS FUND, L.P.
By: Matrix V Management Company, L.L.C.
Its General Partner
/s/ ANDREW W. VERHALEN
-----------------------------------------
By: Andrew W. Verhalen, Member
[SIGNATURE PAGE TO AMENDMENT NO. 2 TO REGISTRATION RIGHTS AGREEMENT]
3
<PAGE> 4
"PREFERRED HOLDERS" (CONT'D) INSTITUTIONAL VENTURE PARTNERS
VII, L.P.,
BY ITS GENERAL PARTNER
INSTITUTIONAL VENTURE MANAGEMENT VII, L.P.
/s/ GEOFFREY Y. YANG
-----------------------------------------
Geoffrey Y. Yang, General Partner
INSTITUTIONAL VENTURE
MANAGEMENT VII, L.P.
/s/ GEOFFREY Y. YANG
-----------------------------------------
Geoffrey Y. Yang, General Partner
IVP FOUNDERS FUND I, L.P.,
BY ITS GENERAL PARTNER
INSTITUTIONAL VENTURE MANAGEMENT VI, L.P.
/s/ GEOFFREY Y. YANG
-----------------------------------------
Geoffrey Y. Yang, General Partner
IVP BROADBAND MANAGEMENT, LLC
BY ITS MANAGING DIRECTOR,
INSTITUTIONAL VENTURE MANAGEMENT VIII, LLC
By: /s/ GEOFFREY Y. YANG
--------------------------------------
Geoffrey Y. Yang, Managing Director
[SIGNATURE PAGE TO AMENDMENT NO. 2 TO REGISTRATION RIGHTS AGREEMENT]
4
<PAGE> 5
"PREFERRED HOLDERS" (CONT'D) BENCHMARK CAPITAL PARTNERS II, L.P.
as nominee for
BENCHMARK CAPITAL PARTNERS, II, L.P.
BENCHMARK FOUNDERS' FUND II, L.P.
BENCHMARK FOUNDERS' FUND II-A, L.P.
BENCHMARK MEMBERS' FUND II, L.P.
By: Benchmark Capital Management
Co. II, L.L.C.
Its General Partner
By:
-------------------------------------
, Managing Member
[SIGNATURE PAGE TO AMENDMENT NO. 2 TO REGISTRATION RIGHTS AGREEMENT]
5
<PAGE> 6
AMENDMENT NO. 1 TO REGISTRATION RIGHTS AGREEMENT
This Amendment No. 1 (the "Amendment") to Registration Rights Agreement
dated as of January 12, 1998 (the "Rights Agreement") is made and entered into
as of January 12, 1999 pursuant to Section 19 of the Rights Agreement by and
among Turnstone Systems, Inc., a Delaware corporation, and the purchasers of the
Company's Series A Preferred Stock pursuant to the Series A Preferred Stock
Purchase Agreement dated January 12, 1998 (the "Series A Purchasers").
Capitalized terms used in this Amendment that are not otherwise defined herein
shall have the respective meanings assigned to them in the Rights Agreement.
RECITALS
WHEREAS, Section 20(b) of the Rights Agreement permits the Company to
grant additional registration rights on a pari passu basis with those granted to
the Series A Purchasers pursuant to the Rights Agreement, and Section 19 of the
Rights Agreement permits amendment thereof by written consent of the Company and
holders of 66-2/3% of the outstanding shares of Registrable Securities;
WHEREAS, certain of the Series A Purchasers and certain other entities
have agreed to purchase shares of the Company's Series B Preferred Stock (the
"Series B Shares") pursuant to the Series B Preferred Stock Purchase Agreement
dated December 23, 1998;
WHEREAS, the Company has agreed to grant the purchasers of the Series B
Shares registration rights on a pari passu basis with those currently held by
the Series A Purchasers.
WHEREAS, the Series A Purchasers and the Company wish to enter this
Amendment to clarify the definition section of the Rights Agreement and to
include as Registrable Securities thereunder future series of Preferred Stock of
the Company (including the Series B Shares) that may be issued pursuant to stock
purchase agreements approved by the Board of Directors.
AGREEMENT
NOW, THEREFORE, the parties hereto hereby agree as follows:
1. For purposes of the Rights Agreement, each reference to "Series A
Preferred" shall hereafter be deemed to refer to the "Preferred."
2. For purposes of the Rights Agreement, "Preferred" shall mean shares
of any series of the Preferred Stock of the Company issued and sold by the
Company pursuant to a stock purchase agreement approved by the Company's Board
of Directors.
3. The definition of "Series A Preferred" in Section 1 of the Rights
Agreement shall be deleted in its entirety.
4. The definition of Purchaser in Section 1 of the Rights Agreements is
hereby amended and restated to read as follows:
<PAGE> 7
"Purchaser" shall mean each person or entity who has acquired
shares of Preferred and who is a signatory to this Agreement or who
holds Registrable Securities and may become a signatory pursuant to
Section 20(b) hereof.
5. This Amendment shall also be deemed to make each of the undersigned
a signatory to the Rights Agreement pursuant to Section 20(b) thereof.
6. Except as expressly set forth in this Amendment, the Rights
Agreement shall continue in full force and effect in accordance with its terms.
7. This Amendment may be executed in one or more counterparts, each of
which shall be deemed an original, but all of which together shall constitute
one and the same instrument. This Amendment shall be governed by and construed
and enforced in accordance with the laws of the State of California, without
reference to the conflict of laws provisions thereof.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
<PAGE> 8
IN WITNESS WHEREOF, the parties hereto have caused this AMENDMENT NO. 1
TO REGISTRATION RIGHTS AGREEMENT to be executed as of the date first above
written.
"COMPANY" TURNSTONE SYSTEMS
A DELAWARE CORPORATION
By: /s/ Richard N. Tinsley
--------------------------------
Name: Richard N. Tinsely
------------------------------
Title: CEO
-----------------------------
"PURCHASERS" INSTITUTIONAL VENTURE PARTNERS
VII, L.P.,
BY ITS GENERAL PARTNER
INSTITUTIONAL VENTURE MANAGEMENT VII, L.P.
/s/ Geoffrey Yang
-----------------------------------
Geoffrey Y. Yang, General Partner
INSTITUTIONAL VENTURE
MANAGEMENT VII, L.P.
/s/ Geoffrey Yang
-----------------------------------
Geoffrey Y. Yang, General Partner
IVP FOUNDERS FUND I, L.P.,
BY ITS GENERAL PARTNER
INSTITUTIONAL VENTURE MANAGEMENT VI, L.P.
/s/ Geoffrey Yang
-----------------------------------
Geoffrey Y. Yang, General Partner
[SIGNATURE PAGE TO AMENDMENT NO. 1 TO REGISTRATION RIGHTS AGREEMENT]
<PAGE> 9
"PURCHASERS" (CONT'D) MATRIX PARTNERS V, L.P.
By: Matrix V Management Company, L.L.C.
Its General Partner
/s/ Andrew Verhalen
-----------------------------------
By: Andrew W. Verhalen, Member
[SIGNATURE PAGE TO AMENDMENT NO. 1 TO REGISTRATION RIGHTS AGREEMENT]
<PAGE> 10
"PURCHASERS" (CONT'D) BENCHMARK CAPITAL PARTNERS II, L.P.
as nominee for
BENCHMARK CAPITAL PARTNERS, II, L.P.
BENCHMARK FOUNDERS' FUND II, L.P.
BENCHMARK FOUNDERS' FUND II-A, L.P.
BENCHMARK MEMBERS' FUND II, L.P.
By: Benchmark Capital Management
Co. II, L.L.C.
Its General Partner
By: /s/ Andrew S. Rachleff
-------------------------------
Managing Member
[SIGNATURE PAGE TO AMENDMENT NO. 1 TO REGISTRATION RIGHTS AGREEMENT]
<PAGE> 11
"PURCHASERS" (CONT'D) WS INVESTMENT COMPANY 97B
By: /s/ Thomas C. DeFilipps
----------------------------------
Thomas C. DeFilipps, General Partner
/s/ Thomas C. DeFilipps
-------------------------------------
Thomas C. DeFilipps
COMDISCO, INC.
By: /s/ James P. Labe
---------------------------------
Name: James P. Labe
-------------------------------
Title: President, Comdisco Ventures Division
-------------------------------------
IVP BROADBAND FUND, L.P.,
BY ITS GENERAL PARTNER
IVP BROADBAND MANAGEMENT, LLC
BY ITS MANAGING DIRECTOR,
INSTITUTIONAL VENTURE MANAGEMENT VIII, LLC
By: /s/ Geoffrey Yang
---------------------------------
Geoffrey Y. Yang, Managing Director
[SIGNATURE PAGE TO AMENDMENT NO. 1 TO REGISTRATION RIGHTS AGREEMENT]
<PAGE> 12
"PURCHASERS" (CONT'D) STANFORD UNIVERSITY
By: /s/ H. A. Turner
---------------------------------
Name: Harry A. Turner
-------------------------------
Title: Managing Director,
Stanford Management Company
------------------------------
[SIGNATURE PAGE TO AMENDMENT NO. 1 TO REGISTRATION RIGHTS AGREEMENT]
<PAGE> 13
IN WITNESS WHEREOF, the parties hereto have caused this Addendum
Signature Page to Registration Rights Agreement to be executed as of the date
first above written.
"COMPANY" TURNSTONE SYSTEMS, INC.
A DELAWARE CORPORATION
By: /s/ Richard N. Tinsley
--------------------------------
Name: Richard N. Tinsley
------------------------------
Title: CEO
-----------------------------
"ADDITIONAL PURCHASER" CHARLES ROSS PARTNERS INVESTMENT
FUND NUMBER 7
By: /s/ Gregory E. Lawler
--------------------------------
Name: Gregory E. Lawler
------------------------------
Title: General Partner
-----------------------------
[SIGNATURE PAGE TO ADDENDUM TO REGISTRATION RIGHTS AGREEMENT]
<PAGE> 14
TURNSTONE SYSTEMS, INC.
REGISTRATION RIGHTS AGREEMENT
This Registration Rights Agreement (the "Agreement") is made as of
January 12, 1998 by and among Turnstone Systems, Inc., a Delaware corporation
(the "Company"), and each of the persons and entities who have purchased shares
of the Company's Series A Preferred Stock (individually, a "Purchaser," and
collectively, the "Purchasers") pursuant to the Series A Preferred Stock
Purchase Agreement of even date herewith between the Company and the Purchasers
(the "Purchase Agreement").
NOW, THEREFORE, the parties hereto agree as follows:
AGREEMENT
1. Certain Definitions. As used in this Agreement, the following terms
shall have the following respective meanings:
"Commission" shall mean the Securities and Exchange Commission or any
successor agency.
"Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended, or any successor law thereto.
"Holder" shall mean each Purchaser, and any transferee of Registrable
Securities who pursuant to Section 15 below is entitled to registration rights
hereunder.
"Purchaser" shall mean each person or entity who has acquired shares of
Series A Preferred Company and who is a signatory to this Agreement or who holds
Registrable Securities and may become a signatory pursuant to Section 20(b)
hereof.
"Registrable Securities" shall mean (i) shares of the Company's Common
Stock issued or issuable upon the conversion of the Series A Preferred; (ii) any
Common Stock of the Company issued or issuable in respect of shares of the
Series A Preferred; (iii) shares of the Company's Common Stock issued or
issuable upon any conversion of the Series A Preferred upon any stock split,
stock dividend, recapitalization, or similar event; and (iv) any shares of the
Company's Common Stock issued or issuable upon conversion or exercise of any
convertible security for which subsequent registration rights are granted in
accordance with Section 20(b); provided, however, that Registrable Securities
shall not include shares of Common Stock that have been sold to or though a
broker or dealer or underwriter in a public distribution or public securities
transaction, sold in a transaction exempt from the registration and prospectus
delivery requirements of the Securities Act under Section 4(1) thereof so that
all transfer restrictions and restrictive legends with respect thereto, if any,
are removed upon the consummation of such sale, or Registrable Securities sold
by a person in a transaction in which rights under this Agreement are not
assigned.
<PAGE> 15
The terms "register," "registered" and "registration" refer to a
registration effected by preparing and filing a registration statement in
compliance with the Securities Act, and the declaration or ordering of the
effectiveness of such registration statement.
"Registration Expenses" shall mean all expenses incurred by the Company
in complying with Sections 5, 6, and 7 hereof, including, without limitation,
all registration, qualification and filing fees, printing expenses, escrow fees,
fees and disbursements of counsel for the Company, fees and disbursements of one
special counsel to the Holders, blue sky fees and expenses, and the expense of
any special audits incident to or required by any such registration but
excluding all Selling Expenses.
"Restricted Securities" shall mean the securities of the Company
required to bear the legend set forth in Section 3 hereof (or any similar
legend).
"Securities Act" shall mean the Securities Act of 1933, as amended, or
any successor law thereto.
"Selling Expenses" shall mean all underwriting discounts, selling
commissions, and stock transfer taxes applicable to the securities registered by
the Holders and any fees of counsel to any Holder.
"Series A Preferred" shall mean shares of the Company's Series A
Preferred Stock issued and sold by the Company pursuant to the Purchase
Agreement.
2. Restrictions on Transferability. The Restricted Securities shall not be
transferable except upon the conditions specified in this Agreement, which
conditions are intended to ensure compliance with the provisions of the
Securities Act. Until the Company's initial public offering pursuant to a
registration statement filed with and declared effective by the Commission under
the Securities Act, the Restricted Securities shall not, without the prior
written consent of the Company, be transferred to any entity (or any affiliate
thereof) which is engaged in the development, marketing or sale of products that
are, in the Company's judgment, the same or similar to those of the Company, and
any such attempted transfer shall be void ab initio. Each holder of Restricted
Securities will cause any proposed transferee of the Restricted Securities held
by such holder to agree to take and hold such Restricted Securities subject to
the provisions and upon the conditions specified in this Agreement.
3. Restrictive Legend. Each certificate representing (i) the Series A
Preferred, (ii) shares of the Company's Common Stock issued upon conversion of
the Series A Preferred, and (iii) any other securities issued in respect of the
Series A Preferred (or Common Stock issued upon conversion of the Series A
Preferred) upon any stock split, stock dividend, recapitalization, merger,
consolidation or similar event, shall (unless otherwise permitted by the
provisions of Section 4 below) be stamped or otherwise imprinted with a legend
in substantially the following form (in addition to any legend required under
applicable state securities laws):
-2-
<PAGE> 16
THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR
INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF
1933, AS AMENDED (THE "SECURITIES ACT"). THESE SECURITIES MAY NOT BE
OFFERED, SOLD, PLEDGED OR TRANSFERRED UNLESS (I) A REGISTRATION
STATEMENT UNDER THE SECURITIES ACT IS EFFECTIVE COVERING SUCH TRANSFER
OR (II) THERE IS AN OPINION OF COUNSEL, SATISFACTORY TO THE COMPANY,
THAT AN EXEMPTION THEREFROM IS AVAILABLE. COPIES OF THE AGREEMENT
COVERING THE PURCHASE OF THESE SECURITIES AND RESTRICTING THEIR
TRANSFER MAY BE OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE
HOLDER OF RECORD OF THIS CERTIFICATE TO THE SECRETARY OF THE COMPANY AT
ITS PRINCIPAL EXECUTIVE OFFICES.
Each Purchaser and Holder consents to the Company's making a notation
on its records and giving instructions to any transfer agent of the Series A
Preferred or the Common Stock in order to implement the restrictions on transfer
established in this Section.
4. Notice of Proposed Transfers. The holder of each certificate
representing Restricted Securities by acceptance thereof agrees to comply in all
respects with the provisions of this Section. Prior to any proposed transfer of
any Restricted Securities, unless there is in effect a registration statement
under the Securities Act covering the proposed transfer, the holder thereof
shall give written notice to the Company of such Holder's intention to effect
such transfer. Each such notice shall describe the manner and circumstances of
the proposed transfer in sufficient detail, and shall be accompanied by either
(i) a written opinion of legal counsel, who shall be reasonably satisfactory to
the Company, addressed to the Company and reasonably satisfactory in form and
substance to the Company's counsel, to the effect that the proposed transfer of
the Restricted Securities may be effected without registration under the
Securities Act or (ii) a "No Action" letter from the Commission to the effect
that the transfer of such securities without registration will not result in a
recommendation by the staff of the Commission that action be taken with respect
thereto, whereupon the holder of such Restricted Securities shall be entitled to
transfer such Restricted Securities in accordance with the terms of the notice
delivered by the holder to the Company. Each certificate evidencing the
Restricted Securities transferred as above provided shall bear the appropriate
restrictive legends described above, except that such certificate shall not bear
any such restrictive legend if in the opinion of counsel for the Company such
legend is not required.
5. Requested Registration. (a) Request for Registration. If at any time
after the expiration of six months following the Company's initial registered
public offering, the Company shall receive from any Holder or group of Holders
of Registrable Securities, representing not less than 66-2/3% of the Registrable
Securities then outstanding (assuming conversion of all shares of the Series A
Preferred), a written request that the Company effect any registration,
qualification or compliance with respect
-3-
<PAGE> 17
to Registrable Securities representing at least 33-1/3% of the Registrable
Securities then outstanding, the Company will:
(x) promptly give written notice of the proposed registration,
qualification, or compliance to all other Holders; and
(y) as soon as practicable, use its best efforts to effect within
120 days of the receipt of such request such registration, qualification or
compliance (including, without limitation, the execution of an undertaking to
file post-effective amendments, appropriate qualification under applicable blue
sky or other state securities laws and appropriate compliance with applicable
regulations issued under the Securities Act and any other governmental
requirements or regulations) as may be so requested and as would permit or
facilitate the sale and distribution of all or such portion of such Registrable
Securities as are specified in such request, together with all or such portion
of the Registrable Securities of any Holder or Holders joining in such request
as are specified in a written request received by the Company within 15 days
after receipt of such written notice from the Company;
provided, however, that the Company shall not be obligated to take any action to
effect any such registration, qualification or compliance pursuant to this
Section:
(A) in any particular jurisdiction in which the Company
would be required to execute a general consent to service of process in
effecting such registration, qualification or compliance unless the Company is
already subject to service in such jurisdiction and except as may be required by
the Securities Act;
(B) prior to 90 days immediately following the effective
date of any registration statement pertaining to securities of the Company
(other than a registration of securities in a Rule 145 transaction or with
respect to an employee benefit plan); or
(C) after the Company has effected two such registrations
pursuant to this Section and such registration has been declared or ordered
effective.
Subject to the foregoing clauses, the Company shall file a registration
statement covering the Registrable Securities so requested to be registered as
soon as practicable after receipt of the request or requests of any Holder or
Holders. If, however, the Company shall furnish to the Holder or Holders
requesting a registration statement pursuant to this Section a certificate
signed by the President of the Company stating that, in the good faith judgment
of the Board of Directors of the Company, it would be seriously detrimental to
the Company and its stockholders for such registration statement to be filed and
it is therefore essential to defer the filing of such registration statement,
the Company shall have the right to defer such filing for a period of not more
than 120 days after receipt of the request of the Holder or Holders requesting
such registration; provided, however, that the Company may not utilize this
right more than once in any 12-month period.
(b) Underwriting. If the Holders intend to distribute the Registrable
Securities covered by their request by means of an underwriting, they shall so
advise the Company as a part of
-4-
<PAGE> 18
their request and the Company shall include such information in its written
notice to the other Holders. The right of any Holder to registration pursuant to
this Section shall be conditioned upon such Holder's participation in such
underwriting and the inclusion of such Holder's Registrable Securities in the
underwriting to the extent provided herein.
The Company shall (together with all Holders proposing to distribute their
securities through such underwriting) enter into an underwriting agreement in
customary form with the managing underwriter selected for such underwriting by
the Holders of a majority of the Registrable Securities proposed by such Holders
to be distributed through such underwriting. Notwithstanding any other provision
of this Section, if the managing underwriter advises the Holders in writing that
marketing factors require a limitation of the number of shares to be
underwritten, then, subject to the provisions of Section 5(a), the Company shall
so advise all Holders and the number of shares of Registrable Securities that
may be included in the registration and underwriting shall be allocated among
all Holders requesting inclusion in the registration in proportion, as nearly as
practicable, to the respective amounts of Registrable Securities originally
requested by such Holders to be included in the registration statement. No
Registrable Securities excluded from the underwriting by reason of the managing
underwriter's marketing limitation shall be included in such registration.
If the managing underwriter has not limited the number of Registrable
Securities to be underwritten, the Company may include securities for its own
account or for the account of others in such registration if the underwriter so
agrees and if the number of Registrable Securities which would otherwise have
been included in such registration and underwriting will not thereby be limited,
and provided that the Company or the other selling stockholders shall bear an
equitable share of the Registration Expenses in connection with such
registration and underwriting.
If any Holder of Registrable Securities disapproves of the terms of the
underwriting, such person may elect to withdraw therefrom by written notice to
the Company, the managing underwriter and the other Holders. The Registrable
Securities and/or other securities so withdrawn shall also be withdrawn from
registration; provided, however, that if, by the withdrawal of such Registrable
Securities, a greater number of Registrable Securities held by other Holders may
be included in such registration (up to the maximum of any limitation imposed by
the underwriters), then the Company shall offer to all Holders who have included
Registrable Securities in the registration the right to include additional
Registrable Securities in the same proportion used in determining the
underwriter limitation in this Section. If the registration does not become
effective due to the withdrawal of Registrable Securities, then either (1) the
Holders requesting registration shall reimburse the Company for expenses
incurred in complying with the request or (2) the aborted registration shall be
treated as effected for purposes of Section 5(a)(C).
6. Company Registration.
(a) Notice of Registration. If the Company shall determine to register
any of its securities, either for its own account or the account of a security
holder or holders exercising their respective demand registration rights, other
than: (i) a registration relating solely to employee benefit
-5-
<PAGE> 19
plans or (ii) a registration relating solely to a transaction pursuant to Rule
145 promulgated under the Securities Act, the Company will:
(x) promptly give to each Holder written notice thereof; and
(y) include in such registration (and any related qualification
under blue sky laws or other compliance), and in any underwriting involved
therein, all the Registrable Securities specified in a written request or
requests, made within 30 days after receipt of such written notice from the
Company, by any Holder or Holders.
(b) Cut-back and Allocation. Notwithstanding any other provision of
this Section, if the managing underwriter determines that marketing factors
require a limitation of the number of shares to be underwritten, the managing
underwriter may limit the number of Registrable Securities to be included in the
registration and underwriting, provided that except in the case of the Company's
initial public offering, the managing underwriter shall include in such offering
at least 25% of the Registrable Securities requested to be included in such
offering. In such event, the Company shall so advise all Holders of Registrable
Securities which would otherwise be registered and underwritten pursuant hereto,
and the number of shares of Registrable Securities that may be included in the
registration and underwriting shall be allocated among the Holders in
proportion, as nearly as practicable, to the respective amounts of Registrable
Securities held by such Holders. If any Holder disapproves of the terms of any
such underwriting, such Holder may elect to withdraw therefrom by written notice
to the Company and the managing underwriter. Any Registrable Securities excluded
or withdrawn from such underwriting shall be withdrawn from such registration.
(c) Right to Terminate Registration. The Company shall have the right
to terminate or withdraw any registration initiated by it under this Section
prior to the effectiveness of such registration whether or not any Holder has
elected to include securities in such registration.
7. Registration on Form S-3. The Company shall use its best efforts to
qualify for registration on Form S-3, and to that end, the Company shall comply
with the reporting requirements of the Exchange Act. After the Company has
qualified for the use of Form S-3, each Holder shall have the right to request
an unlimited number of registrations on Form S-3 (such requests shall be in
writing and shall state the number of shares of Registrable Securities to be
disposed of and the intended method of disposition of such shares by each such
Holder), subject to the following limitations:
(i) the Company shall not be obligated to cause a registration on
Form S-3 to become effective prior to 90 days following the effective date of a
Company-initiated registration (other than a registration effected solely to
qualify an employee benefit plan or to effect a business combination pursuant to
Rule 145);
(ii) the Company shall not be obligated to cause a registration
on Form S-3 to become effective prior to expiration of 90 days following the
effective date of the most recent registration pursuant to a request under
Section 5 of this Agreement or pursuant to a request by a
-6-
<PAGE> 20
holder of registration rights under any other agreement of the Company granting
Form S-3 demand registration rights;
(iii) the Company shall not be required to
effect a registration on Form S-3 unless the Holder or Holders requesting
registration propose to dispose of shares of Registrable Securities having an
aggregate disposition price (before deduction of underwriting discounts and
expenses of sale) of at least $1,000,000; and
(iv) the Company shall not be required to maintain and keep any
such registration on Form S-3 effective for a period greater than the period
equal to the shorter of (x) 90 days or (y) that time reasonably necessary to
permit the disposition of the Registrable Securities subject to such
registration. The Company shall give notice to all Holders of the receipt of a
request for registration pursuant to this Section and shall provide a reasonable
opportunity for all such other Holders, to participate in the registration.
Subject to the foregoing, the Company will use its best efforts to effect
promptly the registration of all shares of Registrable Securities on Form S-3 to
the extent requested by the Holder or Holders thereof for purposes of
disposition.
8. Expenses of Registration. All Registration Expenses incurred in
connection with any registration, qualification or compliance pursuant to
Section 5, Section 6, or Section 7 shall be borne by the Company. All Selling
Expenses relating to securities registered by the Holders pursuant to either
Section 5, Section 6, or Section 7 shall be borne by the Holders of such
securities pro rata on the basis of the number of shares so registered.
Notwithstanding the foregoing, the Company shall not be required to pay for
Registration Expenses pursuant to Section 5 if the registration request is
subsequently withdrawn at the request of the Holders of a majority of the
Registrable Securities to be registered (which Holders shall bear such
expenses), unless the Holders of a majority of the Registrable Securities agree
to forfeit their right to demand registration pursuant to Section 5; provided,
however, that if at the time of such withdrawal, the Holders have learned of a
material adverse change in the condition, business or prospects of the Company
from that known to the Holders at the time of their request, then the Holders
shall not be required to pay any of such Registration Expenses and shall retain
their rights pursuant to Section 5.
9. Registration Procedures. In the case of each registration,
qualification or compliance effected by the Company pursuant to this Agreement,
the Company will keep each Holder advised in writing as to the initiation of
each registration, qualification and compliance and as to the completion
thereof. At its expense the Company will furnish such number of prospectuses and
other documents incident thereto as a Holder from time to time may reasonably
request.
10. Termination of Registration Rights. The registration rights granted
pursuant to this Agreement shall terminate (i) as to any Holder of less than
500,000 shares of Registrable Securities, at such time after the Company's
initial public offering as the Registrable Securities held by such Holder may be
sold within any three month period pursuant to Rule 144 and (ii) as to any
Holder of 500,000 or more shares of Registrable Securities (as adjusted for
stock splits, stock dividends or distributions, recapitalizations, and similar
events), on the earlier to occur of (A) the date such Registrable Securities
held by such Holder may be sold pursuant to Rule 144(k) and (B) the third
-7-
<PAGE> 21
anniversary of the date on which the Company first becomes subject to the
reporting requirements under Section 12 of the Exchange Act.
11. Lock-up Agreement. In consideration for the Company agreeing to its
obligations under this Agreement, each Holder of Registrable Securities and each
transferee pursuant to Section 15 hereof agrees, in connection with the first
registration of the Company's securities, upon request of the Company or the
underwriters managing any underwritten offering of the Company's securities, not
to sell, make any short sale of, loan, grant any option for the purchase of or
otherwise dispose of any securities of the Company (other than those included in
the registration) without the prior written consent of the Company or such
underwriters, as the case may be, for such period of time (not to exceed 180
days) from the effective date of such registration as the Company or the
underwriters may specify, provided that each officer and director of the Company
is similarly bound. Each Holder agrees that the Company may instruct its
transfer agent to place stop-transfer notations in its records to enforce the
provisions of this Section. This Section 11 shall supersede any conflicting
provision of Section 5 or Section 7 above. Notwithstanding any other provision
of this Agreement, the Company may assign each Holder's obligations under this
Section 11 to any underwriter of the Company's initial public offering of
securities.
12. Indemnification.
(a) The Company will indemnify each Holder, each of its officers,
directors and partners and such Holder's legal counsel and independent
accountants, and each person controlling such Holder within the meaning of
Section 15 of the Securities Act, with respect to which registration,
qualification or compliance has been effected pursuant to this Agreement, and
each underwriter, if any, and each person who controls any underwriter within
the meaning of Section 15 of the Securities Act, against all expenses, claims,
losses, damages and liabilities (or actions in respect thereof), including any
of the foregoing incurred in settlement of any litigation, commenced or
threatened, arising out of or based on any untrue statement (or alleged untrue
statement) of a material fact contained in any registration statement,
prospectus, offering circular or other document, or any amendment or supplement
thereto, incident to any such registration, qualification or compliance, or
based on any omission (or alleged omission) to state therein a material fact
required to be stated therein or necessary to make the statements therein, in
light of the circumstances in which they were made, not misleading, or any
violation by the Company of the Securities Act or the Exchange Act or securities
act of any state or any rule or regulation thereunder, and relating to action or
inaction required of the Company in connection with any such registration,
qualification or compliance, and will reimburse each such Holder, each of its
officers, directors and partners and such Holder's legal counsel and independent
accountants, and each person controlling such Holder, each such underwriter and
each person who controls any such underwriter, for any legal and any other
expenses reasonably incurred in connection with investigating, preparing or
defending any such claim, loss, damage, liability or action, provided that the
Company will not be liable in any such case to the extent that any such claim,
loss, damage, liability or expense arises out of or is based on any untrue
statement or omission or alleged untrue statement or omission, made in reliance
upon and in conformity with written information furnished to the Company by an
instrument duly executed by such Holder or underwriter and stated to be
specifically for use therein; and provided,
-8-
<PAGE> 22
further, that the Company will not be liable to any such person or entity with
respect to any such untrue statement or omission or alleged untrue statement or
omission made in any preliminary prospectus that is corrected in the final
prospectus filed with the Commission pursuant to Rule 424(b) promulgated under
the Securities Act (or any amendment or supplement to such prospectus) if the
person asserting any such loss, claim, damage or liability purchased securities
but was not sent or given a copy of the prospectus (as amended or supplemented)
at or prior to the written confirmation of the sale of such securities to such
person in any case where such delivery of the prospectus (as amended or
supplemented) is required by the Securities Act, unless such failure to deliver
the prospectus (as amended or supplemented) was a result of the Company's
failure to provide such prospectus (as amended or supplemented).
(b) Each Holder will, severally and not jointly, if Registrable
Securities held by such Holder are included in the securities as to which such
registration, qualification or compliance is being effected, indemnify the
Company, each of its directors and officers and its legal counsel and
independent accountants, each underwriter, if any, of the Company's securities
covered by such a registration statement, each person who controls the Company
or such underwriter within the meaning of Section 15 of the Securities Act, and
each other such Holder, each of its officers, directors and partners and each
person controlling such Holder within the meaning of Section 15 of the
Securities Act, against all claims, losses, damages and liabilities (or actions
in respect thereof) arising out of or based on any untrue statement (or alleged
untrue statement) of a material fact contained in any such registration
statement, prospectus, offering circular or other document, or any omission (or
alleged omission) to state therein a material fact required to be stated therein
or necessary to make the statements therein not misleading, and will reimburse
the Company, such Holders, such directors, officers, legal counsel, independent
accountants, underwriters or control persons for any legal or any other expenses
reasonably incurred in connection with investigating or defending any such
claim, loss, damage, liability or action, in each case to the extent, but only
to the extent, that such untrue statement (or alleged untrue statement) or
omission (or alleged omission) is made in such registration statement,
prospectus, offering circular or other document in reliance upon and in
conformity with written information furnished to the Company by an instrument
duly executed by such Holder and stated to be specifically for use therein;
provided, however, that the obligations of such Holders hereunder shall be
limited to an amount equal to the proceeds, net of underwriting discounts and
commissions but not expenses, to each such Holder of Registrable Securities sold
as contemplated herein.
(c) Each party entitled to indemnification under this Section (the
"Indemnified Party") shall give notice to the party required to provide
indemnification (the "Indemnifying Party") promptly after such Indemnified Party
has actual knowledge of any claim as to which indemnity may be sought, and shall
permit the Indemnifying Party to assume the defense of any such claim or any
litigation resulting therefrom, provided that counsel for the Indemnifying
Party, who shall conduct the defense of such claim or litigation, shall be
approved by the Indemnified Party (whose approval shall not be unreasonably
withheld), and the Indemnified Party may participate in such defense at such
party's expense, and provided further that the failure of any Indemnified Party
to give notice as provided herein shall not relieve the Indemnifying Party of
its obligations under this Agreement, except to the extent, but only to the
extent, that the Indemnifying Party's ability to defend against
-9-
<PAGE> 23
such claim or litigation is impaired as a result of such failure to give notice.
No Indemnifying Party, in the defense of any such claim or litigation, shall,
except with the consent of each Indemnified Party, consent to entry of any
judgment or enter into any settlement which does not include as an unconditional
term thereof the giving by the claimant or plaintiff to such Indemnified Party
of a release from all liability in respect to such claim or litigation.
(d) If the indemnification provided for in this Section 12 is held by
a court of competent jurisdiction to be unavailable to an indemnified party with
respect to any loss, liability, claim, damage, or expense referred to therein,
then the indemnifying party, in lieu of indemnifying such indemnified party
hereunder, shall contribute to the amount paid or payable by such indemnified
party as a result of such loss, liability, claim, damage, or expense in such
proportion as is appropriate to reflect the relative fault of the indemnifying
party on the one hand and of the indemnified party on the other in connection
with the statements or omissions that resulted in such loss, liability, claim,
damage, or expense as well as any other relevant equitable considerations. The
relative fault of the indemnifying party and of the indemnified party shall be
determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission to state a material fact
relates to information supplied by the indemnifying party or by the indemnified
party and the parties' relative intent, knowledge, access to information, and
opportunity to correct or prevent such statement or omission. In no event shall
any contribution by a Holder under this Section 12(d) exceed the proceeds, net
of underwriting discounts and commissions but not expenses, from the offering
received by such Holder.
13. Information by Holder. The Holder or Holders of Registrable Securities
included in any registration shall furnish to the Company such information
regarding such Holder or Holders and the distribution proposed by such Holder or
Holders as the Company may request in writing and as shall be required in
connection with any registration, qualification or compliance referred to in
this Agreement.
14. Rule 144 Reporting. With a view to making available the benefits of
certain rules and regulations of the Commission which may at any time permit the
sale of the Restricted Securities to the public without registration, after such
time as a public market exists for the Common Stock of the Company, the Company
agrees to use its best efforts to:
(a) make and keep public information available, as those terms are
understood and defined in Rule 144 promulgated under the Securities Act, at all
times after the effective date of the first registration under the Securities
Act filed by the Company for an offering of its securities to the general
public;
(b) file with the Commission in a timely manner all reports and other
documents required of the Company under the Securities Act and the Exchange Act
(at any time after it has become subject to such reporting requirements); and
(c) furnish to Holders upon request a written statement as to its
compliance with the reporting requirements of Rule 144 (at any time after 90
days after the effective date of the first registration statement filed by the
Company for an offering of its securities to the general public),
-10-
<PAGE> 24
and of the Securities Act and the Exchange Act (at any time after it has become
subject to such reporting requirements), a copy of the most recent annual or
quarterly report of the Company, and such other reports and documents of the
Company as a Holder may reasonably request in availing itself of any rule or
regulation of the Commission allowing such Holder to sell any such securities
without registration.
15. Transfer of Rights. Provided that the Company is given prior written
notice of such assignment, the rights granted hereunder to cause the Company to
register securities may be assigned to (i) a transferee or assignee who acquires
at least 500,000 shares of Registrable Securities (appropriately adjusted for
stock splits, recapitalizations and like after the date hereof) and (ii) any
affiliate or constituent partner, including limited partner, of a Purchaser.
16. Governing Law. This Agreement shall be governed by and interpreted in
accordance with the laws of the State of California as applied to agreements
among California residents entered and to be performed entirely within
California. The parties hereto agree to submit to the jurisdiction of the
federal and state courts of the State of California with respect to the breach
or interpretation of this Agreement or the enforcement of any and all rights,
duties, liabilities, obligations, powers and other relations between the parties
arising under this Agreement.
17. Entire Agreement. This Agreement constitutes the full and entire
understanding among the parties regarding the subject matter herein. Except as
otherwise expressly provided herein, the provisions hereof shall inure to the
benefit of, and be binding upon, the successors, assigns, heirs, executors and
administrators of the parties hereto.
18. Notices, etc. All notices and other communications required or
permitted hereunder shall be in writing and shall be deemed effectively given
upon delivery to the party to be notified in person or by courier service or
five (5) days after deposit with the United States mail, by registered or
certified mail, postage prepaid, addressed (a) if to a holder of any Registrable
Securities, to such address as such holder shall have furnished the Company in
writing, or, until any such holder so furnishes an address to the Company, then
to and at the address of the last holder of such securities who has so furnished
an address to the Company, or (b) if to the Company, to its address set forth on
the first page of this Agreement and addressed to the attention of the Chief
Financial Officer, or at such other address as the Company shall have furnished
to the Holders in writing.
19. Amendment. Any provision of this Agreement may be amended, waived or
modified upon the written consent of (i) the Company and (ii) holders of 66-2/3%
of the outstanding shares of Registrable Securities. Any Holder may waive any of
his or her rights or the Company's obligations hereunder without obtaining the
consent of any other person.
20. Limitations on Subsequent Registration Rights.
(a) From and after the date of this Agreement, the Company shall not
enter into any agreement granting any holder or prospective holder of any
securities of the Company registration rights with respect to such securities
without the prior written consent of 66-2/3% of the Registrable Securities then
outstanding unless (1) such new registration rights, including standoff
-11-
<PAGE> 25
obligations, are on a pari passu basis with those rights of the Holders
hereunder or (2) such new registration rights, including standoff obligations,
are subordinate to the registration rights granted the Holders hereunder.
(b) Where the Company determines to grant any holder or prospective
holder of any securities of the Company registration rights that are on a pari
passu basis with those rights of the Holders hereunder and determines that the
grant of such rights shall be made pursuant to this Agreement, then such grant
shall be evidenced by the execution of an additional signature page to this
Agreement by the Company and such holder, without any requirement on the part of
the Company to seek the consent or approval of the Holders.
21. Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be an original and all of which together shall
constitute one instrument.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
-12-
<PAGE> 26
[REGISTRATION RIGHTS AGREEMENT]
IN WITNESS WHEREOF, the undersigned have executed this Registration
Rights Agreement as of the date set forth above.
"COMPANY" TURNSTONE SYSTEMS, INC.,
A DELAWARE CORPORATION
By: /s/ Richard N. Tinsley
-------------------------------------
Name: Richard N. Tinsley
-----------------------------------
Title: CEO
----------------------------------
"PURCHASERS" INSTITUTIONAL VENTURE PARTNERS VII, L.P.,
BY ITS GENERAL PARTNER
INSTITUTIONAL VENTURE MANAGEMENT VII, L.P.
/s/ Geoffrey Yang
----------------------------------------
Geoffrey Y. Yang, General Partner
INSTITUTIONAL VENTURE MANAGEMENT VII, L.P.
/s/ Geoffrey Yang
----------------------------------------
Geoffrey Y. Yang, General Partner
IVP FOUNDERS FUND I, L.P.,
BY ITS GENERAL PARTNER
INSTITUTIONAL VENTURE MANAGEMENT VI, L.P.
/s/ Geoffrey Yang
----------------------------------------
Geoffrey Y. Yang, General Partner
-13-
<PAGE> 27
[REGISTRATION RIGHTS AGREEMENT]
"PURCHASERS" (cont'd) MATRIX PARTNERS V, L.P.
By: Matrix V Management Company, L.L.C.
Its General Partner
/s/ A. Verhalen
-------------------------------------------
By: Andrew W. Verhalen, Member
BENCHMARK CAPITAL PARTNERS II, L.P.
By: BENCHMARK CAPITAL MANAGEMENT CO. II, L.L.C.
Its General Partner
By: /s/ Andrew S. Rachleff
-------------------------------------------
Member
BENCHMARK FOUNDERS' FUND II, L.P.
By: BENCHMARK CAPITAL MANAGEMENT CO. II, L.L.C.
Its General Partner
By: /s/ Andrew S. Rachleff
-------------------------------------------
Member
BENCHMARK FOUNDERS' FUND II-A, L.P.
By: BENCHMARK CAPITAL MANAGEMENT CO. II, L.L.C.
Its General Partner
By: /s/ Andrew S. Rachleff
-------------------------------------------
Member
-14-
<PAGE> 28
[REGISTRATION RIGHTS AGREEMENT]
"PURCHASERS" (cont'd) BENCHMARK MEMBERS' FUND II, L.P.
By: BENCHMARK CAPITAL MANAGEMENT CO. II, L.L.C.
Its General Partner
By: /s/ Andrew S. Rachleff
-------------------------------------------
Member
WS INVESTMENT COMPANY 97B
By: /s/ Thomas C. DeFilipps
-------------------------------------------
Thomas C. DeFilipps, Esq., Member
/s/ Thomas C. DeFilipps
------------------------------------------------
Thomas C. DeFilipps, Esq. (individually)
-15-
<PAGE> 29
[REGISTRATION RIGHTS AGREEMENT SECOND CLOSING FEBRUARY 27, 1998]
IN WITNESS WHEREOF, the undersigned have executed this Registration
Rights Agreement as of the date set forth above.
"COMPANY" TURNSTONE SYSTEMS, INC.,
a Delaware corporation
By: /s/ Richard N. Tinsley
--------------------------------------------------
Name: Richard N. Tinsley
--------------------------------------------------
Title: CEO
--------------------------------------------------
"PURCHASERS" STANFORD UNIVERSITY
By: /s/ Carol Gilmer
--------------------------------------------------
Name: Carol Gilmer
--------------------------------------------------
Title: Assistant Secretary, Board of Trustees of the
Leland Stanford Junior University
----------------------------------------------
/s/ Tim Latchem
-----------------------------------------------------
Timothy Latchem
/s/ Patricia A. Crowe
-----------------------------------------------------
Patricia Crowe
-16-
<PAGE> 1
Exhibit 5.1
WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
650 Page Mill Road
Palo Alto, California 94304-1050
Telephone (650) 493-9300 Facsimile (650) 493-6811
January 10, 2000
Turnstone Systems, Inc.
274 Ferguson Drive
Mountain View, CA 94043
RE: REGISTRATION STATEMENT ON FORM S-1
Ladies and Gentlemen:
We have examined the Registration Statement on Form S-1 filed by you with
the Securities and Exchange Commission on November 22, 1999, as amended by
Amendments No. 1 and No. 2 (the "Registration Statement") in connection with the
registration under the Securities Act of 1933, as amended, of 3,450,000 shares
of Common Stock of Turnstone Systems, Inc. (the "Shares"). As your counsel in
connection with this transaction, we have examined the proceedings proposed to
be taken in connection with said sale and issuance of the Shares.
It is our opinion that, upon completion of the proceedings being taken or
contemplated by us, as your counsel, to be taken prior to the issuance of the
Shares, and upon completion of the proceedings being taken in order to permit
such transactions to be carried out in accordance with the securities laws of
various states, where required, the Shares when issued and sold in the manner
referred to in the Registration Statement will be legally and validly issued,
fully paid and nonassessable.
We consent to the use of this opinion as an exhibit to the Registration
Statement, and further consent to the use of our name wherever appearing in the
Registration Statement, including the prospectus constituting a part thereof,
and any amendment thereto.
Very truly yours,
/s/ WILSON SONSINI GOODRICH & ROSATI
WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
<PAGE> 1
EXHIBIT 10.3
TURNSTONE SYSTEMS, INC.
2000 STOCK PLAN
1. Purposes of the Plan. The purposes of this 2000 Stock Plan are:
- to attract and retain the best available personnel for
positions of substantial responsibility,
- to provide additional incentive to Employees, Directors and
Consultants, and
- to promote the success of the Company's business.
Options granted under the Plan may be Incentive Stock Options or
Nonstatutory Stock Options, as determined by the Administrator at the time of
grant. Stock Purchase Rights may also be granted under the Plan.
2. Definitions. As used herein, the following definitions shall apply:
(a) "Administrator" means the Board or any of its Committees as
shall be administering the Plan, in accordance with Section 4 of the Plan.
(b) "Applicable Laws" means the requirements relating to the
administration of stock option plans under U. S. state corporate laws, U.S.
federal and state securities laws, the Code, any stock exchange or quotation
system on which the Common Stock is listed or quoted and the applicable laws of
any foreign country or jurisdiction where Options or Stock Purchase Rights are,
or will be, granted under the Plan.
(c) "Board" means the Board of Directors of the Company.
(d) "Cause" means (i) any act of personal dishonesty taken by the
Optionee in connection with his responsibilities as an Employee which is
intended to result in personal enrichment of the Optionee, (ii) the Optionee's
conviction of a felony, (iii) any act by the Optionee that constitutes
misconduct, and (iv) continued violations by the Optionee of the Optionee's
obligations to the Company.
(e) "Code" means the Internal Revenue Code of 1986, as amended.
(f) "Committee" means a committee of Directors appointed by the
Board in accordance with Section 4 of the Plan.
(g) "Common Stock" means the common stock of the Company.
(h) "Company" means Turnstone Systems, Inc., a Delaware corporation.
<PAGE> 2
(i) "Consultant" means any person, including an advisor, engaged by
the Company or a Parent or Subsidiary to render services to such entity.
(j) "Director" means a member of the Board.
(k) "Disability" means total and permanent disability as defined in
Section 22(e)(3) of the Code.
(l) "Employee" means any person, including Officers and Directors,
employed by the Company or any Parent or Subsidiary of the Company. A Service
Provider shall not cease to be an Employee in the case of (i) any leave of
absence approved by the Company or (ii) transfers between locations of the
Company or between the Company, its Parent, any Subsidiary, or any successor.
For purposes of Incentive Stock Options, no such leave may exceed ninety days,
unless reemployment upon expiration of such leave is guaranteed by statute or
contract. If reemployment upon expiration of a leave of absence approved by the
Company is not so guaranteed, on the 181st day of such leave any Incentive Stock
Option held by the Optionee shall cease to be treated as an Incentive Stock
Option and shall be treated for tax purposes as a Nonstatutory Stock Option.
Neither service as a Director nor payment of a director's fee by the Company
shall be sufficient to constitute "employment" by the Company.
(m) "Exchange Act" means the Securities Exchange Act of 1934, as
amended.
(n) "Fair Market Value" means, as of any date, the value of Common
Stock determined as follows:
(i) If the Common Stock is listed on any established stock
exchange or a national market system, including without limitation the Nasdaq
National Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its
Fair Market Value shall be the closing sales price for such stock (or the
closing bid, if no sales were reported) as quoted on such exchange or system for
the last market trading day prior to the time of determination, as reported in
The Wall Street Journal or such other source as the Administrator deems
reliable;
(ii) If the Common Stock is regularly quoted by a
recognized securities dealer but selling prices are not reported, the Fair
Market Value of a Share of Common Stock shall be the mean between the high bid
and low asked prices for the Common Stock on the last market trading day prior
to the day of determination, as reported in The Wall Street Journal or such
other source as the Administrator deems reliable; or
(iii) In the absence of an established market for the
Common Stock, the Fair Market Value shall be determined in good faith by the
Administrator.
(o) "Incentive Stock Option" means an Option intended to qualify as
an incentive stock option within the meaning of Section 422 of the Code and the
regulations promulgated thereunder.
(p) "Inside Director" means a Director who is an Employee.
-2-
<PAGE> 3
(q) "IPO Effective Date" means the date upon which the Securities
and Exchange Commission declares the initial public offering of the Company's
Common Stock as effective.
(r) "Nonstatutory Stock Option" means an Option not intended to
qualify as an Incentive Stock Option.
(s) "Notice of Grant" means a written or electronic notice
evidencing certain times and conditions of an individual Option or Stock
Purchase Right grant. The Notice of Grant is part of the Option Agreement.
(t) "Officer" means a person who is an officer of the Company within
the meaning of Section 16 of the Exchange Act and the rules and regulations
promulgated thereunder.
(u) "Option" means a stock option granted pursuant to the Plan.
(v) "Option Agreement" means an agreement between the Company and an
Optionee evidencing the terms and conditions of an individual Option grant. The
Option Agreement is subject to the terms and conditions of the Plan.
(w) "Option Exchange Program" means a program whereby outstanding
Options are surrendered in exchange for Options with a lower exercise price.
(x) "Optioned Stock" means the Common Stock subject to an Option or
Stock Purchase Right.
(y) "Optionee" means the holder of an outstanding Option or Stock
Purchase Right granted under the Plan.
(z) "Outside Director" means a Director who is not an Employee and
who is not the "beneficial owner" (as defined in Rule 13d-3 of the Securities
Exchange Act of 1934, as amended), directly or indirectly, of securities of the
Company representing 1% or more of the total voting power represented by the
Company's outstanding voting securities on the date of any grant hereunder.
(aa) "Plan" means this 2000 Stock Option Plan, as amended and
restated.
(bb) "Restricted Stock" means shares of Common Stock acquired
pursuant to a grant of Stock Purchase Rights under Section 11 of the Plan.
(cc) "Restricted Stock Purchase Agreement" means a written agreement
between the Company and the Optionee evidencing the terms and restrictions
applying to stock purchased under a Stock Purchase Right. The Restricted Stock
Purchase Agreement is subject to the terms and conditions of the Plan and the
Notice of Grant.
(dd) "Rule 16b-3" means Rule 16b-3 of the Exchange Act or any
successor to Rule 16b-3, as in effect when discretion is being exercised with
respect to the Plan.
-3-
<PAGE> 4
(ee) "Section 16(b) " means Section 16(b) of the Exchange Act.
(ff) "Service Provider" means an Employee, Director or Consultant.
(gg) "Share" means a share of the Common Stock, as adjusted in
accordance with Section 14 of the Plan.
(hh) "Stock Purchase Right" means the right to purchase Common Stock
pursuant to Section 11 of the Plan, as evidenced by a Notice of Grant.
(ii) "Subsidiary" means a "subsidiary corporation", whether now or
hereafter existing, as defined in Section 424(f) of the Code.
3. Stock Subject to the Plan. Subject to the provisions of Section 14 of
the Plan, the maximum aggregate number of Shares which may be optioned and sold
under the Plan is 5,000,000 Shares, plus the Shares available for future
issuance under the Turnstone Systems, Inc. 1998 Stock Plan (the "1998 Stock
Plan") as of the effective date of this Plan and any Shares returned to the 1998
Stock Plan. The number of Shares reserved for issuance under the Plan shall
increase annually on the first day of the Company's fiscal year beginning in
2000 by an amount of Shares equal to the lesser of (i) 5,000,000 Shares, (ii) 6%
of the outstanding Shares on such date or (iii) an amount determined by the
Board. The Shares may be authorized, but unissued, or reacquired Common Stock.
If an Option or Stock Purchase Right expires or becomes
unexercisable without having been exercised in full, or is surrendered pursuant
to an Option Exchange Program, the unpurchased Shares which were subject thereto
shall become available for future grant or sale under the Plan (unless the Plan
has terminated); provided, however, that Shares that have actually been issued
under the Plan, whether upon exercise of an Option or Right, shall not be
returned to the Plan and shall not become available for future distribution
under the Plan, except that if Shares of Restricted Stock are repurchased by the
Company at their original purchase price, such Shares shall become available for
future grant under the Plan.
4. Administration of the Plan.
(a) Procedure.
(i) Multiple Administrative Bodies. The Plan may be
administered by different Committees with respect to different groups of Service
Providers.
(ii) Section 162(m). To the extent that the Administrator
determines it to be desirable to qualify Options granted hereunder as
"performance-based compensation" within the meaning of Section 162(m) of the
Code, the Plan shall be administered by a Committee of two or more "outside
directors" within the meaning of Section 162(m) of the Code.
(iii) Rule 16b-3. To the extent desirable to qualify
transactions hereunder as exempt under Rule 16b-3, the transactions contemplated
hereunder shall be structured to satisfy the requirements for exemption under
Rule 16b-3.
-4-
<PAGE> 5
(iv) Other Administration. Other than as provided above,
the Plan shall be administered by (A) the Board or (B) a Committee, which
committee shall be constituted to satisfy Applicable Laws.
(b) Powers of the Administrator. Subject to the provisions of the
Plan, and in the case of a Committee, subject to the specific duties delegated
by the Board to such Committee, the Administrator shall have the authority, in
its discretion:
(i) to determine the Fair Market Value;
(ii) to select the Service Providers to whom Options and
Stock Purchase Rights may be granted hereunder;
(iii) to determine the number of shares of Common Stock
to be covered by each Option and Stock Purchase Right granted hereunder;
(iv) to approve forms of agreement for use under the Plan;
(v) to determine the terms and conditions, not inconsistent
with the terms of the Plan, of any Option or Stock Purchase Right granted
hereunder. Such terms and conditions include, but are not limited to, the
exercise price, the time or times when Options or Stock Purchase Rights may be
exercised (which may be based on performance criteria), any vesting acceleration
or waiver of forfeiture restrictions, and any restriction or limitation
regarding any Option or Stock Purchase Right or the shares of Common Stock
relating thereto, based in each case on such factors as the Administrator, in
its sole discretion, shall determine;
(vi) to reduce the exercise price of any Option or Stock
Purchase Right to the then current Fair Market Value if the Fair Market Value of
the Common Stock covered by such Option or Stock Purchase Right shall have
declined since the date the Option or Stock Purchase Right was granted;
(vii) to institute an Option Exchange Program;
(viii) to construe and interpret the terms of the Plan and
awards granted pursuant to the Plan;
(ix) to prescribe, amend and rescind rules and regulations
relating to the Plan, including rules and regulations relating to sub-plans
established for the purpose of qualifying for preferred tax treatment under
foreign tax laws;
(x) to modify or amend each Option or Stock Purchase Right
(subject to Section 16(c) of the Plan), including the discretionary authority to
extend the post-termination exercisability period of Options longer than is
otherwise provided for in the Plan;
(xi) to allow Optionees to satisfy withholding tax
obligations by electing to have the Company withhold from the Shares to be
issued upon exercise of an Option or Stock Purchase Right that number of Shares
having a Fair Market Value equal to the amount required to be
-5-
<PAGE> 6
withheld. The Fair Market Value of the Shares to be withheld shall be determined
on the date that the amount of tax to be withheld is to be determined. All
elections by an Optionee to have Shares withheld for this purpose shall be made
in such form and under such conditions as the Administrator may deem necessary
or advisable;
(xii) to authorize any person to execute on behalf of the
Company any instrument required to effect the grant of an Option or Stock
Purchase Right previously granted by the Administrator;
(xiii) to make all other determinations deemed necessary
or advisable for administering the Plan.
(c) Effect of Administrator's Decision. The Administrator's
decisions, determinations and interpretations shall be final and binding on all
Optionees and any other holders of Options or Stock Purchase Rights.
5. Eligibility. Nonstatutory Stock Options and Stock Purchase Rights may
be granted to Service Providers. Incentive Stock Options may be granted only to
Employees.
6. Limitations.
(a) Each Option shall be designated in the Option Agreement as
either an Incentive Stock Option or a Nonstatutory Stock Option. However,
notwithstanding such designation, to the extent that the aggregate Fair Market
Value of the Shares with respect to which Incentive Stock Options are
exercisable for the first time by the Optionee during any calendar year (under
all plans of the Company and any Parent or Subsidiary) exceeds $100,000, such
Options shall be treated as Nonstatutory Stock Options. For purposes of this
Section 6(a), Incentive Stock Options shall be taken into account in the order
in which they were granted. The Fair Market Value of the Shares shall be
determined as of the time the Option with respect to such Shares is granted.
(b) Neither the Plan nor any Option or Stock Purchase Right shall
confer upon an Optionee any right with respect to continuing the Optionee's
relationship as a Service Provider with the Company, nor shall they interfere in
any way with the Optionee's right or the Company's right to terminate such
relationship at any time, with or without Cause.
(c) The following limitations shall apply to grants of Options:
(i) No Service Provider shall be granted, in any fiscal
year of the Company, Options to purchase more than 1,000,000 Shares.
(ii) In connection with his or her initial service, a
Service Provider may be granted Options to purchase up to an additional
2,000,000 Shares, which shall not count against the limit, set forth in
subsection (i) above.
(iii) The foregoing limitations shall be adjusted
proportionately in connection with any change in the Company's capitalization as
described in Section 14.
-6-
<PAGE> 7
(iv) If an Option is cancelled in the same fiscal year of
the Company in which it was granted (other than in connection with a transaction
described in Section 14), the cancelled Option will be counted against the
limits set forth in subsections (i) and (ii) above. For this purpose, if the
exercise price of an Option is reduced, the transaction will be treated as a
cancellation of the Option and the grant of a new Option.
7. Term of Plan. Subject to Section 20 of the Plan, the Plan shall become
effective upon its adoption by the Board. It shall continue in effect for a term
of ten (10) years unless terminated earlier under Section 16 of the Plan.
8. Term of Option. The term of each Option shall be stated in the Option
Agreement. In the case of an Incentive Stock Option, the term shall be ten (10)
years from the date of grant or such shorter term as may be provided in the
Option Agreement. Moreover, in the case of an Incentive Stock Option granted to
an Optionee who, at the time the Incentive Stock Option is granted, owns stock
representing more than ten percent (10%) of the total combined voting power of
all classes of stock of the Company or any Parent or Subsidiary, the term of the
Incentive Stock Option shall be five (5) years from the date of grant or such
shorter term as may be provided in the Option Agreement.
9. Option Exercise Price and Consideration.
(a) Exercise Price. The per share exercise price for the Shares to
be issued pursuant to exercise of an Option shall be determined by the
Administrator, subject to the following:
(i) In the case of an Incentive Stock Option
(A) granted to an Employee who, at the time the
Incentive Stock Option is granted, owns stock representing more than ten percent
(10%) of the voting power of all classes of stock of the Company or any Parent
or Subsidiary, the per Share exercise price shall be no less than 110% of the
Fair Market Value per Share on the date of grant.
(B) granted to any Employee other than an Employee
described in paragraph (A) immediately above, the per Share exercise price shall
be no less than 100% of the Fair Market Value per Share on the date of grant.
(ii) In the case of a Nonstatutory Stock Option, the per
Share exercise price shall be determined by the Administrator. In the case of a
Nonstatutory Stock Option intended to qualify as "performance-based
compensation" within the meaning of Section 162(m) of the Code, the per Share
exercise price shall be no less than 100% of the Fair Market Value per Share on
the date of grant.
(iii) Notwithstanding the foregoing, Options may be granted
with a per Share exercise price of less than 100% of the Fair Market Value per
Share on the date of grant pursuant to a merger or other corporate transaction.
-7-
<PAGE> 8
(b) Waiting Period and Exercise Dates. At the time an Option is
granted, the Administrator shall fix the period within which the Option may be
exercised and shall determine any conditions that must be satisfied before the
Option may be exercised.
(c) Form of Consideration. The Administrator shall determine the
acceptable form of consideration for exercising an Option, including the method
of payment. In the case of an Incentive Stock Option, the Administrator shall
determine the acceptable form of consideration at the time of grant. Such
consideration may consist entirely of:
(i) cash;
(ii) check;
(iii) promissory note;
(iv) other Shares which (A) in the case of Shares acquired
upon exercise of an option, have been owned by the Optionee for more than six
months on the date of surrender, and (B) have a Fair Market Value on the date of
surrender equal to the aggregate exercise price of the Shares as to which said
Option shall be exercised;
(v) consideration received by the Company under a cashless
exercise program implemented by the Company in connection with the Plan;
(vi) a reduction in the amount of any Company liability to
the Optionee, including any liability attributable to the Optionee's
participation in any Company-sponsored deferred compensation program or
arrangement;
(vii) any combination of the foregoing methods of payment;
or
(viii) such other consideration and method of payment for
the issuance of Shares to the extent permitted by Applicable Laws.
10. Exercise of Option.
(a) Procedure for Exercise; Rights as a Shareholder. Any Option
granted hereunder shall be exercisable according to the terms of the Plan and at
such times and under such conditions as determined by the Administrator and set
forth in the Option Agreement. Unless the Administrator provides otherwise,
vesting of Options granted hereunder shall be tolled during any unpaid leave of
absence. An Option may not be exercised for a fraction of a Share.
An Option shall be deemed exercised when the Company receives:
(i) written or electronic notice of exercise (in accordance with the Option
Agreement) from the person entitled to exercise the Option, and (ii) full
payment for the Shares with respect to which the Option is exercised. Full
payment may consist of any consideration and method of payment authorized by the
Administrator and permitted by the Option Agreement and the Plan. Shares issued
upon exercise of an Option shall be issued in the name of the Optionee or, if
requested by the Optionee, in the name of the Optionee and his or her spouse.
Until the Shares are issued (as evidenced by the appropriate
-8-
<PAGE> 9
entry on the books of the Company or of a duly authorized transfer agent of the
Company), no right to vote or receive dividends or any other rights as a
shareholder shall exist with respect to the Optioned Stock, notwithstanding the
exercise of the Option. The Company shall issue (or cause to be issued) such
Shares promptly after the Option is exercised. No adjustment will be made for a
dividend or other right for which the record date is prior to the date the
Shares are issued, except as provided in Section 14 of the Plan.
Exercising an Option in any manner shall decrease the number
of Shares thereafter available, both for purposes of the Plan and for sale under
the Option, by the number of Shares as to which the Option is exercised.
(b) Termination of Relationship as a Service Provider. Subject to
Section 14, if an Optionee ceases to be a Service Provider (but not in the event
of an Optionee's change of status from Employee to Consultant (in which case an
Employee's Incentive Stock Option shall automatically convert to a Nonstatutory
Stock Option on the ninety-first (91st) day following such change of status) or
from Consultant to Employee), such Optionee may, but only within such period of
time as is specified in the Option Agreement (but in no event later than the
expiration date of the term of such Option as set forth in the Option
Agreement), exercise his or her Option to the extent that Optionee was entitled
to exercise it at the date of such termination. In the absence of a specified
time in the Option Agreement, the Option shall remain exercisable for three (3)
months following the Optionee's termination. If, on the date of termination, the
Optionee is not vested as to his or her entire Option, the Shares covered by the
unvested portion of the Option shall revert to the Plan. If, after termination,
the Optionee does not exercise his or her Option within the time specified by
the Administrator, the Option shall terminate, and the Shares covered by such
Option shall revert to the Plan.
(c) Disability of Optionee. If an Optionee ceases to be a Service
Provider as a result of the Optionee's Disability, the Optionee may, but only
within twelve (12) months from the date of such termination (and in no event
later than the expiration date of the term of such Option as set forth in the
Option Agreement), exercise his or her Option to the extent that the Option is
vested on the date of termination. If, on the date of termination, the Optionee
is not vested as to his or her entire Option, the Shares covered by the unvested
portion of the Option shall revert to the Plan. If, after termination, the
Optionee does not exercise his or her Option within the time specified herein,
the Option shall terminate, and the Shares covered by such Option shall revert
to the Plan.
(d) Death of Optionee. If an Optionee dies while a Service Provider,
the Option may be exercised at any time within twelve (12) months following the
date of death (but in no event later than the expiration of the term of such
Option as set forth in the Notice of Grant), by the Optionee's estate or by a
person who acquires the right to exercise the Option by bequest or inheritance,
but only to the extent that the Option is vested on the date of death. If, at
the time of death, the Optionee is not vested as to his or her entire Option,
the Shares covered by the unvested portion of the Option shall immediately
revert to the Plan. The Option may be exercised by the executor or administrator
of the Optionee's estate or, if none, by the person(s) entitled to exercise the
Option under the Optionee's will or the laws of descent or distribution. If the
Option is not so
-9-
<PAGE> 10
exercised within the time specified herein, the Option shall terminate, and the
Shares covered by such Option shall revert to the Plan.
(e) Buyout Provisions. The Administrator may at any time offer to
buy out for a payment in cash or Shares an Option previously granted based on
such terms and conditions as the Administrator shall establish and communicate
to the Optionee at the time that such offer is made.
11. Stock Purchase Rights.
(a) Rights to Purchase. Stock Purchase Rights may be issued either
alone, in addition to, or in tandem with other awards granted under the Plan
and/or cash awards made outside of the Plan. After the Administrator determines
that it will offer Stock Purchase Rights under the Plan, it shall advise the
offeree in writing or electronically, by means of a Notice of Grant, of the
terms, conditions and restrictions related to the offer, including the number of
Shares that the offeree shall be entitled to purchase, the price to be paid, and
the time within which the offeree must accept such offer. The offer shall be
accepted by execution of a Restricted Stock Purchase Agreement in the form
determined by the Administrator.
(b) Repurchase Option. Unless the Administrator determines
otherwise, the Restricted Stock Purchase Agreement shall grant the Company a
repurchase option exercisable upon the voluntary or involuntary termination of
the purchaser's service with the Company for any reason (including death or
Disability). The purchase price for Shares repurchased pursuant to the
Restricted Stock Purchase Agreement shall be the original price paid by the
purchaser and may be paid by cancellation of any indebtedness of the purchaser
to the Company. The repurchase option shall lapse at a rate determined by the
Administrator.
(c) Other Provisions. The Restricted Stock Purchase Agreement shall
contain such other terms, provisions and conditions not inconsistent with the
Plan as may be determined by the Administrator in its sole discretion.
(d) Rights as a Shareholder. Once the Stock Purchase Right is
exercised, the purchaser shall have the rights equivalent to those of a
shareholder, and shall be a shareholder when his or her purchase is entered upon
the records of the duly authorized transfer agent of the Company. No adjustment
will be made for a dividend or other right for which the record date is prior to
the date the Stock Purchase Right is exercised, except as provided in Section 14
of the Plan.
12. Non-Transferability of Options and Stock Purchase Rights. Unless
determined otherwise by the Administrator, an Option or Stock Purchase Right may
not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any
manner other than by will or by the laws of descent or distribution and may be
exercised, during the lifetime of the Optionee, only by the Optionee. If the
Administrator makes an Option or Stock Purchase Right transferable, such Option
or Stock Purchase Right shall contain such additional terms and conditions as
the Administrator deems appropriate.
13. Formula Option Grants to Outside Directors. Outside Directors shall be
granted Options each year in accordance with the following provisions:
-10-
<PAGE> 11
(a) All Options granted pursuant to this Section shall be
Nonstatutory Stock Options and, except as otherwise provided herein, shall be
subject to the other terms and conditions of the Plan.
(b) Except as provided in subsection (d) below, each person who
first becomes an Outside Director on or after the IPO Effective Date, whether
through election by the stockholders of the Company or appointment by the Board
to fill a vacancy shall be automatically granted an Option to purchase up to
30,000 Shares (the "First Option"), as determined by the Board in its sole and
absolute discretion, on the date he or she first becomes an Outside Director;
provided, however, that an Inside Director who ceases to be an Inside Director
but who remains a Director shall not receive a First Option.
(c) Except as provided in subsection (d) below, each Outside
Director shall be automatically granted an Option to purchase up to 10,000
Shares (a "Subsequent Option") following each annual meeting of the stockholders
of the Company occurring after the end of the Company's fiscal year 2000, if
immediately after such meeting, he or she shall continue to serve on the Board
and shall have served on the Board for at least the preceding six (6) months.
(d) Notwithstanding the provisions of subsections (b) and (c)
hereof, any exercise of an Option granted before the Company has obtained
stockholder approval of the Plan in accordance with Section 20 hereof shall be
conditioned upon obtaining such stockholder approval of the Plan in accordance
with Section 20 hereof.
(e) The terms of each First Option granted pursuant to this Section
shall be as follows:
(i) the term of the Option shall be ten (10) years.
(ii) the exercise price per Share shall be 100% of the Fair
Market Value per Share on the date of grant of the Option.
(iii) the Option shall vest and become exercisable in three
(3) equal annual installments on each of the first three anniversaries of its
date of grant; provided that the Outside Director shall continue to serve on the
Board on such dates.
(f) The terms of each Subsequent Option granted pursuant to this
Section shall be as follows:
(i) the term of the Option shall be ten (10) years.
(ii) the exercise price per Share shall be 100% of the Fair
Market Value per Share on the date of grant of the Option.
(iii) the Option shall vest and become exercisable on the
first anniversary of the date that all stock options have vested that were
granted to the Outside Director by the Company before the Option; provided,
however, that the Option shall in all events vest and become
-11-
<PAGE> 12
exercisable on the last day of its ten-year term; provided, further, that in
each case the Outside Director shall continue to serve on the Board on such
date.
14. Adjustments Upon Changes in Capitalization, Merger or Asset Sale.
(a) Changes in Capitalization. Subject to any required action by the
stockholders of the Company, the number of shares of Common Stock covered by
each outstanding Option or Stock Purchase Right, and the number of shares of
Common Stock which have been authorized for issuance under the Plan but as to
which no Options or Stock Purchase Rights have yet been granted or which have
been returned to the Plan upon cancellation or expiration of an Option or Stock
Purchase Right, as well as the price per share of Common Stock covered by each
such outstanding Option or Stock Purchase Right, shall be proportionately
adjusted for any increase or decrease in the number of issued shares of Common
Stock resulting from a stock split, reverse stock split, stock dividend,
combination or reclassification of the Common Stock, or any other increase or
decrease in the number of issued shares of Common Stock effected without receipt
of consideration by the Company. The conversion of any convertible securities of
the Company shall not be deemed to have been "effected without receipt of
consideration." Such adjustment shall be made by the Board, whose determination
in that respect shall be final, binding and conclusive. Except as expressly
provided herein, no issuance by the Company of shares of stock of any class, or
securities convertible into shares of stock of any class, shall affect, and no
adjustment by reason thereof shall be made with respect to, the number or price
of shares of Common Stock subject to an Option or Stock Purchase Right.
(b) Dissolution or Liquidation. In the event of the proposed
dissolution or liquidation of the Company, the Administrator shall notify each
Optionee as soon as practicable prior to the effective date of such proposed
transaction. The Administrator in its discretion may provide for an Optionee to
have the right to exercise his or her Option or Stock Purchase Right until
fifteen (15) days prior to such transaction as to all of the Optioned Stock
covered thereby, including Shares as to which the Option or Stock Purchase Right
would not otherwise be exercisable. In addition, the Administrator may provide
that any Company repurchase option applicable to any Shares purchased upon
exercise of an Option or Stock Purchase Right shall lapse as to all such Shares,
provided the proposed dissolution or liquidation takes place at the time and in
the manner contemplated. To the extent it has not been previously exercised, an
Option or Stock Purchase Right will terminate immediately prior to the
consummation of such proposed action.
(c) Merger or Asset Sale.
(i) General. Subject to subsections (ii) and (iii) below,
in the event of a merger of the Company with or into another corporation, or the
sale of substantially all of the assets of the Company (a "Merger"), each
outstanding Option and Stock Purchase Right shall be assumed or an equivalent
option or right substituted by the successor corporation or a Parent or
Subsidiary of the successor corporation (the "Successor Corporation"). In the
event that the Successor Corporation refuses to assume or substitute for the
Option or Stock Purchase Right, the Optionee shall fully vest in and have the
right to exercise the Option or Stock Purchase Right as to all of the Optioned
Stock, including Shares as to which it would not otherwise be vested or
exercisable. If an Option or Stock
-12-
<PAGE> 13
Purchase Right becomes fully vested and exercisable in lieu of assumption or
substitution in the event of a Merger, the Administrator shall notify the
Optionee in writing or electronically that the Option or Stock Purchase Right
shall be fully vested and exercisable for a period of fifteen (15) days from the
date of such notice, and the Option or Stock Purchase Right shall terminate upon
the expiration of such period. For the purposes of this Section 14(c), the
Option or Stock Purchase Right shall be considered assumed if, following the
Merger, the option or right confers the right to purchase or receive, for each
Share of Optioned Stock subject to the Option or Stock Purchase Right
immediately prior to the Merger, the consideration (whether stock, cash, or
other securities or property) received in the Merger by holders of Common Stock
for each Share held on the effective date of the transaction (and if holders
were offered a choice of consideration, the type of consideration chosen by the
holders of a majority of the outstanding Shares); provided, however, that if
such consideration received in the Merger is not solely common stock of the
Successor Corporation or its Parent, the Administrator may, with the consent of
the Successor Corporation, provide for the consideration to be received upon the
exercise of the Option or Stock Purchase Right, for each Share of Optioned Stock
subject to the Option or Stock Purchase Right, to be solely common stock of the
Successor Corporation or its Parent equal in fair market value to the per share
consideration received by holders of Common Stock in the Merger.
(ii) Employee and Consultant Options.
(A) General. In the event of a Merger in which the
stockholders immediately prior to the Merger hold less than 50% of the
outstanding voting equity securities of the Successor Corporation immediately
after such Merger (a "Change of Control Merger"), then (i) the vesting of each
outstanding Option and Stock Purchase Right shall be deemed vested to the extent
each such outstanding Option and Stock Purchase Right would have been vested on
the date twelve (12) months following the effectiveness of the Change of Control
Merger and (ii) each outstanding Option and Stock Purchase Right held by an
Employee or Consultant (and granted to such person in such capacity) shall be
assumed or an equivalent option or right substituted by the Successor
Corporation. In the event that the Successor Corporation refuses to assume or
substitute for the Option or Stock Purchase Right, the Employee or Consultant
shall, as set forth in subsection (i) above, fully vest in and have the right to
exercise such Option or Stock Purchase Right as to all of the Optioned Stock,
including Shares as to which the Employee or Consultant would not otherwise be
vested or exercisable.
(B) Employee and Consultant Options Following Assumption
or Substitution. Following an assumption or substitution in connection with a
Merger or Change of Control Merger, if an Employee or Consultant's status as an
Employee (or employee) or Consultant (or consultant) of the Successor
Corporation, as applicable, is terminated by the Successor Corporation as a
result of an involuntary termination (other than for Cause) within twelve months
following the Merger, the Optionee shall fully vest in and have the right to
exercise Optionee's Option or Stock Purchase Right as to all of the Optioned
Stock, including Shares as to which Optionee would not otherwise be vested or
exercisable. Thereafter, the Option or Stock Purchase Right shall remain
exercisable in accordance with Section 10.
-13-
<PAGE> 14
(iii) Outside Director Options. In the event of a Change of
Control Merger, each outstanding Option and Stock Purchase Right held by an
Outside Director (and granted to such person in such capacity) shall fully vest
as to all of the Optioned Stock, including Shares as to which the Outside
Director would not otherwise be vested or exercisable. If an Option or Stock
Purchase Right becomes fully vested and exercisable as provided in this
paragraph, the Administrator shall notify the Optionee in writing or
electronically that the Option or Stock Purchase Right shall be fully vested and
exercisable for a period of fifteen (15) days from the date of such notice, and
the Option or Stock Purchase Right shall terminate upon the expiration of such
period.
15. Date of Grant. The date of grant of an Option or Stock Purchase Right
shall be, for all purposes, the date on which the Administrator makes the
determination granting such Option or Stock Purchase Right, or such other later
date as is determined by the Administrator. Notice of the determination shall be
provided to each Optionee within a reasonable time after the date of such grant.
16. Amendment and Termination of the Plan.
(a) Amendment and Termination. The Board may at any time amend,
alter, suspend or terminate the Plan.
(b) Shareholder Approval. The Company shall obtain shareholder
approval of any Plan amendment to the extent necessary and desirable to comply
with Applicable Laws.
(c) Effect of Amendment or Termination. No amendment, alteration,
suspension or termination of the Plan shall impair the rights of any Optionee,
unless mutually agreed otherwise between the Optionee and the Administrator,
which agreement must be in writing and signed by the Optionee and the Company.
Termination of the Plan shall not affect the Administrator's ability to exercise
the powers granted to it hereunder with respect to Options granted under the
Plan prior to the date of such termination.
17. Conditions Upon Issuance of Shares.
(a) Legal Compliance. Shares shall not be issued pursuant to the
exercise of an Option or Stock Purchase Right unless the exercise of such Option
or Stock Purchase Right and the issuance and delivery of such Shares shall
comply with Applicable Laws and shall be further subject to the approval of
counsel for the Company with respect to such compliance.
(b) Investment Representations. As a condition to the exercise of an
Option or Stock Purchase Right, the Company may require the person exercising
such Option or Stock Purchase Right to represent and warrant at the time of any
such exercise that the Shares are being purchased only for investment and
without any present intention to sell or distribute such Shares if, in the
opinion of counsel for the Company, such a representation is required.
18. Inability to Obtain Authority. The inability of the Company to obtain
authority from any regulatory body having jurisdiction, which authority is
deemed by the Company's counsel to be necessary to the lawful issuance and sale
of any Shares hereunder, shall relieve the Company of any
-14-
<PAGE> 15
liability in respect of the failure to issue or sell such Shares as to which
such requisite authority shall not have been obtained.
19. Reservation of Shares. The Company, during the term of this Plan, will
at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan.
20. Shareholder Approval. The Plan shall be subject to approval by the
shareholders of the Company within twelve (12) months after the date the Plan is
adopted. Such shareholder approval shall be obtained in the manner and to the
degree required under Applicable Laws.
-15-
<PAGE> 16
TURNSTONE SYSTEMS, INC.
2000 STOCK PLAN
STOCK OPTION AGREEMENT
Unless otherwise defined herein, the terms defined in the Plan shall have
the same defined meanings in this Option Agreement.
I. NOTICE OF STOCK OPTION GRANT
[Optionee's Name and Address]
You have been granted an option to purchase Common Stock of the Company,
subject to the terms and conditions of the Plan and this Option Agreement, as
follows:
Grant Number ______________________________
Date of Grant ______________________________
Vesting Commencement Date ______________________________
Exercise Price per Share $_____________________________
Total Number of Shares Granted______________________________
Total Exercise Price $_____________________________
Type of Option: ___ Incentive Stock Option
___ Nonstatutory Stock Option
Term/Expiration Date: 10 years from the Date of Grant
Vesting Schedule:
Subject to accelerated vesting as set forth in the Plan, this Option may
be exercised, in whole or in part, in accordance with the following schedule:
25% of the Shares subject to the Option shall vest twelve months after the
Vesting Commencement Date, and 1/48 of the Shares subject to the Option shall
vest each month thereafter, provided that on such dates the Optionee remains in
Continuous status as a Service Provider on such dates.
Termination Period:
This Option may be exercised for three months after Optionee ceases to be
a Service Provider. Upon the death or Disability of the Optionee, this Option
may be exercised for twelve months after Optionee ceases to be a Service
Provider. In no event shall this Option be exercised later than the
Term/Expiration Date as provided above.
<PAGE> 17
II. AGREEMENT
A. Grant of Option.
The Plan Administrator of the Company hereby grants to the Optionee
named in the Notice of Grant attached as Part I of this Agreement (the
"Optionee") an option (the "Option") to purchase the number of Shares, as set
forth in the Notice of Grant, at the exercise price per share set forth in the
Notice of Grant (the "Exercise Price"), subject to the terms and conditions of
the Plan, which is incorporated herein by reference. Subject to Section 15(c) of
the Plan, in the event of a conflict between the terms and conditions of the
Plan and the terms and conditions of this Option Agreement, the terms and
conditions of the Plan shall prevail.
If designated in the Notice of Grant as an Incentive Stock Option
("ISO"), this Option is intended to qualify as an Incentive Stock Option under
Section 422 of the Code. However, if this Option is intended to be an Incentive
Stock Option, to the extent that it exceeds the $100,000 rule of Code Section
422(d) it shall be treated as a Nonstatutory Stock Option ("NSO").
B. Exercise of Option.
(a) Right to Exercise. This Option is exercisable during its term
in accordance with the Vesting Schedule set out in the Notice of Grant and the
applicable provisions of the Plan and this Option Agreement.
(b) Method of Exercise. This Option is exercisable by delivery of
an exercise notice, in the form attached as Exhibit A (the "Exercise Notice"),
which shall state the election to exercise the Option, the number of Shares in
respect of which the Option is being exercised (the "Exercised Shares"), and
such other representations and agreements as may be required by the Company
pursuant to the provisions of the Plan. The Exercise Notice shall be completed
by the Optionee and delivered to the Stock Plan Administrator of the Company.
The Exercise Notice shall be accompanied by payment of the aggregate Exercise
Price as to all Exercised Shares. This Option shall be deemed to be exercised
upon receipt by the Company of such fully executed Exercise Notice accompanied
by such aggregate Exercise Price.
No Shares shall be issued pursuant to the exercise of this
Option unless such issuance and exercise complies with Applicable Laws. Assuming
such compliance, for income tax purposes the Exercised Shares shall be
considered transferred to the Optionee on the date the Option is exercised with
respect to such Exercised Shares.
C. Method of Payment.
Payment of the aggregate Exercise Price shall be by any of the
following, or a combination thereof, at the election of the Optionee:
1. cash; or
2. check; or
3. consideration received by the Company under a cashless
exercise program implemented by the Company in connection with the Plan; or
-2-
<PAGE> 18
4. surrender of other Shares which (i) in the case of Shares
acquired upon exercise of an option, have been owned by the Optionee for more
than six (6) months on the date of surrender, and (ii) have a Fair Market Value
on the date of surrender equal to the aggregate Exercise Price of the Exercised
Shares; or
5. a reduction in the amount of any Company liability to the
Optionee, including any liability attributable to the Optionee's participation
in any Company-sponsored deferred compensation program or arrangement; or
6. such other consideration and method of payment for the
issuance of Shares to the extent permitted by Applicable Laws.
D. Non-Transferability of Option.
This Option may not be transferred in any manner otherwise than by
will or by the laws of descent or distribution and may be exercised during the
lifetime of Optionee only by the Optionee. The terms of the Plan and this Option
Agreement shall be binding upon the executors, administrators, heirs, successors
and assigns of the Optionee.
E. Term of Option.
This Option may be exercised only within the term set out in the
Notice of Grant, and may be exercised during such term only in accordance with
the Plan and the terms of this Option Agreement.
F. Tax Consequences.
Some of the federal tax consequences relating to this Option, as of
the date of this Option, are set forth below. THIS SUMMARY IS NECESSARILY
INCOMPLETE, AND THE TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE. THE OPTIONEE
SHOULD CONSULT A TAX ADVISER BEFORE EXERCISING THIS OPTION OR DISPOSING OF THE
SHARES.
G. Exercising the Option.
1. Nonstatutory Stock Option. The Optionee may incur regular
federal income tax liability upon exercise of a NSO. The Optionee will be
treated as having received compensation income (taxable at ordinary income tax
rates) equal to the excess, if any, of the Fair Market Value of the Exercised
Shares on the date of exercise over their aggregate Exercise Price. If the
Optionee is an Employee or a former Employee, the Company will be required to
withhold from his or her compensation or collect from Optionee and pay to the
applicable taxing authorities an amount in cash equal to a percentage of this
compensation income at the time of exercise, and may refuse to honor the
exercise and refuse to deliver Shares if such withholding amounts are not
delivered at the time of exercise.
2. Incentive Stock Option. If this Option qualifies as an ISO, the
Optionee will have no regular federal income tax liability upon its exercise,
although the excess, if any, of the Fair Market Value of the Exercised Shares on
the date of exercise over their aggregate Exercise Price will be treated as an
adjustment to alternative minimum taxable income for federal tax purposes and
may
-3-
<PAGE> 19
subject the Optionee to alternative minimum tax in the year of exercise. In the
event that the Optionee ceases to be an Employee but remains a Service Provider,
any Incentive Stock Option of the Optionee that remains unexercised shall cease
to qualify as an Incentive Stock Option and will be treated for tax purposes as
a Nonstatutory Stock Option on the date three (3) months and one (1) day
following such change of status.
3. Disposition of Shares.
(a) NSO. If the Optionee holds NSO Shares for at least one
year, any gain realized on disposition of the Shares will be treated as
long-term capital gain for federal income tax purposes.
(b) ISO. If the Optionee holds ISO Shares for at least one
year after exercise and two years after the grant date, any gain realized on
disposition of the Shares will be treated as long-term capital gain for federal
income tax purposes. If the Optionee disposes of ISO Shares within one year
after exercise or two years after the grant date, any gain realized on such
disposition will be treated as compensation income (taxable at ordinary income
rates) to the extent of the excess, if any, of the lesser of (A) the difference
between the Fair Market Value of the Shares acquired on the date of exercise and
the aggregate Exercise Price, or (B) the difference between the sale price of
such Shares and the aggregate Exercise Price. Any additional gain will be taxed
as capital gain, short-term or long-term depending on the period that the ISO
Shares were held.
(c) Notice of Disqualifying Disposition of ISO Shares. If the
Optionee sells or otherwise disposes of any of the Shares acquired pursuant to
an ISO on or before the later of (i) two years after the grant date, or (ii) one
year after the exercise date, the Optionee shall immediately notify the Company
in writing of such disposition. The Optionee agrees that he or she may be
subject to income tax withholding by the Company on the compensation income
recognized from such early disposition of ISO Shares by payment in cash or out
of the current earnings paid to the Optionee.
H. Entire Agreement; Governing Law.
The Plan is incorporated herein by reference. The Plan and this
Option Agreement constitute the entire agreement of the parties with respect to
the subject matter hereof and supersede in their entirety all prior undertakings
and agreements of the Company and Optionee with respect to the subject matter
hereof, and may not be modified adversely to the Optionee's interest except by
means of a writing signed by the Company and Optionee. This agreement is
governed by the internal substantive laws, but not the choice of law rules, of
California.
I. NO GUARANTEE OF CONTINUED SERVICE.
OPTIONEE ACKNOWLEDGES AND AGREES THAT THE VESTING OF SHARES PURSUANT TO
THE VESTING SCHEDULE HEREOF IS EARNED ONLY BY CONTINUING AS A SERVICE PROVIDER
AT THE WILL OF THE COMPANY (AND NOT THROUGH THE ACT OF BEING HIRED, BEING
GRANTED AN OPTION OR PURCHASING SHARES HEREUNDER). OPTIONEE FURTHER ACKNOWLEDGES
AND AGREES THAT THIS AGREEMENT, THE TRANSACTIONS CONTEMPLATED HEREUNDER AND THE
VESTING SCHEDULE SET FORTH HEREIN DO NOT CONSTITUTE AN EXPRESS OR IMPLIED
PROMISE OF CONTINUED ENGAGEMENT AS A SERVICE PROVIDER FOR THE VESTING PERIOD,
FOR ANY PERIOD, OR AT ALL, AND SHALL NOT INTERFERE WITH
-4-
<PAGE> 20
OPTIONEE'S RIGHT OR THE COMPANY'S RIGHT TO TERMINATE OPTIONEE'S RELATIONSHIP AS
A SERVICE PROVIDER AT ANY TIME, WITH OR WITHOUT CAUSE.
By your signature and the signature of the Company's representative below,
you and the Company agree that this Option is granted under and governed by the
terms and conditions of the Plan and this Option Agreement. Optionee has
reviewed the Plan and this Option Agreement in their entirety, has had an
opportunity to obtain the advice of counsel prior to executing this Option
Agreement and fully understands all provisions of the Plan and Option Agreement.
Optionee hereby agrees to accept as binding, conclusive and final all decisions
or interpretations of the Administrator upon any questions relating to the Plan
and Option Agreement. Optionee further agrees to notify the Company upon any
change in the residence address indicated below.
OPTIONEE: TURNSTONE SYSTEMS, INC.
- ------------------------------------ --------------------------------------
Signature By
- ------------------------------------ --------------------------------------
Print Name Title
- ------------------------------------
Residence Address
- ------------------------------------
-5-
<PAGE> 21
CONSENT OF SPOUSE
The undersigned spouse of Optionee has read and hereby approves the terms
and conditions of the Plan and this Option Agreement. In consideration of the
Company's granting his or her spouse the right to purchase Shares as set forth
in the Plan and this Option Agreement, the undersigned hereby agrees to be
irrevocably bound by the terms and conditions of the Plan and this Option
Agreement and further agrees that any community property interest shall be
similarly bound. The undersigned hereby appoints the undersigned's spouse as
attorney-in-fact for the undersigned with respect to any amendment or exercise
of rights under the Plan or this Option Agreement.
--------------------------------------
Spouse of Optionee
<PAGE> 22
EXHIBIT A
TURNSTONE SYSTEMS, INC.
2000 STOCK OPTION PLAN
EXERCISE NOTICE
Turnstone Systems, Inc.
274 Ferguson Drive
Mountain View, CA 94043
Attention: Corporate Secretary
1. Exercise of Option. Effective as of today, ________________, 2000,
the undersigned ("Purchaser") hereby elects to purchase ______________ shares
(the "Shares") of the Common Stock of Turnstone Systems, Inc. (the "Company")
under and pursuant to the Turnstone Systems, Inc. 2000 Stock Plan (the "Plan")
and the Stock Option Agreement dated, _____ (the "Option Agreement"). The
purchase price for the Shares shall be $_____, as required by the Option
Agreement.
2. Delivery of Payment. Purchaser herewith delivers to the Company the
full purchase price for the Shares.
3. Representations of Purchaser. Purchaser acknowledges that Purchaser
has received, read and understood the Plan and the Option Agreement and agrees
to abide by and be bound by their terms and conditions.
4. Rights as Shareholder. Until the issuance (as evidenced by the
appropriate entry on the books of the Company or of a duly authorized transfer
agent of the Company) of the Shares, no right to vote or receive dividends or
any other rights as a shareholder shall exist with respect to the Optioned
Stock, notwithstanding the exercise of the Option. The Shares so acquired shall
be issued to the Optionee as soon as practicable after exercise of the Option.
No adjustment will be made for a dividend or other right for which the record
date is prior to the date of issuance, except as provided in Section 13 of the
Plan.
5. Tax Consultation. Purchaser understands that Purchaser may suffer
adverse tax consequences as a result of Purchaser's purchase or disposition of
the Shares. Purchaser represents that Purchaser has consulted with any tax
consultants Purchaser deems advisable in connection with the purchase or
disposition of the Shares and that Purchaser is not relying on the Company for
any tax advice.
<PAGE> 23
6. Entire Agreement; Governing Law. The Plan and Option Agreement are
incorporated herein by reference. This Agreement, the Plan and the Option
Agreement constitute the entire agreement of the parties with respect to the
subject matter hereof and supersede in their entirety all prior undertakings and
agreements of the Company and Purchaser with respect to the subject matter
hereof, and may not be modified adversely to the Purchaser's interest except by
means of a writing signed by the Company and Purchaser. This agreement is
governed by the internal substantive laws, but not the choice of law rules, of
California.
Submitted by: Accepted by:
PURCHASER: TURNSTONE SYSTEMS, INC.
- ------------------------------------ --------------------------------------
Signature By
- ------------------------------------ --------------------------------------
Print Name Its
Address: Address:
- ------------------------------------ Turnstone Systems, Inc.
274 Ferguson Drive
- ------------------------------------ Mountain View, CA 94043
--------------------------------------
Date Received
-2-
<PAGE> 1
EXHIBIT 10.8
Agreement No. 1
ARISTASOFT CORPORATION
APPLICATION SERVICES AGREEMENT
This APPLICATION SERVICES AGREEMENT ("Agreement") is made effective as of
December 23rd, 1999 ("Effective Date"), by and between AristaSoft Corporation
("AristaSoft"), a California corporation, having its principal place of business
at 1300 Charleston Road, Mountain View, CA 94043 and Turnstone Systems, Inc.
("Customer"), a Delaware corporation, having its principal place of business at
274 Ferguson Drive, Mountain View, CA 94043. The terms of this Agreement shall
apply to all services provided by AristaSoft under this Agreement.
1. DEFINITIONS
1.1 "Charter Customer" means Customer is part of the initial set of
AristaSoft customers. Charter Customers have access to special terms and
conditions not available to all customers. The special terms include, but are
not limited to, pricing and protection clause described in this Agreement and
its attached Schedules.
1.2 "Derivative Works" means a modification of an existing work
protected by a copyright in the name of AristaSoft or a licensor of the
Software, but excluding any Customer Data (as defined hereinafter) or reports
that are created by the Customer using the Software. For the purpose of this
Agreement, Software shall be deemed to include any Derivative Works of the
Software.
1.3 "Designates" means those Customers' customers, suppliers, vendors,
benefits providers and other such external parties whose access to the Software
is necessary to effect Customer's business purposes for which Software is
provided.
1.4 "Documentation" means the guides and manuals for use of the
Software. Documentation is provided in whatever form is generally available to
users of the Software.
1.5 "Servers" means the host-processing computer hardware servers that
are customized, installed, managed, maintained and supported by AristaSoft.
1.6 "Software" shall mean the computer software, as specified in
Schedule A and including any other Server software used by AristaSoft to provide
the Service, in object code form owned or distributed by AristaSoft for which
Customer is granted access pursuant to this Agreement, and the media,
Documentation, Upgrades and Updates thereof.
1.7 "Update" shall mean a subsequent release of the Software containing
minor corrections, bug fixes, and other modifications that do not meet the
definition of Upgrades and are generally made available for the Software without
additional charge. Update shall not include any release, option or future
product that AristaSoft provides and prices separately.
1.8 "Upgrade" shall mean modifications which provide new or improved
features, functionality, or performance for the Software and are priced
separately by the owner of the Software.
1.9 "User," as further specified in Schedule A shall mean an individual
authorized by Customer to access the Software, regardless of whether the
individual is actively using the Software at any given time.
2. ARISTASOFT APPLICATION SERVICES
2.1 AristaSoft offers an information processing service that is
delivered over a private dedicated network and the Internet to its Customers,
giving them access to the Software hosted on AristaSoft's Servers to support the
customers' internal business information processing activities.
2.2 Subject to the terms and conditions of this Agreement, AristaSoft
will provide to Customer the following services (collectively the "Services"):
i. AristaSoft will provide Customer with remote access to
Servers controlled by AristaSoft on which AristaSoft hosts the Software which
shall be specifically listed in Schedule A - Service Order Form.
ii. AristaSoft will provide Customer with certain hardware,
software, and customer support
<PAGE> 2
services for the Software (the "Support Services") which shall be specifically
listed in Schedule B - Software Access and Support Services Schedule.
iii. AristaSoft will provide Customer with consulting services
associated to the implementation of the Software and the on-going integration
and operation of the Software with Customer's business processes which shall be
provided in accordance with Schedule C - Consulting Services Schedule.
2.3 Access. AristaSoft will provide Customer with the ability to
remotely access the Software hosted on the Servers, as of the date that
installation and implementation is completed (the "Initial Access Date"). Such
access shall be provided on a twenty-four hours-a-day, seven days-a-week basis,
except during scheduled and unscheduled maintenance downtime. AristaSoft will
use best efforts to perform any scheduled downtime outside of normal business
hours. Notwithstanding the foregoing, Customer will be able to remotely access
the Software for not less than 99% of the scheduled available time, with the
exception of telecommunication company service problems, software defects, any
problems caused by Customer, and any other forces beyond the immediate control
of AristaSoft.
2.4 Network Equipment. AristaSoft will provide network hardware and
software to be used on Customer's premises to access the Software hosted by
AristaSoft (the "Equipment"). AristaSoft retains exclusive and complete
ownership of the Equipment including all rights, title and interest thereto.
Customer shall provide to AristaSoft reasonable electronic and physical access
to the Equipment. Customer is responsible for the physical security of the
Equipment and will carry both general liability and property casualty insurance
policies in amounts sufficient for the replacement of the Equipment. Relocation
of the Equipment outside the continental United States is prohibited. Relocation
of the Equipment within the continental United States is permitted upon sixty
(60) days prior written notice to AristaSoft. Customer will be required to
provide space, power, and physical security on Customer's own file servers and
personal computers to support various aspects of AristaSoft hosting. AristaSoft
will determine the exact configuration and amount of space.
3. ACCESS TO SOFTWARE
3.1 Pursuant to the terms and conditions herein, including those in any
attached Schedules, AristaSoft grants to Customer, its Users, and its
Designates, a non-exclusive, non-transferable right to access and use the
Software as described in Schedule A, in accordance with the associated
Documentation, solely in connection with Customer's business operations. The
foregoing license is only granted for the duration of the Term set forth in
Schedule A.
3.2 Access exclusions. Except as expressly authorized herein, Customer
shall not:
i. Authorize or permit Designates to access the Software other
than in connection with Customer's internal data processing operations.
ii. Copy, except for backup purposes, assign, relicense or
sublicense the Software or the use of the Software; or
iii. Reverse engineer, reverse compile or reverse assemble the
Software.
3.3 AristaSoft or its licensors shall retain all title, copyright and
other proprietary rights in the Software and Derivative Works. Customer does not
acquire any implied rights to the Software or the Derivative Works.
3.4 Data and Documents Resulting from the Software. Customer shall be
free to use any customer data, such as customer data in databases or reports,
that are used in connection with, or created as a by-product of, the Software
("Customer Data"). Customer retains all right, title and interest to Customer
Data except as to preexisting portions of the Software included in the Customer
Data.
4. CUSTOMER'S OBLIGATIONS
4.1 Customer shall fulfill its obligations as specified in Schedules B
and C or as may be supplemented or modified according to the guidelines set
forth in Schedules A, B, or C and mutually agreed to by the parties hereto.
5. CONFIDENTIALITY
5.1 Confidential Information. Each party acknowledges that it will have
access to certain confidential information of the other party ("Confidential
Information") including the Software, the terms and pricing under this
Agreement, and all materials or information clearly identified as confidential.
Each party agrees that during the Term,
-2-
<PAGE> 3
and for two (2) years after the expiration or termination of this Agreement, (a)
it will hold the Confidential Information of the other party in confidence with
at least the same level of care as it uses for its own confidential information
of the same nature, but not less than a reasonable level of care; (b) it will
not use it, for its own account or the account of any third party, except as
expressly permitted by this Agreement, (c) unless required by law, it will not
disclose it to any third party, except that party's attorneys, accountants and
other advisors as reasonably necessary.
5.2 Confidentiality of Customer Data. AristaSoft will treat with utmost
confidentiality the Customer Data and documents resulting from the Software,
according to Section 3.4. The Customer Data is the sole and exclusive property
of the Customer, and AristaSoft will not have any rights, title or interest to
Customer Data. Should AristaSoft require access to the Customer Data in order to
fulfill its own duties under this Agreement, Customer will permit such access,
as reasonable under the circumstances, to specifically identified AristaSoft
personnel. As a precondition for access by such personnel, each must first agree
in writing to maintain the confidentiality of any Customer Data to which they
are exposed no less stringently than as required by this Agreement. Should
AristaSoft be required to give access to Customer Data to any of its
subcontractors, vendors, Software licensors or any other third party in order to
fulfill AristaSoft's own duties under this Agreement, Customer will permit such
access, as reasonable under the circumstances, to specifically identified third
parties. As a precondition for access by such third party, each must first agree
in writing to maintain the confidentiality of any Customer Data to which they
are exposed no less stringently than as required by this Agreement. AristaSoft
will not use any information of the Customer in any manner except as necessary
to fulfill its obligations under this Agreement.
5.3 Exceptions. Information will not be deemed Confidential Information
hereunder if such information: (i) is known to the receiving party prior to
receipt from the disclosing party directly or indirectly from a source other
than one having an obligation of confidentiality to the disclosing party; (ii)
becomes known (independently of disclosure by the disclosing party) to the
receiving party directly or indirectly from a source other than one having an
obligation of confidentiality to the disclosing party; (iii) becomes publicly
known or otherwise ceases to be secret or confidential, except through a breach
of this Agreement by the receiving party; or (iv) is independently developed by
the receiving party.
6. FEES AND BILLING
6.1 Customer will pay all fees incurred pursuant to Schedules A and C.
6.2 Unless otherwise specified in either Schedules A or C, AristaSoft
will invoice Customer monthly, one month in advance of actual service delivery.
All invoices are due and payable in full within 30 days of date of invoice.
Application access fees will begin to accrue on the Initial Access Date. Any
increases in fees due to additional Users, or any other adjustments in fees,
will be reflected in subsequent invoices. Any invoice not paid within 15 days of
the due date will be deemed late, and will accrue late charges as of the date
due. Late charges shall be at a rate of 1 1/2% per month, or the maximum rate
allowed under law, whichever is lower, from the date such payment was due until
the date paid.
6.3 Customer shall be responsible for all sales taxes, use taxes and any
other similar taxes and charges of any kind imposed by any federal, state or
local governmental entity on the transactions contemplated by this Agreement,
excluding only U.S. taxes based solely upon AristaSoft's income. When AristaSoft
has the legal obligation to pay or collect such taxes, the appropriate amount
shall be invoiced to and paid by Customer unless Customer provides AristaSoft
with a valid tax exemption certificate authorized by the appropriate taxing
authority.
7. WARRANTIES AND REMEDIES
7.1 AristaSoft warrants that: (a) it has rights to the Software to the
extent required to grant Customer the rights granted herein; (b) it otherwise
has the full right and authority to enter into this Agreement; (c) it has full
right and authority to make any representations in Schedules A or B referring to
the licensor of the Software.
7.2 Software. AristaSoft warrants that during the term of this
Agreement: (a) the Software will perform in accordance with the published
product specifications in effect from time to time; (b) the Software will
continue to function after January 1, 2000 in the same manner as they functioned
on December 31, 1999; and (c) the Documentation produced by AristaSoft,
including manuals and training materials, are accurate and correct in all
material respects.
-3-
<PAGE> 4
AristaSoft will correct any material nonconformance to the most current version
of the Software at no additional cost to the Customer. Customer shall notify
AristaSoft of such nonconformance in reasonably sufficient detail to allow
AristaSoft, or its business partners, to duplicate the nonconformity.
7.3 PRODUCTS COVERED UNDER THIS AGREEMENT MAY CONTAIN OR BE DERIVED FROM
SOFTWARE PROVIDED BY THIRD PARTIES UNDER LICENSE TO ARISTASOFT. Customer shall
have the benefit of any warranties retaining thereto that are available to
AristaSoft, provided however, that Customer's remedy for breach of any such
warranty shall be solely against AristaSoft.
7.4 The warranties given herein only apply during the Term of this
Agreement, as provided in Schedule A.
7.5 Services. AristaSoft represents and warrants that the Services shall
be performed in a professional and workmanlike manner in accordance with
applicable professional standards consistent with industry practices.
7.6 Limitation of Performance Warranties. These warranties are subject
to Customer fulfilling its obligations under the terms of this Agreement as
described in Schedules A and B. THESE WARRANTIES DO NOT APPLY TO ANY ARISTASOFT
PRODUCTS OR SERVICES THAT EXPRESSLY EXCLUDE THIS WARRANTY (AS DESCRIBED IN THE
SPECIFICATION SHEETS FOR SUCH PRODUCTS AND SERVICES).
7.7 Disclaimers. EXCEPT FOR THE EXPRESS WARRANTIES SET OUT IN THIS
SECTION 7, THE SOFTWARE AND SERVICES ARE PROVIDED ON AN "AS IS" BASIS, AND
CUSTOMER'S USE OF THE SOFTWARE AND SERVICES IS AT ITS OWN RISK. ARISTASOFT AND
ITS LICENSORS DO NOT MAKE ANY OTHER WARRANTIES, WHETHER EXPRESS OR IMPLIED,
INCLUDING THE IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR
PURPOSE, NONINFRINGEMENT AND TITLE, AND ANY WARRANTIES ARISING FROM A COURSE OF
DEALING, USAGE, OR TRADE PRACTICE.
8. LIMITATIONS OF LIABILITY
8.1 In no event shall either party be liable for any consequential,
exemplary, indirect, special or incidental damages, or damages for loss of
profits, revenue, data or use, incurred by either party or any third party,
whether in an action in contract or tort, even if the other party has been
advised of the possibility of such damages.
8.2 Maximum Liability. NOTWITHSTANDING ANYTHING TO THE CONTRARY IN THIS
AGREEMENT ARISTASOFT'S MAXIMUM AGGREGATE LIABILITY TO CUSTOMER RELATED TO, OR IN
CONNECTION WITH, THIS AGREEMENT WILL BE LIMITED TO THE TOTAL AMOUNT PAID BY
CUSTOMER TO ARISTASOFT HEREUNDER FOR THE [***] PERIOD, AND IF SUCH DAMAGES
RESULT FROM CUSTOMER'S USE OF A SPECIFIC SERVICE, SUCH LIABILITY SHALL BE
LIMITED TO FEES PAID FOR THE SERVICE GIVING RISE TO THE LIABILITY. CUSTOMER'S
MAXIMUM AGGREGATE LIABILITY TO ARISTASOFT RELATED TO, OR IN CONNECTION WITH,
THIS AGREEMENT SHALL BE LIMITED TO THE TOTAL AMOUNT PAID TO ARISTASOFT HEREUNDER
FOR THE [***] PERIOD.
8.3 The provisions of this Agreement allocate the rights between
Aristasoft and Customer. Aristasoft's pricing reflects this allocation of risk
and the limitation of liability specified herein.
9. INDEMNIFICATION
9.1 Indemnification of Customer. AristaSoft will indemnify, defend and
hold harmless Customer, its employees, officers, directors, and agents, from and
against any and all costs, liabilities, losses, and expenses (including, but not
limited to, reasonable attorneys' fees) (collectively, "Losses"): (i) resulting
from any claim, suit, action, or proceeding (each, an "Action") brought against
Customer alleging the infringement of any third party trade secret, U.S.
copyright, or registered trademark resulting from the provision of the Services
pursuant to this Agreement; (ii) any damage arising from the breach of
AristaSoft's representations and warranties in this Agreement; (iii) any damage
or destruction to the Customer Data caused in whole or in part by AristaSoft; or
(iv) any other damage arising out of AristaSoft's acts or failure
*** Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to
the omitted portions.
-4-
<PAGE> 5
to act provided that: (1) Customer notifies AristaSoft in writing within thirty
(30) days of receiving notice of such Action; (2) AristaSoft has sole control of
the defense and all related settlement negotiations; and (3) Customer provides
AristaSoft with the assistance, information and authority necessary to perform
its obligations under this Section. AristaSoft shall reimburse Customer for
reasonable out-of-pocket expenses incurred by Customer in providing such
assistance. AristaSoft may not settle or compromise any claim in a manner which
requires Customer to assume liability or pay money or which subjects Customer to
injunctive relief without Customer's express written consent. AristaSoft shall
have no liability for any claim of infringement based on use of a superseded or
altered release of Software and Services if the infringement would have been
avoided by the use of a current unaltered release of the Software and Services
that AristaSoft provides to Customer.
9.2 If the Software is held, or is reasonably believed by AristaSoft, to
infringe the intellectual property rights of a third party, AristaSoft shall
have the option, at its expense, to (a) modify the Software to be noninfringing;
(b) obtain for Customer a license to continue using the Software; or (c)
terminate the license for the infringing Software.
9.3 Indemnification of AristaSoft. Customer will indemnify, defend and
hold AristaSoft harmless from and against any and all Losses resulting from or
arising out of any Action brought by a third party against AristaSoft alleging:
(i) defamation, libel, slander, obscenity, pornography, or violation of the
rights of privacy or publicity; (iii) spamming, or any other offensive,
harassing or illegal conduct; (iv) any damage or destruction to the Customer
Data or the equipment of AristaSoft caused in whole or in part by Customer or
Customer's Designees; (v) any other damage arising from the breach of Customer's
representation and warranties in this Agreement, or from Customer's acts or
failure to act provided that (1) AristaSoft notifies Customer in writing within
thirty (30) days of the claim; (2) Customer has sole control over the defenses
and all related settlement negotiations; and (3) AristaSoft provides Customer
with the assistance, information and authority necessary to perform its
obligations under this Section 9.3. Customer shall reimburse AristaSoft's
reasonable out-of-pocket expenses incurred in providing such assistance.
10. TERM AND TERMINATION
10.1 Term. This Agreement will be effective for three (3) years after
the Effective Date (the "Initial Term"), unless otherwise specified for relevant
services in Schedule A. This Agreement will automatically renew for additional
terms of one (1) year unless otherwise specified in, or terminated pursuant to,
the applicable Schedule A.
10.2 Direct License Conversion. At the end of the Initial Term, Customer
may choose to directly license the Software from AristaSoft's licensor rather
than renew this Agreement and applicable Schedules. In such case, Customer must
provide AristaSoft with written notice of this choice not later than four (4)
months prior to expiration of the Initial Term. AristaSoft shall provide
Customer with consulting services, at a reasonable cost mutually agreed by both
parties, sufficient to accomplish Customer's transition to a direct license of
the Software, including operational start-up of the necessary hardware
components.
10.3 Termination for Convenience. Customer may terminate this Agreement
for convenience as specified for relevant services in Schedules A through C. All
application access fees, if any, for the remaining period of the contract under
this Agreement will be due and may be paid [***] payment in the same amount that
would be due if this Agreement were not terminated. [***]. Notwithstanding the
foregoing, Customer's payment obligations for [***] fees shall not include any
[***] that otherwise would be due if this Agreement were not terminated. All
other payment obligations for relevant services as specified in this Agreement
will be due immediately.
10.4 Termination for Cause. Either party may terminate this Agreement
if: (i) the other party breaches any material term or condition of this
Agreement and fails to cure such breach within ninety (90) days after receipt of
written notice of the same, except in the case of failure to pay fees, which
must be cured within ten (10) days after receipt of written notice from
AristaSoft; provided, however, that Customer [***], in which case no breach
shall occur until [***]; (ii) the other party becomes the subject of a voluntary
petition in bankruptcy or any voluntary proceeding relating to insolvency,
receivership, liquidation, or composition for the benefit of creditors if
*** Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to
the omitted portions.
-5-
<PAGE> 6
such petition or proceeding is not dismissed within sixty (60) days of filing.
10.5 Termination for Failure to Meet Software Access Performance
Standards. If AristaSoft fails to meet the Software Access Performance Standards
described in Schedule B for any three (3) consecutive months or any four (4)
months during a one (1) year period, Customer may terminate this Agreement and
all attached Schedules pursuant to Section 10.4, or substitute for this
Agreement and all attached Schedules a direct license with AristaSoft's licensor
of the Software. In the latter event, AristaSoft shall provide Customer with
consulting services, [***], sufficient to accomplish Customer's transition to a
direct license of the Software [***]. Pricing of the direct license shall be
pursuant to Section 10 of Schedule A.
10.6 Termination Upon Change of Control. In the event that AristaSoft is
acquired, is not the surviving entity in a merger, or sells the assets relevant
to this Agreement and the attached Schedules, Customer may terminate this
Agreement and all attached Schedules pursuant to Section 10.4, or substitute for
this Agreement and all attached Schedules a direct license with AristaSoft's
licensor of the Software. In the latter event, AristaSoft's successor shall
provide Customer with consulting services, [***], sufficient to accomplish
Customer's transition to a direct license of the Software [***]. Pricing of the
direct license shall be pursuant to Section 10 of Schedule A.
10.7 Effect of Termination. Upon the effective date of expiration or
termination of this Agreement, subject to Section 10 of Schedule A, AristaSoft
will cease providing the Services. Immediately thereafter AristaSoft will
provide: (i) Customer with electronic copies from the full backup of the most
recent Customer Data and instructions, so that Customer may restore the data
into an AristaSoft similar server hardware environment; (ii) the necessary
customization of the Software provided that Customer has agreed to pay a special
termination fee, in an amount to be mutually agreed to; and (iii) the
specifications for the hardware and software environment that would be necessary
for Customer to restore and operate the Software and Customer Data. Within
thirty (30) days after such expiration or termination, but not before the
expiration of any additional period pursuant to Section 10 of Schedule A: (i)
each party agrees to return or destroy all Confidential Information of the other
party in its possession at the time of expiration or termination and will not
make or retain any copies of such Confidential Information except as required to
comply with any applicable legal or accounting record keeping requirement; and
(ii) Customer will return any Equipment provided hereunder and that is located
within its premises or under its control. Termination of this Agreement or any
License shall not limit either party from pursuing other remedies available to
it, including injunctive relief, nor shall such termination relieve Customer's
obligation to pay all fees that have accrued or are otherwise owed by Customer
under any Schedule A or C. Subject to Section 10 of Schedule A, Customer shall
cease access to the Software, and certify to AristaSoft within one month after
expiration or termination that Customer has destroyed or has returned to
AristaSoft all copies of the Software, if any. This requirement applies to
copies in all forms, partial and complete, in all types of media and computer
memory, and whether or not modified or merged into other materials.
10.8 Survival. The following provisions will survive any expiration or
termination of the Agreement: Sections 5, 7, 8, 9, 10, and 11.
11. MISCELLANEOUS PROVISIONS
11.1 Marketing Programs:
i. Joint Press Release. Customer agrees to participate with
AristaSoft in a joint press release ("Press Release"). The Press Release will be
issued on a mutually agreed upon date or the first business day following the
ninetieth (90th) day after the Effective Date, whichever is earlier. Customer
and AristaSoft must both approve the Press Release in advance, such approval not
to be unreasonably delayed or withheld.
ii. Customer Success Story. Subject to its satisfaction with the
Services, Customer agrees to be the subject of a AristaSoft "Customer Success
Story", although any such material released to the public or press by AristaSoft
which mentions or discusses Customer is subject to Customer's prior approval,
which shall not be unreasonably delayed or withheld. AristaSoft may write a
collateral piece discussing Customer's business and use of Services and its
impact on Customer's business. The Customer Success Story will be delivered to
Customer for review on a mutually agreed upon date, not to exceed ninety (90)
days after the Effective Date.
*** Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to
the omitted portions.
-6-
<PAGE> 7
iii. Customer Reference. Subject to its own resource constraints
and satisfaction with the Services provided by AristaSoft hereunder, Customer
consents to AristaSoft identifying it as a reference for AristaSoft customer
prospects' inquiries and press inquiries. It is understood that this will be a
controlled effort and will be managed to ensure minimum impact on Customer. The
objective focuses on Customer discussing its use of AristaSoft service in
addition to the positive experiences and support provided in the working
relationship with AristaSoft. Customer's obligation under this provision is
entirely voluntary, and the parties agree that Customer's refusal to perform
under this provision shall not constitute a breach of this Agreement
iv. Customer Acknowledgement: Customer agrees that AristaSoft
can disclose Customer as a customer of AristaSoft.
11.2 Force Majeure. Except for the obligation to pay money, neither
party will be liable for any failure or delay in its performance under this
Agreement due to any cause beyond its reasonable control, including acts of God,
earthquake, flood, war, embargo, riot, sabotage, labor shortage or dispute,
governmental act or failure of the Internet, provided that the delayed party:
(a) gives the other party prompt notice of such cause, and (b) uses reasonable
commercial efforts to correct promptly such failure or delay in performance. If
the interruption exceeds thirty (30) days, either party may terminate this
Agreement without any liability to the other party for such termination.
11.3 Government Regulations. Customer will not export, re-export,
transfer, or make available, whether directly or indirectly, any regulated item
or information to anyone outside the United States in connection with this
Agreement without first complying with all export control laws and regulations
which may be imposed by the United States Government and any country or
organization of nations within whose jurisdiction Customer operates or does
business.
11.4 Non-Solicitation. During the term of this Agreement, and for one
year after the termination or expiration of this Agreement in accordance with
its terms, each party will not directly or indirectly, solicit, or attempt to
solicit, for employment any persons employed by the other party in the
performance or supervision of the Services for the other party during such
period.
11.5 Governing Law. This Agreement is made under, and will be governed
by and construed in accordance with, the laws of the State of California (except
that body of law controlling conflicts of law) and specifically excluding from
application to this Agreement that law known as the United Nations Convention on
the International Sale of Goods.
11.6 Arbitration. Any dispute relating to the terms, interpretation or
performance of this Agreement (other than claims for preliminary injunctive
relief or other pre-judgment remedies) will be resolved at the request of either
party through binding arbitration. Arbitration will be conducted in Santa Clara
County, California, under the rules and procedures of the Judicial Arbitration
and Mediation Society ("JAMS"). The parties will request that JAMS appoint a
single arbitrator possessing knowledge of online services agreements; however,
the arbitration will proceed even if such a person is unavailable.
11.7 Severability. If a tribunal of competent jurisdiction holds any
provision of this Agreement to be contrary to the law, the remaining provisions
of this Agreement will remain in full force and effect, and the illegal
provision will be replaced with a legal provision that incorporates the original
intent of the parties.
11.8 Waiver. The waiver of any breach or default of this Agreement will
not constitute a waiver of any subsequent breach or default, and will not act to
amend or negate the rights of the waiving party.
11.9 Assignment. Neither party may assign its rights or delegate its
duties under this Agreement either in whole or in part without the prior written
consent of the other party, except as part of a corporate reorganization,
consolidation, merger, or sale of substantially all of its assets. Any attempted
assignment or delegation without such consent will be void. This Agreement will
bind and inure to the benefit of each party's successors and permitted assigns.
11.10 Notices. Any notice or communication required or permitted to be
given hereunder may be delivered by hand, deposited with an overnight courier,
or mailed by registered or certified mail, return receipt requested, postage
prepaid, in each case to the address of the receiving party indicated on the
signature page hereof, or at such other address as may hereafter be furnished in
writing by either party hereto to the other. Such notice will be deemed to have
been given as of the date it is delivered, mailed or sent, whichever is earlier.
To expedite communications, each party agrees to treat
-7-
<PAGE> 8
documents faxed or e-mailed as original documents; nevertheless, each party may
require the other to exchange original signed documents.
11.11 Relationship of Parties. AristaSoft and Customer are independent
contractors and this Agreement will not establish any relationship of
partnership, joint venture, employment, franchise or agency between AristaSoft
and Customer. Neither AristaSoft nor Customer will have the power to bind the
other or incur obligations on the other's behalf without the other's prior
written consent, except as otherwise expressly provided herein.
11.12 Entire Agreement; Counterparts. This Agreement, including these
general terms and conditions, the Schedules and exhibits thereto, and all other
documents incorporated herein by reference, constitutes the complete and
exclusive agreement between the parties with respect to the subject matter
hereof, and supersedes and replaces any and all prior or contemporaneous
discussions, negotiations, understandings and agreements, written and oral,
regarding such subject matter. This Agreement may be executed in two or more
counterparts, each of which will be deemed an original, but all of which
together shall constitute one and the same instrument.
11.13 Attachments. The following documents are attached hereto as
Schedules, and are incorporated by reference in their entirety:
- Schedule-A (Application Services Order Form)
- Schedule-B (Software Access and Support Services Schedule)
- Schedule-C (Consulting Services Schedule)
11.14 IMPORTANT-THIS ARISTASOFT SERVICE AGREEMENT IS A LEGAL AGREEMENT
BETWEEN CUSTOMER AND ARISTASOFT CORPORATION FOR THE ARISTASOFT SERVICES
IDENTIFIED ABOVE, INCLUDING THOSE SET FORTH IN RELATED SCHEDULES. BY USING THESE
SERVICES YOU AGREE TO BE BOUND BY THE TERMS OF THIS AGREEMENT EFFECTIVE AS OF
THE DATE FIRST ABOVE WRITTEN. IF YOU DO NOT AGREE TO THE TERMS OF THIS
AGREEMENT, PROMPTLY RETURN THE UNUSED MATERIAL RELATED TO THE SERVICES TO
ARISTASOFT CORPORATION.
Accepted and Agreed:
CUSTOMER ARISTASOFT
By: By:
-------------------------------- ---------------------------------
Print Name: Print Name:
------------------------ -------------------------
Title: Title:
----------------------------- ------------------------------
Date: Date:
------------------------------ -------------------------------
-8-
<PAGE> 9
SCHEDULE A
APPLICATION SERVICES ORDER FORM
This Schedule A, Application Services Order Form, is attached to, and governed
by, the terms and conditions as set forth in the AristaSoft Corporation
Application Services Agreement No. 1, dated December 23rd, 1999 (the
"Agreement"). Capitalized terms not otherwise defined herein shall have the
meanings used in the Agreement.
SOFTWARE
AristaSoft will provide Customer with remote access to Servers controlled by
AristaSoft on which AristaSoft hosts the following Software:
<TABLE>
<CAPTION>
VENDOR SOFTWARE PRODUCT SOFTWARE APPLICATION
------ ---------------- --------------------
<S> <C> <C>
J.D. Edwards OneWorld Foundation
J.D. Edwards OneWorld Financial
J.D. Edwards OneWorld Logistics/Distribution
J.D. Edwards OneWorld Manufacturing
</TABLE>
APPLICATION ACCESS FEES
The application access fees for the Software listed in this schedule will be
calculated as per the following fees:
<TABLE>
<CAPTION>
TYPE OF USER FEE PER USER PER MONTH
------------ ----------------------
<S> <C>
Named User [***]
Moderate User [***]
Inquiry User [***]
</TABLE>
1. MINIMUM USERS FOR SOFTWARE.
<TABLE>
<CAPTION>
<S> <C> <C>
Number of Minimum Named Users [***] [***]
Number of Minimum Moderate Users [***] [***]
Number of Minimum Inquiry Users [***] [***]
TOTAL MINIMUM USERS [***]
TOTAL MINIMUM MONTHLY FEE [***]
</TABLE>
2. TERM.
The term of this Schedule is three (3) years, which shall commence on
the Initial Access Date, as defined in Section 2.3 of the Agreement.
*** Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to
the omitted portions.
<PAGE> 10
3. ADDITIONAL USER FEES.
The monthly fee for the minimum Users up to the amount set forth in
Section 1 shall be fixed for the term of this Schedule. Customer may add
additional Users at any time during the term of this Schedule. Monthly fees for
additional Users shall be based on the category of the User (Named, Moderate, or
Inquiry Users as defined below) at the above rates. Customer will use its best
efforts to notify AristaSoft of any changes in the number of Users, (increase or
decrease) 30 days prior to such change. Notwithstanding the foregoing,
AristaSoft will add Users within one business day of written notification by
Customer and delete Users within four (4) hours of written notification from
Customer.
4. USER DEFINITIONS.
- A "Named User" shall mean a User of the Software to whom a "user id"
has been assigned.
- A "Moderate User" is a User authorized to use the Software only to
complete the following tasks: time entry, address book, calendar
approvals, approvals and processing of procurement and sales orders,
work order approval and entry, and job completion and job status
functions.
- An "Inquiry User" is a User accessing the Software for inquiry and
information retrieval purposes only.
AristaSoft will tailor application restrictions for individual Users at
Customer's written request.
5. NETWORK & INFRASTRUCTURE SET-UP FEE.
AristaSoft will perform network and infrastructure set-up at the premise
of Customer's principal place of business. Additional Customer premises may
receive the Services at a charge of [***] for the complete delivery,
installation, and configuration of Equipment, provided that such additional
premises are within the greater San Francisco Bay area. This charge includes
installation of communications lines and associated termination and local
hardware and software. Customer must provide AristaSoft no less than sixty (60)
days notice before the desired installation date. AristaSoft will invoice
Customer for this fee upon completion of installation, including successful
testing and Customer acceptance of Services to be provided.
6. TELECOMMUNICATIONS USAGE COSTS.
AristaSoft will be responsible for the initial telecommunications
connection and recurring telecommunications costs for usage of the communication
line. AristaSoft is responsible for the telecommunications provider relationship
and maintenance of the line. AristaSoft will include a backup communication line
to mitigate line outage problems.
*** Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to
the omitted portions.
-2-
<PAGE> 11
7. SERVERS.
AristaSoft will be responsible for providing Servers to host the
Software. The Servers will be provisioned, installed, managed, backed-up,
maintained, and controlled by AristaSoft to ensure proper and adequate operation
of the Software.
8. SOFTWARE MANAGEMENT.
AristaSoft will be responsible for managing the Software hosted on the
Servers. Software management will include but is not limited to Software
administration, Software security, Software performance tuning, network
administration, and Software maintenance.
9. DATA CENTER FACILITY.
AristaSoft will be responsible for locating the Servers in a Data Center
facility that provides proper and adequate environment for operation of the
Servers including but not limited to capabilities such uninterrupted power
supply, back-up power systems, access to alternate power grid, redundant fire
suppression system, 24-hour physical security systems with automatic
surveillance and intrusion detection, and electronic firewall protection against
unauthorized electronic access.
10. CHARTER CUSTOMER PROTECTION.
a. UNINTERRUPTED SERVICE PROTECTION
AristaSoft will ensure an additional [***] of uninterrupted Services for
Customer in the event that either AristaSoft discontinues providing the Services
or Customer terminates the Service Agreement and associated Schedules pursuant
to Sections 10.3, 10.4, 10.5, or 10.6 ("Charter Customer Protection"). The
Charter Customer Protection will consist of:
1. Continuation of access to Software
a. [***]
b. [***]
c. [***]
d. [***]
e. [***]
2. Porting of Customer Data to environment specified by Customer
a. [***]
b. [***]
AristaSoft will provide Customer with written certification of such
agreements from its key suppliers not later than sixty (60) days after the
Effective Date of the Agreement.
*** Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to
the omitted portions.
-3-
<PAGE> 12
b. TRIAL ACCEPTANCE PERIOD
Customer shall have [***] after the Initial Access Date in which to
assess, in its sole discretion, Software Access Performance and the quality of
AristaSoft's Support Services (the "Trial Acceptance Period"). At any time
during the Trial Acceptance Period, Customer may provide AristaSoft with written
notice of termination of the Agreement and all attached Schedules, which shall
be treated as a termination pursuant to Section 10.5 of the Agreement, and
Customer shall be entitled to the remedies provided by that Section.
c. DIRECT LICENSE OPTION
Customer will have the option to directly license the Software listed in
this Schedule from AristaSoft's licensor [***] if: a) Customer discontinues the
Services for any reason during the [***] acceptance period outlined above; or b)
AristaSoft discontinues the Services for any reason, including a bankruptcy or
reorganization but excluding Customer's material breach of the Agreement, during
the term of this Schedule. For purposes of this provision, [***].
Accepted and Agreed:
CUSTOMER ARISTASOFT
By: By:
-------------------------------- ---------------------------------
Print Name: Print Name:
------------------------ -------------------------
Title: Title:
----------------------------- ------------------------------
Date: Date:
------------------------------ -------------------------------
*** Certain information on this page has been omitted and filed separately with
the Commission. Confidential treatment has been requested with respect to
the omitted portions.
-4-
<PAGE> 13
SCHEDULE B
SOFTWARE ACCESS AND SUPPORT SERVICES SCHEDULE
This Schedule B, Software Access and Support Services Schedule, is
attached to, and governed by, the terms and conditions as set forth in the
AristaSoft Corporation Application Services Agreement No. 1, dated December
23rd, 1999 (the "Agreement"). Capitalized terms not otherwise defined herein
shall have the meanings used in the Agreement.
1. SOFTWARE ACCESS.
1.1 Access. Subject to the terms and conditions of this Schedule, and
for as long as Customer is granted access per this Agreement, AristaSoft grants
Customer non-exclusive, non-transferable rights to access and use the Software
solely for Customer's own internal business processing operations; and solely by
the number of authorized users of the Software identified in Schedule A to the
Agreement and any additional User added by Customer during the term of this
Agreement.
1.2 Restrictions. During the term of this Agreement, Customer will not:
(i) disassemble, reverse engineer, decompile, or otherwise attempt to derive
source code from the Software; modify, adapt, create derivative works based
upon, or translate the Software; (ii) copy, install or use the Software on any
of its computer systems, servers, or networks; (iii) transfer, lease, loan,
resell for profit, distribute or otherwise grant any rights in the Software in
any form to any other party, including commercial time-sharing, rental, or
service bureau use.
1.3 Ownership. The right to access the Software is not a license sale
and does not convey any rights of ownership in or to the Software. AristaSoft is
not granting Customer any rights whatsoever in the Software source code. All
right, title, and interest in the Software and any Updates, Upgrades or
modifications thereof, or in any ideas, know-how, and programs developed by
AristaSoft or its licensor during the term of the Agreement will remain the
property of AristaSoft or its licensor. All right, title, and interest in
Customer Data will remain the property of Customer
2. DESIGNATED CONTACTS.
2.1 AristaSoft Contacts. AristaSoft will designate one primary and one
alternate contact per functional area of the Software (for example: Financial,
Distribution/Logistics, Manufacturing) for Customer to communicate with for
customer support service.
3. SUPPORT SERVICES.
3.1 Software Management Services. AristaSoft will locate the Servers
where the Software is hosted in a Data Center. AristaSoft will provide
performance analysis and tuning services, hardware preventative maintenance, and
regular back-up services. With respect to the Software, AristaSoft will be
responsible for installing and configuring the Software on AristaSoft's Servers.
AristaSoft will answer technical questions by Customer concerning application
functionality of the Software within the scope of this Schedule.
<PAGE> 14
3.2 Backup Operations. AristaSoft will perform an incremental backup of
its Servers, including Customer Data, on a daily basis and full backup on a
weekly basis. Backup tapes will be stored off-site at a physically secure
location. Customer Data will be archived every six (6) months and available
online for up to eighteen (18) months. AristaSoft will verify its backup
capabilities every six months by restoring the system and Customer Data onto a
duplicate Server.
3.3 Physical Security. AristaSoft's Data Center is located in a facility
physically secure against unauthorized entry. Only select AristaSoft employees
have access to the Data Center, and Customer access requires an authorized
AristaSoft escort.
3.4 Electronic Security. AristaSoft's Data Center includes an electronic
"firewall" to prevent unauthorized electronic access. Authorized electronic
access is limited to specific AristaSoft employees.
3.5 Security Audits. AristaSoft's physical and electronic security
measures will be subject to semi-annual audit by an independent contractor.
AristaSoft will disclose the audit results and corrective actions plan, if any,
to Customer, and will implement reasonable corrective measures recommended by
such results.
3.6 Upgrades. Upgrades and Updates may be made available to Customer
only when they are made available to AristaSoft by AristaSoft's third party
licensor per the agreement between AristaSoft and its licensor. AristaSoft will
install Upgrades and Updates into live operations once they have been certified
by AristaSoft as being operations-worthy. AristaSoft and Customer will
collaborate concerning the impact of Upgrades and Updates on Customer's business
processes. AristaSoft will make a range of implementation dates for Upgrades
available to Customer, and Customer agrees to implement within a mutually agreed
timeframe.
3.7 System Maintenance. AristaSoft will implement regularly scheduled
maintenance, application "bug" fixes, software patches, etc. during 12:00 a.m.
to 6:00 a.m. Pacific Time. AristaSoft will report maintenance activities will be
reported to Customer via e-mail in advance. However, unless necessary to ensure
functioning of the Software , no changes to the processing environment or
network will be made during the last week and the first two weeks of every
calendar quarter.
3.8 Change Support. AristaSoft will provide one hour per month per Named
User as "Change Support" for on-going changes after the Initial Access Date.
These hours expire on a quarterly basis if unutilized. Customer may request
additional hours and these will be charged for on a time and material basis. The
Change Support hours cannot be used to add new modules or build interfaces with
external subsystems, but can be used towards making reasonable incremental
changes over the initial set-up, including: adding new reports, modifying
existing reports, extracting data, modifying existing business process, or
adding new business processes.
-2-
<PAGE> 15
3.9 Customer Support.
(a) During the term of this Agreement, AristaSoft will provide
support personnel that will be available during AristaSoft Business Days, and
via the communication methods defined below.
(b) AristaSoft Business Days. Except for designated holidays and
critical and priority events as described below, standard support hours are
Monday through Friday, 8:00 a.m. to 5:00 p.m., Pacific Time.
(c) Communication Methods. Customer can communicate with
AristaSoft's service team by phone at 1-800-787-0100 or 1-650-318-9888 or e-mail
at [email protected]. AristaSoft will inform Customer in writing
of any changes to this number or of additional communication methods.
(d) Customer Support Services. AristaSoft will provide support
on the use of the Software. Support is provided for the Software only as it is
configured by AristaSoft, and not in any other form, or configuration.
AristaSoft will provide Customer with the following Customer Support Services:
<TABLE>
<S> <C>
Customer Support Calls Unlimited number of calls for the first 3 months
after Initial Access Date 5 calls per Named User
per month after Initial Access Date Unlimited
calls for a designated Customer contact.
User Meetings None
Conference Calls Once every calendar quarter
Site Visits Once every six months
Service Usage Reports Once per month via e-mail
Reports will include information on User access,
system uptime, backup, average response time, and
customer support call reports
</TABLE>
Adverse Events. AristaSoft will respond to reported adverse events according to
the following protocols mutually defined by Customer and AristaSoft.:
<TABLE>
<CAPTION>
SEVERITY DEFINITION RESPONSE TIME
-------- ---------- -------------
<S> <C> <C>
Critical Access to the Software is not available to Corrective actions will commence
any of Customer's users, including due to immediately, 24 hours per day, 7
telecommunications outages/problems. days per week, with the objective
to resume availability within 8
hours.
Priority Access to the Software is available, but Actions will commence within 4
a specific function, field, or business hours, 24 hours per day, 7 days
process is not functioning or producing per week, with the objective to
desired results. resume full functionality within
48 hours.
</TABLE>
-3-
<PAGE> 16
<TABLE>
<CAPTION>
SEVERITY DEFINITION RESPONSE TIME
-------- ---------- -------------
<S> <C> <C>
Standard A problem or question that does not AristaSoft will seek to
require immediate attention for address/solve the problem within
clarification or guidance on how to use 1 week, on a first come, first
the documentation or online help screens. served basis.
</TABLE>
(e) Customer and AristaSoft agree to review and update the
Customer Support Services described in this Section during the first year of
Service since the Initial Access Date to reflect any required changes. Any
changes will be mutually agreed by both parties.
3.10 Management and Classification of Software Errors. AristaSoft will
promptly report all reproducible errors experienced by Customer, which have been
reported to AristaSoft by the Customer, to the applicable licensor of the
Software. AristaSoft agrees to use all commercially reasonable efforts to
document and report Software errors to the applicable licensor of the Software
for resolution. AristaSoft agrees to cooperate with Customer in seeking
resolution of such errors.
3.11 Customer Service Disputes. If, not later than one (1) week of
reporting a customer service issue or an adverse event to AristaSoft, Customer
is unhappy with the outcome or AristaSoft's progress toward an outcome, a
three-stage process is available for escalating customer service issues and
resolution of application events.
(i) If, for any reason Customer decides a customer service issue
or application event is not being properly addressed, Customer must bring the
issue to the attention of the Manager, Customer Support. The Manager, Customer
Support will thereafter be responsible for tracking and overseeing resolution of
the reported issue or event until Customer is satisfied with the outcome.
(ii) If, for any reason Customer still is not satisfied that the
customer service issue or application event is being properly addressed,
Customer may request that the matter be brought to the attention of the
Director, Customer Support. At this point, the Director, Customer Support must
respond to the issue and track and oversee resolution of the reported issue or
event until Customer is satisfied with the outcome.
(iii) If the matter remains unresolved, Director, Support will
report it to Vice President, Customer Support. The Vice President, Customer
Support will ensure that the issue is resolved to Customer's satisfaction and
report all such issues to the President and Chief Executive Officer of
AristaSoft.
4. CUSTOMER RESPONSIBILITIES.
4.1 Customer's responsibilities shall be to:
(a) Provide to AristaSoft all applicable information regarding
any Software performance issue, to enable AristaSoft to duplicate the
circumstances indicating a reported Software defect or error;
-4-
<PAGE> 17
(b) Provide best efforts to cooperate with AristaSoft with
respect to testing, isolating, identifying, documenting, and in any other
actions necessary to resolve any Software issues and errors;
(c) Appoint a single person as an AristaSoft Contact who shall
be the primary information technology support contact for AristaSoft and
internal Customer users with regard to Customer information technology issues. A
secondary contact will be appointed as an alternate for times when the primary
contact is unavailable for urgent issues. Customer information technology issues
include, but are not limited to, hardware, software, desktop setup, network and
all other technical issues that affect operation of the Software; and
(d) Notify AristaSoft of any of Customer's network changes that
may impact user connectivity one week prior to implementation of such changes.
(e) Assist AristaSoft to ensure that access to the Software is
granted only to Users who are properly trained on the use of the Software
(f) Assist AristaSoft to ensure that access to the Software and
Servers is granted only to Users who are authorized to see the applicable
Customer Data, as specified in the Software, Server and Customer Data minimum
security requirements guidelines published by AristaSoft from time to time.
(g) Provide to Users the necessary personal computer hardware
and software required to access the Software, as specified in the minimum
requirements guidelines published by AristaSoft from time to time.
5. SOFTWARE ACCESS PERFORMANCE STANDARDS.
5.1 Performance Standards. During the Trial Acceptance Period (as
defined in Schedule A), AristaSoft and Customer will mutually agree on the
Software Access Performance Standards for AristaSoft's Services provided
hereunder. Such criteria will be reduced to writing and attached as a
replacement Exhibit 1 to this Schedule. Preliminary standards are attached
hereto as Exhibit B-1.
(a) If AristaSoft and Customer are unable to reach agreement on
the Software Access Performance Standards prior to the end of the Trial
Acceptance Period, Customer may terminate this entire Agreement and all
Schedules with AristaSoft pursuant to Section 10.5 of the Service Agreement and
the remedies provided therein.
6. WARRANTY AND DISCLAIMER.
6.1 Warranty. AristaSoft warrants to Customer that:
(a) it has the right and authority to enter into and to grant
the rights described in this Schedule and it will perform its obligations
hereunder in a professional and workmanlike manner by employees with the
requisite education, training, and skills to perform such obligations;
-5-
<PAGE> 18
(b) the Software shall function substantially in accordance with
its specifications in the Documentation;
(c) any hardware provided by AristaSoft which malfunctions
during the term of this Agreement or any renewal thereof, shall be promptly
repaired or replaced by AristaSoft at no cost to Customer; and
(d) Customer shall have the benefit of any warranties from the
Software licensor that are available to AristaSoft, provided however, that
Customer's remedy for breach of any such warranty shall be solely against that
licensor.
6.2 Disclaimer. AristaSoft specifically does not warrant that the
Software will meet all of Customer's requirements, that the access to the
Software and the Servers will be uninterrupted or error-free, that patches or
workarounds will be provided, or that errors will be corrected in Updates,
according to this Schedule, or in every case.
6.3 ARISTASOFT SPECIFICALLY DISCLAIMS ALL IMPLIED WARRANTIES OF
MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE AND NONINFRINGEMENT.
7. SURVIVAL OF TERMS.
7.1 Section 6 will survive termination or expiration of the Agreement
and this Schedule for any reason.
Accepted and Agreed:
CUSTOMER ARISTASOFT
By: By:
-------------------------------- ---------------------------------
Print Name: Print Name:
------------------------ -------------------------
Title: Title:
----------------------------- ------------------------------
Date: Date:
------------------------------ -------------------------------
-6-
<PAGE> 19
EXHIBIT B-1
Preliminary Software Access Performance Standards
ACCESS
AristaSoft will provide Customer with the ability to remotely access the
Software hosted on the Servers, as of Initial Access Date. Such access shall be
provided on a twenty-four hours-a-day, seven days-a-week basis, except during
scheduled and unscheduled maintenance downtime. AristaSoft will use best efforts
to perform any scheduled downtime outside of normal business hours.
Notwithstanding the foregoing, Customer will be able to remotely access the
Software for not less than 99% of the scheduled available time, with the
exception of telecommunication company service problems, software defects, any
problems caused by Customer, and any other forces beyond the immediate control
of AristaSoft.
RESPONSE TIME
AristaSoft will provide Customer with a telecommunication lines from the
Customer premises to the Servers that hosts the software. Such communication
lines shall be provided such that the aggregate round-trip latency will not
exceed one (1) second in normal operation.
SERVER CAPACITY
AristaSoft will provide Customer with Servers to host the Software. Such Server
shall be controlled to deliver sufficient capacity to satisfy Customer's
requirements including but not limited to processing, memory and storage
capacity.
<PAGE> 20
SCHEDULE C
Consulting Services Schedule
This Schedule C, Consulting Services Schedule, is attached to, and governed by,
the terms and conditions as set forth in the AristaSoft Corporation Application
Services Agreement No. 1, dated December 23rd, 1999 (the "Agreement").
Capitalized terms not otherwise defined herein shall have the meanings used in
the Agreement.
1. SCOPE OF SERVICES.
1.1 Services. AristaSoft will provide the consulting services (the
"Consulting Services") described in the Statement of Work attached hereto, as
amended from time to time by written, mutual agreement of the parties. Should
Customer desire to change the Consulting Services, or obtain additional
services, Customer will submit the proposed modification in writing to
AristaSoft. AristaSoft may, at its sole option, elect to perform the
modifications and/or additional services and the parties will execute a revised
Statement of Work setting forth the modified Consulting Services to be
performed.
1.2 Manner of Performance.
(a) AristaSoft will retain the sole and exclusive right to
control or direct the manner or means by which the Consulting Services are
performed and may subcontract or assign any or all of its obligations and rights
under this Schedule. AristaSoft will inform Customer of any third party who
requires access to Customer Data, and will ensure that confidentiality of
Customer Data is maintained as specified in Section 5.2 of the Agreement.
(b) Unless otherwise agreed, the Consulting Services shall be
performed during AristaSoft's normal business hours.
(c) AristaSoft shall use reasonable commercial efforts to
provide the Consulting Services in accordance with any dates or delivery
schedule that may be set forth in the Statement of Work.
1.3 Statement of Work. Any Statement of Work that is provided under this
Schedule shall be (1) made in writing; (2) reference this Schedule; and (3) be
executed by authorized representatives of both Customer and AristaSoft.
2. CUSTOMER'S DUTIES AND RESPONSIBILITIES.
2.1 Data and Information. Customer will make available in a timely
manner at no charge to AristaSoft all technical data, computer facilities,
programs, files, documentation, test data, sample output, or other information
and resources required by AristaSoft for the performance of the Services.
Customer will be responsible for, and assumes the risk of any problems resulting
from, the content, accuracy, completeness and consistency of all such data,
materials and information supplied by Customer.
-8-
<PAGE> 21
2.2 Equipment. Customer shall provide, at no charge to AristaSoft,
office space, services and equipment (such as copiers, fax machines and modems)
as AristaSoft reasonably requires to perform the Services.
3. SERVICES CONTACT.
3.1 Each party will appoint in writing an employee or agent of such
party to act as the "Consulting Contact" for all communication between the
parties related to the Consulting Services. The Consulting Contact will monitor
the status of the Consulting Services and schedule regular meetings with both
technical and management personnel of each party to review the status of the
Consulting Services. Either party may change its Consulting Contact upon written
notice to the other.
4. LIMITED WARRANTY.
AristaSoft warrants that it will perform its obligations hereunder in a
professional and workmanlike manner. Except as set forth in the preceding
sentence, ALL SERVICES PROVIDED PURSUANT TO THIS SCHEDULE ARE PROVIDED "AS IS",
AND ARISTASOFT DISCLAIMS ALL WARRANTIES, EXPRESS, IMPLIED, STATUTORY, OR
OTHERWISE REGARDING OR RELATING TO ANY MATERIALS OR SERVICES FURNISHED OR
PROVIDED TO CUSTOMER UNDER THIS SCHEDULE. ARISTASOFT SPECIFICALLY DISCLAIMS ALL
IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE WITH
RESPECT TO SAID MATERIALS AND SERVICES, AND WITH RESPECT TO THE USE OF ANY OF
THE FOREGOING.
5. NON-SOLICITATION.
5.1 Both parties acknowledge and agree that the employees and
consultants of each are a valuable asset to each party, respectively, and are
difficult to replace. Accordingly, each of AristaSoft and Customer agrees that,
for a period of one (1) year after the completion of the Consulting Services,
neither party will solicit the employment, as an employee, independent
contractor, or consultant, of any employee or consultant of either party.
-2-
<PAGE> 22
6. TERM.
6.1 This Schedule will take effect on the date of signing and will
remain in effect, unless earlier terminated in accordance with the Service
Agreement or any Schedule attached thereto, until all of the Consulting Services
have been completed. The specific pricing for each Statement of Work referencing
this Schedule C will be contained therein.
Accepted and Agreed:
CUSTOMER ARISTASOFT
By: By:
-------------------------------- ---------------------------------
Print Name: Print Name:
------------------------ -------------------------
Title: Title:
----------------------------- ------------------------------
Date: Date:
------------------------------ -------------------------------
-3-
<PAGE> 1
EXHIBIT 23.1
CONSENT OF KPMG LLP, INDEPENDENT AUDITORS
The Board of Directors
Turnstone Systems, Inc.
The audits referred to in our report dated January 6, 2000, included the
related financial statement schedule as of December 31, 1998 and 1999, and for
the period from January 2, 1998 (inception) to December 31, 1998 and for the
year ended December 31, 1999, included in the registration statement. This
financial statement schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion on this financial statement schedule
based on our audits. In our opinion, such financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
We consent to the use of our reports dated January 6, 2000 on the balance
sheets of Turnstone Systems, Inc., as of December 31, 1998 and 1999, and the
related statements of operations, stockholders' equity, and cash flows for the
period from January 2, 1998 (inception) to December 31, 1998 and the year ended
December 31, 1999, included herein and to the reference to our firm under the
heading "Experts" in the prospectus.
Mountain View, California
January 10, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
BALANCE SHEETS AT DECEMBER 31, 1998 AND 1999 AND STATEMENTS OF OPERATIONS FOR
THE YEAR ENDED DECEMBER 31, 1998 AND 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1999
<PERIOD-START> JAN-02-1998 JAN-01-1999
<PERIOD-END> DEC-31-1998 DEC-31-1999
<CASH> 1,338 8,063
<SECURITIES> 0 0
<RECEIVABLES> 0 6,715
<ALLOWANCES> 0 276
<INVENTORY> 0 2,939
<CURRENT-ASSETS> 1,434 18,040
<PP&E> 616 1,505
<DEPRECIATION> 108 420
<TOTAL-ASSETS> 1,970 19,257
<CURRENT-LIABILITIES> 474 7,071
<BONDS> 0 0
0 0
12 15
<COMMON> 10 11
<OTHER-SE> 1,204 11,865
<TOTAL-LIABILITY-AND-EQUITY> 1,970 19,257
<SALES> 0 27,196
<TOTAL-REVENUES> 0 27,196
<CGS> 0 12,359
<TOTAL-COSTS> 4,941 14,737
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 276
<INTEREST-EXPENSE> 12 45
<INCOME-PRETAX> (4,748) 280
<INCOME-TAX> 1 463
<INCOME-CONTINUING> (4,749) (183)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (4,749) (183)
<EPS-BASIC> (3.97) (0.04)
<EPS-DILUTED> (3.97) (0.04)
</TABLE>
