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Filed Pursuant to Rule 424(b)(4)
File No. 333-92097
PROSPECTUS
6,000,000 Shares
LOGO
COMMON STOCK
------------------------
AVANEX CORPORATION IS OFFERING SHARES OF ITS COMMON STOCK. THIS IS OUR INITIAL
PUBLIC OFFERING AND NO PUBLIC MARKET CURRENTLY EXISTS FOR OUR SHARES. CONCURRENT
WITH THE SALE OF THE SHARES OF OUR COMMON STOCK IN THIS OFFERING, WE WILL SELL
DIRECTLY TO EACH OF MICROSOFT CORPORATION AND MCI WORLDCOM VENTURE FUND, AN
AFFILIATE OF MCI WORLDCOM, INC., 384,615 SHARES OF OUR COMMON STOCK AT A
PURCHASE PRICE OF $13 PER SHARE. SEE "CONCURRENT SALE OF STOCK TO CORPORATE
INVESTORS" ON PAGE 21.
------------------------
OUR COMMON STOCK HAS BEEN APPROVED FOR QUOTATION ON THE NASDAQ NATIONAL MARKET
UNDER THE SYMBOL "AVNX."
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INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 7.
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PRICE $36 A SHARE
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<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS AVANEX
-------- ------------- -----------
<S> <C> <C> <C>
Per Share..................................... $36.00 $2.52 $33.48
Total......................................... $216,000,000 $15,120,000 $200,880,000
</TABLE>
Avanex has granted the underwriters the right to purchase up to an additional
900,000 shares to cover over-allotments.
The Securities and Exchange Commission and state securities regulators have not
approved or disapproved these securities, or determined if this prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.
Morgan Stanley & Co. Incorporated expects to deliver the shares to purchasers on
February 9, 2000.
------------------------
MORGAN STANLEY DEAN WITTER
LEHMAN BROTHERS
ROBERTSON STEPHENS
U.S. BANCORP PIPER JAFFRAY
February 3, 2000
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[INSIDE FRONT COVER]
[The inside front cover page of the prospectus starts with the heading
"Next-Generation Optical Network." Underneath it is a subheading that reads "The
Avanex Solution . . ." followed by a large box. Inside the box is a diagram with
four rectangles, one on top of the other, with a single line between each two
adjacent rectangles. Inside the four rectangles are the following words:
"Communications Service Providers
Optical Systems Providers
[LOGO] Avanex(TM) Photonic Processors
Optical Component Manufacturers"
To the left of the rectangles are two ellipses, one on top of the other,
containing the following words:
"Network System Expertise
Optical Expertise"
There is an arrow pointing from the Avanex rectangle to the bottom of the
Optical Expertise ellipse, arrows from that ellipse pointing up to the Network
System Expertise ellipse and pointing to the right between the Optical Systems
Providers rectangle and the Avanex rectangle, and an arrow pointing from the
Network System Expertise ellipse to the right between the Communications Service
Providers rectangle and Optical Systems Providers rectangles.
Below the large box is the subheading ". . . Meeting Tomorrow's Network
Requirements." Below the subheading are three rectangles side-by-side containing
the words:
"Quality of Service
Flexibility
Scalability"
Below the boxes is the following text:
"Avanex photonic processors optimize optical network performance,
providing flexible, scalable and cost-effective optical transport
solutions that facilitate data transmission over optical networks and
the deployment of next-generation, all-optical network services."]
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
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PAGE
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Prospectus Summary.................... 4
Risk Factors.......................... 7
Special Note Regarding Forward-Looking
Statements.......................... 21
Concurrent Sale of Stock to Corporate
Investors........................... 21
Use of Proceeds....................... 22
Dividend Policy....................... 22
Capitalization........................ 23
Dilution.............................. 24
Selected Financial Data............... 25
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 26
</TABLE>
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Business.............................. 35
Management............................ 47
Certain Transactions.................. 60
Principal Stockholders................ 65
Description of Capital Stock.......... 68
Shares Eligible for Future Sale....... 70
Underwriters.......................... 72
Legal Matters......................... 74
Experts............................... 74
Additional Information................ 74
Index to Financial Statements......... F-1
</TABLE>
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We were incorporated in California in October 1997 and reincorporated in
Delaware in January 2000. Our principal executive offices are located at 40919
Encyclopedia Circle, Fremont, California 94538, and our telephone number is
(510) 897-4188. Our web site address is www.avanex.com. The information on our
web site is not incorporated by reference into this prospectus. Avanex,
PowerFilter, PowerMux, PowerShaper and The Photonics Center are our trademarks.
This prospectus also contains trademarks of other companies.
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell shares of common stock and
seeking offers to buy shares of common stock only in jurisdictions where offers
and sales are permitted. The information contained in this prospectus is
accurate only as of the date of this prospectus, regardless of the time of
delivery of this prospectus or of any sale of the common stock.
UNTIL FEBRUARY 29, 2000, ALL DEALERS THAT BUY, SELL OR TRADE OUR COMMON
STOCK, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER
A PROSPECTUS. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF
DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO
THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
For investors outside the United States: Neither we nor any of the
underwriters have done anything that would permit this offering or possession or
distribution of this prospectus in any jurisdiction where action for that
purpose is required, other than in the United States. You are required to inform
yourselves about and to observe any restrictions relating to this offering and
the distribution of this prospectus.
Unless otherwise indicated, all information contained in this prospectus:
- assumes that the underwriters' over-allotment option is not exercised;
- except as noted in the financial statements, gives effect to the
conversion of all shares of preferred stock outstanding as of December
31, 1999 into 35,019,134 shares of common stock effective upon the
completion of this offering; and
- reflects the exercise of warrants to purchase 337,500 shares of common
stock prior to the completion of this offering;
- gives effect to the sale of 769,230 shares of common stock to two
corporate investors. The shares will be sold directly to these corporate
investors in a private placement at a price of $13.00 per share
contemporaneously with this offering, for an aggregate of $9,999,990; and
- reflects a 3-for-2 stock split effected in connection with the
reincorporation in Delaware.
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PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company and the common stock being sold in this
offering and our consolidated financial statements and notes appearing elsewhere
in this prospectus.
Avanex designs, manufactures and markets fiber optic-based products, known
as photonic processors, which are designed to increase the performance of
optical networks. Our photonic processors offer communications service providers
and optical systems manufacturers greater levels of performance and
miniaturization, reduced complexity and increased cost-effectiveness as compared
to current alternatives. We believe photonic processors will enable the
next-generation, all-optical network, which is necessary to support the
increasing demand for capacity, or bandwidth.
The proliferation of the Internet and the increase in activities such as
electronic commerce, the transmission of large data files, Internet-based
businesses and telecommuting, have caused a significant increase in the volume
of traffic across the communications infrastructure. According to Ryan, Hankin &
Kent, a leading market research and consulting firm, Internet traffic will
increase from 350,000 terabytes, or trillions of bytes, per month, at the end of
1999 to over 15 million terabytes per month in 2003. This market research
suggests that, at the end of 1999, the volume of Internet data traffic will have
surpassed the volume of voice traffic. In an effort to increase network capacity
and performance, the transport layer, or medium over which the data traffic is
transmitted, is currently being upgraded from electrical to optical transmission
by many common carriers, including MCI, AT&T and Sprint. Despite the advances
that have occurred in the existing communications infrastructure, there are
still many challenges to deploying a next-generation, optical network,
including:
- the need to prevent an optical signal from degrading, a phenomenon known
as attenuation, by converting it into an electrical signal and back into
an optical signal at frequent intervals across a network;
- the need to compensate for chromatic dispersion, a negative effect caused
by different wavelengths of light traveling down the optical fiber at
different velocities and reaching their destination at different times;
- the need to carry increased amounts of data in each wavelength of light;
- the high cost of the optical products needed for an optical network; and
- the difficulty in deploying large pieces of optical equipment.
Our PowerFilter and PowerMux products are designed to overcome the
technological challenges, such as chromatic dispersion and attenuation, and the
cost and deployment challenges inherent in optical networks. Our products are
designed to enable the transmission of more data in a wavelength of light, at
higher speeds and across greater distances in a network, than currently
available optical technologies. Our customers can also optimize the utilization
of limited network space because we miniaturize our products and combine
multiple components in a single package. We design our products to work within
existing network deployments, as well as in future optical networks. We believe
our photonic processors enable communications service providers and optical
systems manufacturers to maximize the capacity of optical networks to facilitate
next generation services and applications, such as virtual private networking
and business-to-business electronic commerce.
Our objective is to be the leading provider of innovative, fiber
optic-based solutions that enable our customers to deploy and optimize fiber
optic networks. In order to achieve this objective, our strategy is to leverage
our technology leadership and expertise to develop new products and expand
customer relationships. We also intend to expand our manufacturing facilities,
automate our manufacturing processes and extend awareness of our brand. Our
marketing strategy is based on a push-pull approach. With our push approach, we
target optical systems manufacturers that can buy our products and then resell
them as part of their optical solutions. Using our pull approach, we target
communications service providers that can create demand for our products by
directly purchasing, or requiring that their systems incorporate, our products.
We believe this approach will drive demand for our products and help enable the
transition to the next-generation, all-optical network.
4
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THE OFFERING
Common stock offered........................ 6,000,000 shares
Common stock to be outstanding after this
offering.................................... 62,529,320 shares
Use of proceeds............................. We intend to use the net
proceeds for general corporate
purposes, including capital
expenditures and working
capital. See "Use of Proceeds."
Nasdaq National Market symbol............... AVNX
The above information is based on the number of shares of common stock
outstanding as of December 31, 1999 and assumes the exercise of warrants to
purchase 337,500 shares of common stock at an exercise price of $4.00 per share
prior to the completion of this offering, the subsequent conversion of all of
our outstanding preferred stock as of December 31, 1999 into an aggregate of
35,019,134 shares of common stock upon the completion of this offering and the
sale of 769,230 shares of common stock to two corporate investors at a price of
$13.00 per share for an aggregate of $9,999,990 in a private placement that will
close contemporaneously with this offering. It excludes 3,401,427 shares of
common stock issuable upon exercise of outstanding options with a
weighted-average exercise price of $1.40 per share, 29,347 shares of common
stock issuable upon exercise of an outstanding warrant with an exercise price of
$3.83 per share, 1,245,117 shares of common stock reserved for future awards
under our stock plans as of December 31, 1999 and an additional 7,500,000 shares
reserved for future awards under our stock plans subsequent to December 31,
1999. It also excludes 525,000 shares of stock to be reserved for issuance under
our Employee Stock Purchase Plan and 300,000 shares of stock to be reserved for
issuance under our 1999 Director Option Plan. Both of these plans will become
effective upon the completion of this offering.
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
OCTOBER 24, 1997 ----------------------------
(INCEPTION) TO YEAR ENDED DECEMBER 31, DECEMBER 31,
JUNE 30, 1998 JUNE 30, 1999 1998 1999
---------------- ------------- ------------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenue................................ $ -- $ 510 $ -- $ 10,916
Gross profit (loss)........................ -- (21) -- 2,722
Stock compensation expense................. 362 3,464 673 15,697
Total operating expenses................... 1,133 9,229 2,609 22,490
Loss from operations....................... (1,133) (9,250) (2,609) (19,768)
Net loss................................... (1,137) (9,221) (2,607) (19,794)
Net loss attributable to common
stockholders............................. (1,137) (9,221) (2,607) (39,845)
Pro forma basic and diluted net loss per
common share (unaudited)................. $ (.39) $ (1.02)
Weighted average shares used in computing
pro forma basic and diluted net loss per
common share (unaudited)................. 23,628 39,110
</TABLE>
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The following table presents our summary consolidated balance sheet data as
of December 31, 1999. The pro forma as adjusted information reflects:
- the assumed exercise of warrants to purchase 337,500 shares of common
stock at an exercise price of $4.00 per share prior to this offering and
the subsequent conversion of all of our outstanding preferred stock as of
December 31, 1999 into an aggregate of 35,019,134 shares of common stock
upon completion of this offering;
- our sale of 6,000,000 shares of our common stock in this offering after
deducting underwriting discounts and commissions and our estimated
offering expenses; and
- the sale of 769,230 shares of common stock to two corporate investors at
a price of $13.00 per share for an aggregate of $9,999,990 in a private
placement that will close contemporaneously with this offering.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
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PRO FORMA
ACTUAL AS ADJUSTED
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(UNAUDITED)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments........... $14,379 $224,584
Working capital............................................. 14,313 224,518
Total assets................................................ 28,152 238,357
Long-term obligations, excluding current portion............ 1,320 1,320
Redeemable convertible preferred stock...................... 30,408 --
Total other stockholders' equity (deficit).................. (10,498) 230,115
</TABLE>
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RISK FACTORS
This offering and any investment in our common stock involve a high degree
of risk. You should carefully consider the risks described below and all of the
information contained in this prospectus before deciding whether to purchase our
common stock. If any of the following risks actually occur, our business,
financial condition and results of operations could be harmed. The trading price
of our common stock could decline, and you may lose all or part of your
investment in our common stock.
RISKS RELATED TO OUR BUSINESS
WE HAVE NEVER BEEN PROFITABLE AND OUR FAILURE TO INCREASE OUR REVENUES
SIGNIFICANTLY WOULD PREVENT US FROM ACHIEVING AND MAINTAINING PROFITABILITY
We have incurred significant losses since inception and expect to continue
to incur losses in the future. We incurred net losses of $1.1 million in the
period from our inception on October 24, 1997 through June 30, 1998, $9.2
million in the fiscal year ended June 30, 1999, $7.5 million in the quarter
ended October 1, 1999 and $12.3 million in the quarter ended December 31, 1999.
As of December 31, 1999, we had an accumulated deficit of $50.2 million. To
date, we have not achieved profitability on a quarterly or annual basis. Due to
lack of cash generated from operations, we have funded our operations through
the sale of equity securities, bank borrowings and equipment lease financing. We
have a large amount of fixed expenses and we expect to continue to incur
significant and increasing manufacturing, sales and marketing, product
development and administrative expenses. As a result, we will need to generate
significantly higher revenues while containing costs and operating expenses if
we are ever to achieve profitability. Although our net revenue has grown from
zero in the quarter ended March 31, 1999 to $10.9 million in the six months
ended December 31, 1999, we cannot be certain that our revenues will continue to
grow or that we will ever achieve sufficient revenue levels to achieve
profitability.
BECAUSE WE HAVE A LIMITED OPERATING HISTORY AND ONLY RECENTLY BEGAN SHIPPING OUR
PRODUCTS, WE MAY BE UNABLE TO ACCURATELY EVALUATE OUR BUSINESS AND FORECAST OUR
PROSPECTS, WHICH MAY PREVENT US FROM MEETING THE PRODUCT DEMANDS OF OUR
POTENTIAL CUSTOMERS IN A TIMELY MANNER
As a result of our limited operating history, particularly our short
history of manufacturing products for sale, it is difficult to forecast our
revenues accurately, and we have limited meaningful historical financial data
upon which to plan future operating expenses. We began operations in October
1997. Until April 1999, we were a development stage company, and our only
activities were research and development. We began shipping our PowerFilter and
PowerMux products to customers for evaluation in April 1999. Volume shipments
did not commence until the quarter ended October 1, 1999. We face the risks and
difficulties frequently encountered by early stage companies in a new and
rapidly evolving market. The revenue and income potential of our products and
business are, and the size of our market is, unproven. Our ability to sell
products and achieve success will depend on, among other things, the level of
demand for our products and our capacity to meet demand.
WE EXPECT OUR QUARTERLY REVENUES AND OPERATING RESULTS TO FLUCTUATE
SIGNIFICANTLY AND THIS MAY CAUSE OUR STOCK PRICE TO DECLINE AND YOU MAY LOSE ALL
OR PART OF YOUR INVESTMENT
Our revenues and operating results are likely to vary significantly from
quarter to quarter. A number of factors, many of which are more fully discussed
in other risk factors, are likely to cause these variations, including:
- fluctuations in demand for and sales of our products, which will depend
on the speed and magnitude of the transition to an all-optical network;
- cancellations of orders and shipment rescheduling;
- our ability to significantly expand our manufacturing capacity at our new
facility in Fremont, California, which commenced operations in November
1999;
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- the ability of Concord Micro-Optics, Inc., or CMI, to timely produce and
deliver subcomponents from its facility in China in the quantity and of
the quality we require;
- the practice of companies in the communications industry to sporadically
place large orders with short lead times;
- competitive factors, including introductions of new products and product
enhancements by potential competitors, entry of new competitors into the
photonic processor market, including Lucent Technologies, Nortel Networks
and Fujitsu, and pricing pressures;
- our ability to develop, introduce, manufacture and ship new and enhanced
fiber optic products in a timely manner without defects;
- our ability to control expenses, particularly in light of our limited
operating history;
- availability of components for our products and increases in the price of
these components;
- mix of our products sold; and
- economic conditions specific to the communications and related
industries.
A high percentage of our expenses, including those related to
manufacturing, engineering, sales and marketing, research and development and
general and administrative functions, are essentially fixed in the short term.
As a result, if we experience delays in generating and recognizing revenue, our
quarterly operating results are likely to be seriously harmed. As we expand our
manufacturing capacity, we will incur expenses in one quarter relating to the
expansion and related yield issues that may not result in off-setting revenue
until a subsequent quarter. New product introductions can also result in a
mismatching of research and development expenses and sales and marketing
expenses that are incurred in one quarter with revenues that are not received
until a subsequent quarter when the new product is introduced. If growth in our
revenues does not outpace the increase in our expenses, our results of
operations could be seriously harmed.
Due to these and other factors, we believe that quarter-to-quarter
comparisons of our operating results will not be meaningful. You should not rely
on our results for one quarter as any indication of our future performance. It
is likely that in future quarters our operating results may be below the
expectations of public market analysts or investors. If this occurs, the price
of our common stock would likely decrease.
OUR POWERFILTER PRODUCT CURRENTLY REPRESENTS NEARLY ALL OF OUR REVENUES AND IF
WE ARE UNSUCCESSFUL IN COMMERCIALLY SELLING OUR POWERMUX PRODUCT, OUR REVENUES
WILL NOT GROW SIGNIFICANTLY
We currently offer only two products, PowerFilter and PowerMux. Sales of
our PowerFilter product accounted for 95% of our net revenue in the quarter
ended June 30, 1999 and 99% of our net revenue in each of the quarters ended
October 1, 1999 and December 31, 1999. We substantially depend on this product
for our near-term revenue. Most customers who have purchased PowerFilter
products from us to date have purchased them for evaluation purposes only and
may not choose to purchase any additional products for commercial use. Any
decline in the price of, or demand for, our PowerFilter product, or its failure
to achieve broad market acceptance, would seriously harm our business. In
addition, we believe that our future growth and a significant portion of our
future revenue will depend on the commercial success of our PowerMux product,
which to date has only been shipped for evaluation. If our target customers do
not widely adopt, purchase and successfully deploy our products, our revenues
will not grow significantly and our business will be seriously harmed.
WE RELY ON A LIMITED NUMBER OF CUSTOMERS, AND ANY DECREASE IN REVENUES FROM, OR
LOSS OF, THESE CUSTOMERS WITHOUT A CORRESPONDING INCREASE IN REVENUES FROM OTHER
CUSTOMERS WOULD HARM OUR OPERATING RESULTS
Our customer base is limited and highly concentrated. We began recognizing
revenues from sales of our products in the quarter ended June 30, 1999. Three
customers accounted for an aggregate of 94% of our net revenue in the quarter
ended June 30, 1999, an aggregate of 99% of our net revenue in the quarter ended
October 1, 1999 and an aggregate of 96% of our net revenue in the quarter ended
December 31, 1999. MCI Telecommunications and MCI Worldcom, collectively MCI
Worldcom, accounted for 92% of our net revenue in the quarter ended October 1,
1999 and 85% in the quarter ended December 31, 1999. We expect
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that the majority of our revenues will continue to depend on sales of our
products to a small number of customers.
If current customers do not continue to place significant orders, we may
not be able to replace these orders. In addition, any downturn in the business
of existing customers could result in significantly decreased sales to these
customers, which could seriously harm our revenues and results of operations.
Sales to any single customer may vary significantly from quarter to
quarter. Customers in the communications industry tend to order large quantities
of products on an irregular basis. They base these orders on a decision to
deploy their system in a particular geographic area and may not order additional
products until they make their next major deployment decision. This means that
customers who account for a significant portion of our net revenue in one
quarter may not place any orders in the succeeding quarter. These ordering
patterns can result in significant quarterly fluctuations in our operating
results.
WE MUST RAPIDLY EXPAND OUR MANUFACTURING CAPACITY OR WE WILL NOT BE ABLE TO
DELIVER OUR PRODUCTS TO OUR CUSTOMERS IN A TIMELY MANNER
We must devote significant resources in order to expand our manufacturing
capacity. We have no experience in rapidly increasing our manufacturing capacity
or in manufacturing products at high volumes, and we only commenced
manufacturing operations in the quarter ended June 30, 1999. We will be required
to hire, train and manage significant numbers of additional manufacturing
personnel in order to increase our production capacity. We also intend to have
some of our subcomponents and products manufactured by a third party contract
manufacturer located in China. Expanding our manufacturing capacity at different
facilities will be expensive and will require management's time. There are
numerous risks associated with rapidly increasing capacity, including:
- the inability to procure and install the necessary equipment;
- lack of availability of manufacturing personnel;
- difficulties in achieving adequate yields from new manufacturing lines;
and
- the inability to match future order volumes with capacity.
If we are unable to expand our manufacturing capacity in a timely manner or if
we do not accurately project demand, we will have excess capacity or
insufficient capacity, either of which will seriously harm our business.
Our planned manufacturing expansion and related capital expenditures are
being made in anticipation of a level of customer orders that may not be
realized or, if realized, may not be sustained over multiple quarters. If
anticipated levels of customer orders are not received, our gross margins will
decline and we will not be able to reduce our operating expenses quickly enough
to prevent a decline in our operating results.
BECAUSE WE EXPECT TO DEPEND ON A THIRD PARTY LOCATED IN CHINA TO MANUFACTURE
SUBCOMPONENTS AND PRODUCTS FOR US, WE MAY HAVE DIFFICULTIES OBTAINING A
SUFFICIENT AMOUNT OF HIGH QUALITY PRODUCTS, WHICH WOULD DELAY OUR ABILITY TO
FULFILL CUSTOMER ORDERS
We have entered into a five-year agreement with CMI, a California-based
company, under which a subsidiary of CMI, located in Tianjin, China,
manufactures optical subcomponents for us. CMI has a limited history of
manufacturing optical subcomponents. As a result, CMI may not meet our
technological or delivery requirements. Any interruption in the operations of
CMI could harm our ability to meet our scheduled product deliveries to our
customers, which could cause the loss of existing or potential customers. In
addition, the products that CMI builds for us may be insufficient in quality or
in quantity to meet our needs. The inability of CMI to provide us with adequate
supplies of high-quality products in the future could cause a delay in our
ability to fulfill customer orders while we obtain a replacement manufacturer
and could seriously harm our business.
CMI manufactures limited quantities of subcomponents for us at a small
facility in Tianjin. We expect CMI to manufacture a significant portion of our
subcomponents and products in the future. Although CMI is
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<PAGE> 10
building a larger manufacturing facility in Tianjin, it will not be operational
until at least the quarter ending September 29, 2000. If this larger facility is
not completed on time, or at all, it may be more difficult to grow our business.
To successfully meet our overall production goals, we will also have to
coordinate effectively our operations in California and CMI's operations in
China. We have no experience in coordinating and managing production operations
that are located on different continents or in the transfer of manufacturing
operations from one facility to another. The geographic distance between our
headquarters in California and CMI's manufacturing facility in China will make
it difficult for us to manage the relationship and oversee operations there to
assure product quality and timely delivery. Our failure to successfully
coordinate and manage multiple sites or to transfer our manufacturing operations
could seriously harm our overall production.
Because CMI's manufacturing facility is located in China, CMI will be
subject to the risk of political instability in China and the possible
imposition of restrictive trade regulations and tariffs. We will also be exposed
to risks of foreign currency exchange rate fluctuations and lack of adequate
protection of intellectual property under Chinese law.
UNDER OUR LICENSE AGREEMENT WITH CMI, CMI CAN MANUFACTURE AND SELL OPTICAL
SUBCOMPONENTS BASED ON OUR TECHNOLOGY TO OUR POTENTIAL COMPETITORS, WHICH COULD
HARM OUR MARKET POSITION IN THE FUTURE
Under the agreement with CMI, we have granted licenses to CMI to make in
China and the United States, and to use and sell worldwide, the licensed
subcomponents. We also granted them a license to use some of our technical
information and manufacturing process know-how in China and the United States.
These licenses are exclusive in China and non-exclusive elsewhere. As a result,
CMI can manufacture and sell optical subcomponents based on our technology to
third parties, including our potential competitors. Furthermore, unless the
license is terminated, we cannot use an additional manufacturer for these
subcomponents in China.
BECAUSE WE DEPEND ON SINGLE OR LIMITED SOURCES OF SUPPLY WITH LONG LEAD TIMES
FOR SOME OF THE KEY COMPONENTS IN OUR PRODUCTS, WE COULD ENCOUNTER DIFFICULTIES
IN MEETING SCHEDULED PRODUCT DELIVERIES TO OUR CUSTOMERS, WHICH COULD CAUSE
CUSTOMERS TO CANCEL ORDERS
We currently purchase several key components used in our products from
single or limited sources of supply, including Nippon Sheet Glass, Hoya USA,
Inc., CMI, Sumitomo Corporation of America, Casix, Inc. and Browave Corporation.
These key components include filters, lenses and specialty glass. We have no
guaranteed supply arrangement with any of these suppliers and we typically
purchase our components through purchase orders. We may fail to obtain these
supplies in a timely manner in the future. 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 impair our ability to meet scheduled product deliveries to our
customers and could cause customers to cancel orders. Lead times for components
vary significantly and depend on numerous factors, including the specific
supplier, the size of the order, contract terms and market demand for a
component at a given time. For substantial increases in production levels,
suppliers may need longer-than-normal lead times and some may need at least six
months.
Furthermore, financial or other difficulties faced by these suppliers, or
significant changes in demand for these components, could limit the availability
of these components. In addition, a third party could acquire control of one or
more of our suppliers and cut off our access to raw materials or components.
Obtaining components from alternate suppliers is difficult because we must
qualify each new supplier, and this process is time-consuming and expensive.
OUR LENGTHY AND VARIABLE QUALIFICATION AND SALES CYCLE MAKES IT DIFFICULT TO
PREDICT THE TIMING OF A SALE OR WHETHER A SALE WILL BE MADE, WHICH MAY CAUSE US
TO HAVE EXCESS MANUFACTURING CAPACITY OR INVENTORY AND NEGATIVELY IMPACT OUR
OPERATING RESULTS
Customers typically expend significant efforts in evaluating and qualifying
our products and manufacturing process. This evaluation and qualification
process frequently results in a lengthy sales cycle, typically ranging from
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three to nine months and sometimes longer. While our customers are evaluating
our products and before they place an order with us, we may incur substantial
sales and marketing and research and development expenses, expend significant
management efforts, increase manufacturing capacity and order long-lead-time
supplies prior to receiving an order. Even after this evaluation process, it is
possible a potential customer will not purchase our products for deployment. In
addition, product purchases are frequently subject to unplanned processing and
other delays, particularly with respect to larger customers for which our
products represent a very small percentage of their overall purchase activity.
If we increase capacity and order supplies in anticipation of an order that
does not materialize, our gross margins will decline and we will have to carry
or write off excess inventory. Even if we receive an order, the additional
manufacturing capacity that we add to service the customer's requirements may be
underutilized in a subsequent quarter. Either situation could cause our results
of operations to be below the expectations of investors and public market
analysts, which could, in turn, cause the price of our common stock to decline.
Our long sales cycles, as well as the practice of companies in the
communications industry to sporadically place large orders with short lead
times, may cause our revenues and operating results to vary significantly and
unexpectedly from quarter to quarter.
IF WE FAIL TO PREDICT OUR MANUFACTURING REQUIREMENTS ACCURATELY, WE COULD INCUR
ADDITIONAL COSTS OR EXPERIENCE MANUFACTURING DELAYS, WHICH COULD CAUSE US TO
LOSE ORDERS OR CUSTOMERS AND RESULT IN LOWER REVENUES
We currently use a rolling 12-month forecast based primarily on our
anticipated product orders and our limited product order history to determine
our requirements for components and materials. We provide these forecasts to CMI
and use them internally as well. It is very important that we accurately predict
both the demand for our products and the lead time required to obtain the
necessary components and raw materials. Lead times for materials and components
that we order vary significantly and depend on factors such as the specific
supplier, the size of the order, contract terms and demand for each component at
a given time. If we underestimate our requirements, both our company and CMI may
have inadequate manufacturing capacity or inventory, which could interrupt
manufacturing of our products and result in delays in shipments and revenues. If
we overestimate our requirements, we could have excess inventory of parts. We
also may experience shortages of components from time to time, which also could
delay the manufacturing of our products and could cause us to lose orders or
customers.
IF WE DO NOT ACHIEVE ACCEPTABLE MANUFACTURING YIELDS IN A COST-EFFECTIVE MANNER
OR ACHIEVE SUFFICIENT PRODUCT RELIABILITY, THIS COULD DELAY PRODUCT SHIPMENTS TO
OUR CUSTOMERS OR REQUIRE US TO DEVELOP NEW MANUFACTURING PROCESSES, WHICH WOULD
IMPAIR OUR OPERATING RESULTS
The manufacture of our products involves complex and precise processes.
Changes in our manufacturing processes or those of our suppliers, or their
inadvertent use of defective materials, could significantly reduce our
manufacturing yields and product reliability. Because the majority of our
manufacturing costs are relatively fixed, manufacturing yields are critical to
our results of operations. Lower than expected production yields could delay
product shipments and impair our gross margins. We may not obtain acceptable
yields in the future.
In some cases, existing manufacturing techniques, which involve substantial
manual labor, may not allow us to cost-effectively meet our production goals so
that we maintain acceptable gross margins while meeting the cost targets of our
customers. We will need to develop new manufacturing processes and techniques
that will involve higher levels of automation to increase our gross margins and
achieve the targeted cost levels of our customers. We may not achieve
manufacturing cost levels that will fully satisfy customer demands.
Because we plan to introduce new products and product enhancements
regularly, we must effectively transfer production information from our product
development department to our manufacturing group and coordinate our efforts
with those of our suppliers to rapidly achieve volume production. If we fail to
effectively manage this process or if we experience delays, disruptions or
quality control problems in our manufacturing operations, our shipments of
products to our customers could be delayed.
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WE WILL LOSE SIGNIFICANT CUSTOMER SALES AND OPPORTUNITIES AND MAY NOT BE
SUCCESSFUL IF OUR CUSTOMERS DO NOT QUALIFY OUR PRODUCTS TO BE DESIGNED INTO
THEIR PRODUCTS AND SYSTEMS
In the communications industry, service providers and optical systems
manufacturers often undertake extensive qualification processes prior to placing
orders for large quantities of products such as ours, because these products
must function as part of a larger system or network. Once they decide to use a
particular supplier's product or component, these potential customers design the
product into their system, which is known as a design-in win. Suppliers whose
products or components are not designed in are unlikely to make sales to that
company until at least the adoption of a future redesigned system. Even then,
many companies may be reluctant to design entirely new products into their new
systems, as it could involve significant additional redesign efforts. If we fail
to achieve design-in wins in our potential customer's qualification process, we
will lose the opportunity for significant sales to that customer for a lengthy
period of time.
WE WILL NOT ATTRACT ORDERS AND CUSTOMERS OR WE MAY LOSE CURRENT ORDERS AND
CUSTOMERS AND WILL NOT BE SUCCESSFUL IN OUR INDUSTRY IF WE ARE UNABLE TO COMMIT
TO DELIVER SUFFICIENT QUANTITIES OF OUR PRODUCTS TO SATISFY MAJOR CUSTOMERS'
NEEDS
Communications service providers and optical systems manufacturers
typically require that suppliers commit to provide specified quantities of
products over a given period of time. If we are unable to commit to deliver
sufficient quantities of our products to satisfy a customer's anticipated needs,
we will lose the order and the opportunity for significant sales to that
customer for a lengthy period of time. We are just beginning to receive orders
for significant quantities of products while simultaneously increasing our
manufacturing capacity. We would be unable to pursue many large orders if we do
not have sufficient manufacturing capacity to enable us to commit to provide
customers with specified quantities of products.
IF OUR CUSTOMERS DO NOT QUALIFY OUR MANUFACTURING LINES FOR VOLUME SHIPMENTS,
OUR PRODUCTS MAY BE DROPPED FROM SUPPLY PROGRAMS AND OUR OPERATING RESULTS COULD
SUFFER
Customers generally will not purchase any of our products, other than
limited numbers of evaluation units, before they qualify our products, approve
our manufacturing process and approve our quality system. Our existing
manufacturing line, as well as each new manufacturing line, must pass through
various levels of approval with our customers. Customers may require that we be
registered under international quality standards, such as ISO 9001. Our products
may also have to be qualified to specific customer requirements. This customer
approval process determines whether the manufacturing line achieves the
customers' quality, performance and reliability standards. In order for CMI to
manufacture products or discrete components for us in the future, their
manufacturing line would also need to be qualified by our customers. Delays in
product qualification or ISO 9001 registration may cause a product to be dropped
from a long-term supply program and result in significant lost revenue
opportunity over the term of that program.
IF WE ARE UNABLE TO DEVELOP PRODUCTS AND PRODUCT ENHANCEMENTS THAT ACHIEVE
MARKET ACCEPTANCE, SALES OF OUR PRODUCTS WILL SUFFER AND WE WILL NOT BE
SUCCESSFUL
Our future success depends on our ability to anticipate market needs and
develop products that address those needs. Any failure to predict market needs
accurately or to develop new products or product enhancements in a timely manner
will substantially decrease market acceptance and sales of our products. In
addition, our products could quickly become obsolete as new technologies are
introduced and incorporated into new and improved products. In particular, we
anticipate that our PowerMux product, which incorporates our PowerFilter product
and additional functionality, will replace our PowerFilter product in most
applications. We must continue to develop state-of-the-art products and
introduce them in the commercial market quickly in order to be successful. We
plan to introduce our PowerShaper product, which is currently in the beta
testing stage, during the second half of the fiscal year ending June 30, 2000.
If the development of any future products takes longer than we anticipate, or if
we are unable to develop and introduce these products to the commercial market,
our revenues could suffer and we will not gain market share. Even if we are able
to develop and commercially introduce new products and enhancements, we cannot
assure you that the new products or enhancements will
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achieve widespread market acceptance. Any failure of PowerMux, PowerShaper or
our other future products to achieve market acceptance could significantly harm
our business.
WE MAY EXPERIENCE INCREASED COMPETITION FROM COMPANIES IN THE PHOTONIC PROCESSOR
MARKET AND IN THE OPTICAL SYSTEMS AND COMPONENT INDUSTRY, WHICH COULD CAUSE
REDUCED SALES LEVELS AND RESULT IN PRICE REDUCTIONS, REDUCED GROSS MARGINS OR
LOSS OF MARKET SHARE
The markets we are targeting are new and rapidly evolving, and we expect
these markets to become highly competitive in the future. While we do not have
any direct competitors in the photonic processor market today, we anticipate
that other companies will expand into our market in the future, and introduce
competitive products. We also face indirect competition from public and private
companies providing products that address the same optical network problems that
our products address. The development of alternative solutions to optical
transmission problems by competitors, particularly systems companies who also
manufacture components, could significantly limit our growth.
Some companies in the optical systems and component industry may compete
with us in the future, including Lucent Technologies, Nortel Networks, Alcatel,
Fujitsu, JDS Uniphase and E-Tek Dynamics. These are large public companies that
have longer operating histories and significantly greater financial, technical,
marketing and other resources than we have. As a result, these competitors are
able to devote greater resources to the development, promotion, sale and support
of their products. In addition, our competitors that have large market
capitalizations or cash reserves are much better positioned than we are to
acquire other companies in order to gain new technologies or products that may
displace our product lines. Any of these acquisitions could give our competitors
a strategic advantage. Many of our potential competitors have significantly more
established sales and customer support organizations than we do. In addition,
many of our competitors have much greater name recognition and have more
extensive customer bases, better developed distribution channels and broader
product offerings than our company. These companies can use their customer bases
and broader product offerings and adopt aggressive pricing policies to gain
market share. We expect to encounter potential customers that, due to existing
relationships with our competitors, are committed to the products offered by
these competitors. As a result, these potential customers may not consider
purchasing our products.
Existing and potential customers are also our potential competitors. These
customers may develop or acquire additional competitive products or technologies
in the future, which may cause them to reduce or cease their purchases from us.
In addition, customers who are also competitors may unfairly disparage our
products in order to gain a competitive advantage.
As a result of these factors, we expect that competitive pressures may
result in price reductions, reduced margins and loss of market share.
IF WE DO NOT SUBSTANTIALLY EXPAND OUR DIRECT AND INDIRECT SALES OPERATIONS, WE
MAY NOT BE ABLE TO INCREASE MARKET AWARENESS AND SALES OF OUR PRODUCTS AND OUR
REVENUES WILL SUFFER
Our products and services require a long, involved sales effort targeted at
several departments within our prospective customers' organizations. Therefore,
our sales effort requires the prolonged efforts of executive personnel and
specialized system and application engineers working together with dedicated
salespersons in making sales. Because we have a small number of dedicated
salespersons, we need to hire additional qualified sales personnel and system
and application engineers. Competition for these individuals is intense, and we
might not be able to hire the type and number of sales personnel and system and
application engineers we need.
In addition, we believe that our future success depends significantly on
our ability to establish relationships successfully with a variety of
distribution partners, such as original equipment manufacturers, value-added
resellers and distributors, both domestically and internationally. To date, we
have entered into agreements with two distributors in Japan. These distributors
also sell products that compete with our products. We cannot be certain that we
will be able to reach agreement with additional distribution partners on a
timely basis or at all, or that our distribution partners will devote adequate
resources to selling our
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products. Even if we enter into agreements with additional distribution
partners, they may not result in increased product sales.
If we are unable to expand our direct and indirect sales operations, we may
not be able to increase market awareness or sales of our products, which may
prevent us from increasing our revenues.
IF THE COMMUNICATIONS INDUSTRY DOES NOT ACHIEVE A RAPID AND WIDESPREAD
TRANSITION TO OPTICAL NETWORKS, OUR BUSINESS WILL NOT SUCCEED
The market for our products is relatively new. Future demand for our
products is uncertain and will depend to a great degree on the speed of the
widespread adoption of optical networks. If the transition occurs too slowly,
the market for our products and the growth of our business will be significantly
limited.
IF THE INTERNET DOES NOT CONTINUE TO EXPAND AS A WIDESPREAD COMMUNICATION AND
COMMERCE MEDIUM, DEMAND FOR OUR PRODUCTS MAY DECLINE SIGNIFICANTLY
Our future success depends on the continued growth of the Internet as a
widely-used medium for commerce and communication and the continuing demand for
increased bandwidth over communications networks. If the Internet does not
continue to expand as a widespread communication medium and commercial
marketplace, the need for significantly increased bandwidth across networks and
the market for optical transmission products may not develop. As a result, it
would be unlikely that our products would achieve commercial success.
OUR MARKET IS NEW AND IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGES AND
EVOLVING STANDARDS, AND IF WE DO NOT RESPOND IN A TIMELY MANNER, OUR PRODUCTS
WILL NOT ACHIEVE MARKET ACCEPTANCE
The communications market is characterized by rapid technological change,
frequent new product introductions, changes in customer requirements and
evolving industry standards. In developing our products, we have made, and will
continue to make, assumptions with respect to which standards will be adopted
within our industry. If the standards that are actually adopted are different
from those that we have chosen to support, our products may not achieve
significant market acceptance.
OUR PRODUCTS MAY HAVE DEFECTS THAT ARE NOT DETECTED UNTIL FULL DEPLOYMENT OF A
CUSTOMER'S SYSTEM, WHICH COULD RESULT IN A LOSS OF CUSTOMERS, DAMAGE TO OUR
REPUTATION AND SUBSTANTIAL COSTS
Our products are designed to be deployed in large and complex optical
networks and must be compatible with other components of the system, both
current and future. Our products can only be fully tested for reliability when
deployed in networks for long periods of time. Our customers may discover
errors, defects or incompatibilities in our products after they have been fully
deployed and operated under peak stress conditions. They may also have errors,
defects or incompatibilities that we find only after a system upgrade is
installed. If we are unable to fix errors or other problems, we could
experience:
- loss of customers;
- loss of or delay in revenues;
- loss of market share;
- loss or damage to our brand and reputation;
- inability to attract new customers or achieve market acceptance;
- diversion of development resources;
- increased service and warranty costs;
- legal actions by our customers; and
- increased insurance costs.
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IF WE FAIL TO EFFECTIVELY MANAGE OUR FINANCIAL AND MANAGERIAL CONTROLS,
REPORTING SYSTEMS AND PROCEDURES AS WELL AS EXPAND, TRAIN AND MANAGE OUR
WORKFORCE, OUR BUSINESS MAY NOT SUCCEED
We continue to expand the scope of our operations domestically and
internationally and have increased the number of our employees substantially. We
have grown from no revenue in the quarter ended March 31, 1999, $4.4 million in
the quarter ended October 1, 1999 to $6.5 million in the quarter ended December
31, 1999. At March 31, 1999, we had a total of 45 employees, at October 1, 1999,
we had a total of 132 employees and at December 31, 1999, we had 251 employees.
In addition, we plan to hire a significant number of employees over the next
several quarters. We currently operate facilities in Fremont, California and in
Richardson, Texas, and CMI has recently begun manufacturing subcomponents for us
in China. In addition, we have a sales office with a regional sales director in
Newtown, Pennsylvania. The growth in employees and in revenue, combined with the
challenges of managing geographically-dispersed operations, has placed, and our
anticipated growth in future operations will continue to place, a significant
strain on our management systems and resources. We expect that we will need to
continue to improve our financial and managerial controls, reporting systems and
procedures, and will need to continue to expand, train and manage our work force
worldwide.
WE DEPEND ON A SINGLE APPLICATION SERVICE PROVIDER FOR INFORMATION SYSTEMS AND
SERVICES, AND IF THERE IS A SERVICE INTERRUPTION, WE MAY HAVE DIFFICULTY IN
ACCESSING DATA THAT IS CRITICAL TO THE MANAGEMENT OF OUR BUSINESS
We rely on a single application service provider, Aristasoft Corporation,
to provide an Internet-based management information system and support for this
system. Aristasoft recently began providing information systems and services to
us on a regular basis and we are one of their few customers. All of our
financial records and ordering and data tracking information are stored on
Aristasoft's computer system and are only accessible over the Internet. The
Internet has suffered from delays and outages in the past, which could make it
difficult for us to access our data. From time to time, we have experienced
difficulties and delays in accessing our data. Lack of direct control over our
management information system and delays in obtaining information when needed
could harm our business.
We do not have an agreement with Aristasoft requiring it to provide
services to us for any specified period, and they could terminate their
relationship with us on short notice. If we needed to qualify a new application
service provider, we might be unable to do so on a timely basis, or at all. The
services are provided on application and database servers located at offsite
data facilities and accessed via communications links from our facility. We
cannot be certain that Aristasoft will be able to manage a scalable and reliable
information technology infrastructure to support the growth of our business. If
they stop providing services to us or if there is a service interruption, our
ability to process orders, manufacture products, ship products, prepare invoices
and manage our day-to-day financial transactions would be harmed, and our
results of operations would suffer.
WE DEPEND ON KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLY
CHANGING MARKET, AND IF WE ARE UNABLE TO HIRE ADDITIONAL PERSONNEL, OUR ABILITY
TO SELL OUR PRODUCTS COULD BE HARMED
Our future success depends upon the continued services of our executive
officers, particularly Walter Alessandrini, our Chief Executive Officer, and
Xiaofan (Simon) Cao, our Senior Vice President of Product Development, and other
key engineering, sales, marketing, manufacturing and support personnel. None of
our officers or key employees is bound by an employment agreement for any
specific term and these personnel may terminate their employment at any time. In
addition, we do not have "key person" life insurance policies covering any of
our employees.
We must hire a significant number of additional employees in the near
future, particularly engineering, sales and manufacturing personnel. Our ability
to continue to attract and retain highly skilled personnel will be a critical
factor in determining whether we will be successful in the future. Competition
for highly skilled personnel is intense, especially in the San Francisco Bay
Area. We may not be successful in attracting, assimilating or retaining
qualified personnel to fulfill our current or future needs. Our planned growth
will
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place a significant demand on our management and operational resources. Many of
the members of our management team have only been with us for a relatively short
period of time. For example, our Chief Executive Officer joined us in March
1999, and four of our eight current executive officers have joined us since
then. Failure of the new management team to work effectively together could
seriously harm our business.
IF WE BECOME SUBJECT TO UNFAIR HIRING CLAIMS, THESE CLAIMS COULD DIVERT THE
ATTENTION OF OUR MANAGEMENT AWAY FROM OUR OPERATIONS AND COULD CAUSE US TO INCUR
SUBSTANTIAL COSTS IN DEFENDING OURSELVES
Companies in our industry whose employees accept positions with competitors
frequently claim that their competitors have engaged in unfair hiring practices.
For instance, in December 1999, E-Tek Dynamics, Inc. filed a lawsuit against us.
E-Tek's complaint alleges that we have participated in the illegal recruiting of
E-Tek employees. Despite the fact that we believe this complaint is without
merit, we will incur costs in defending this lawsuit, including management time
and attention. We cannot assure you that we will not receive claims of this kind
in the future as we seek to hire qualified personnel or that those claims will
not result in litigation. We could incur substantial costs in defending
ourselves against these claims, regardless of their merits or outcomes. In
addition, defending ourselves from these claims could divert the attention of
our management away from our operations.
IF WE ARE UNABLE TO PROTECT OUR PROPRIETARY TECHNOLOGY, THIS TECHNOLOGY COULD BE
MISAPPROPRIATED, WHICH WOULD MAKE IT DIFFICULT TO COMPETE IN OUR INDUSTRY
We rely on a combination of patent, copyright, trademark and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
We cannot assure you that the 25 U.S. patent applications that we have filed,
six of which were jointly filed, and four foreign patent applications that we
have filed, one of which was jointly filed, will be approved, that any patents
that may issue will protect our intellectual property or that any patents issued
will not 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. We use various methods to attempt to protect
our intellectual property rights. However, we cannot be certain that the steps
we have taken will prevent the misappropriation of our intellectual property,
particularly in foreign countries, such as China, where the laws may not protect
our proprietary rights as fully as in the United States.
IF NECESSARY LICENSES OF THIRD-PARTY TECHNOLOGY BECOME UNAVAILABLE TO US OR
BECOME VERY EXPENSIVE, WE MAY BECOME UNABLE TO DEVELOP NEW PRODUCTS AND PRODUCT
ENHANCEMENTS, WHICH WOULD PREVENT US FROM OPERATING OUR CURRENT BUSINESS
From time to time we may be required to license technology from third
parties to develop new products or product enhancements. We cannot assure you
that third-party licenses will be available to us on commercially reasonable
terms, if at all. The inability to obtain any third-party license required to
develop new products and product enhancements could require us to obtain
substitute technology of lower quality or performance standards or at greater
cost, either of which could prevent us from operating our business.
We license technology from Fujitsu that is critical to our PowerShaper
product. The license agreement is subject to termination upon the acquisition of
more than a 50% interest in us by certain major communications system suppliers.
Thus, if we are acquired by any of these specified companies, we will lose this
license. The existence of this license termination provision may have an
anti-takeover effect in that it would discourage those specified companies from
making a bid to acquire us.
WE COULD BECOME SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY RIGHTS,
WHICH COULD DIVERT MANAGEMENT ATTENTION, CAUSE US TO INCUR SIGNIFICANT COSTS AND
PREVENT US FROM SELLING OR USING THE CHALLENGED TECHNOLOGY
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. As a result of the
proliferation of the Internet and other networking technologies, there has been,
and we expect that there will continue to be, an increasing amount of this
litigation in our
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industry. Many companies in the high-technology industry aggressively use their
patent portfolios to bring infringement claims against their competitors. As a
result, it is possible that we may be a party to litigation in the future to
protect our intellectual property or as a result of an alleged infringement of
others' intellectual property. These claims and any resulting lawsuit, if
successful, could subject us to significant liability for damages and
invalidation of 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:
- stop selling, incorporating or using our products that use the challenged
intellectual property;
- obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on reasonable terms, or at all; or
- redesign the products that use the technology.
If we are forced to take any of these actions, our business may be
seriously harmed. Although we carry general liability insurance, our insurance
may not cover potential claims of this type or may not be adequate to indemnify
us for all liability that may be imposed.
We may in the future initiate claims or litigation against third parties
for infringement of our proprietary rights in order 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.
WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS THAT COULD PREVENT US
FROM SUCCESSFULLY MANUFACTURING, MARKETING AND DISTRIBUTING OUR PRODUCTS
INTERNATIONALLY
We intend to expand our international operations in the future, including
having some of our subcomponents manufactured in China. This expansion will
require significant management attention and financial resources to develop
successfully direct and indirect international sales and support channels and
manufacturing. We may not be able to establish or maintain international market
demand for our products. We currently have little or no experience in
manufacturing, marketing and distributing our products internationally.
In addition, international operations are subject to inherent risks,
including:
- greater difficulty in accounts receivable collection and longer
collection periods;
- difficulties and costs of staffing and managing foreign operations with
personnel who have expertise in optical network technology;
- unexpected changes in regulatory or certification requirements for
optical systems or networks;
- reduced protection for intellectual property rights in some countries,
including China, where some of our subcomponents will be manufactured;
and
- political and economic instability.
While we expect our international revenues and expenses to be denominated
predominantly in U.S. dollars, a portion of our international revenues and
expenses may be denominated in foreign currencies in the future. Accordingly, we
could experience the risks of fluctuating currencies and could choose to engage
in currency hedging activities.
IF WE ARE UNABLE TO RAISE ANY NEEDED ADDITIONAL CAPITAL, WE MAY NOT BE ABLE TO
GROW OUR BUSINESS, WHICH COULD LOWER THE VALUE OF YOUR INVESTMENT
The development and marketing of new products and the expansion of our
manufacturing facilities and associated support personnel will require a
significant commitment of resources. In addition, if the market for photonic
processors develops at a slower pace than we anticipate or if we fail to
establish significant market share and achieve a significantly increased level
of revenue, we may continue to incur significant operating
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losses and utilize significant amounts of capital. If cash from available
sources is insufficient, or if cash is used for acquisitions or other
unanticipated uses, we may need to raise additional capital. We cannot be
certain that additional capital will be available to us at all, or that, if it
is available, it will be on terms favorable to us. Any inability to raise
additional capital when we require it would seriously harm our business. Any
additional issuance of equity or equity-related securities will be dilutive to
our stockholders.
WE FACE A NUMBER OF UNKNOWN RISKS ASSOCIATED WITH YEAR 2000 PROBLEMS THAT COULD
RESULT IN CLAIMS AGAINST US OR IMPAIR THE USE OF OUR PRODUCTS BY OUR CUSTOMERS
Our products are generally integrated into larger systems involving
sophisticated hardware and software products supplied by other vendors. Our
customers' systems involve different combinations of third party products. We
cannot evaluate whether all of their products are year 2000 compliant. Despite
the passing of January 1, 2000, 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. We may in the future be required
to defend our products in legal proceedings, which could be expensive regardless
of the merits of these claims.
Despite the passing of January 1, 2000, our suppliers, vendors,
distributors, customers or service providers could still experience year 2000
problems. If any year 2000 related failures occur, they could result in an
interruption in, or a failure of, our normal business activities or operations.
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. Due to the general uncertainty
inherent in the year 2000 problem with regard to our third party suppliers and
vendors, we are unable to determine at this time whether year 2000 failures
could harm our business.
Our customers' purchasing plans may have been and may continue to be
affected by year 2000 issues if they needed to expend significant resources to
fix their existing systems to become year 2000 compliant. This situation may
reduce funds available to purchase our products.
RISKS RELATED TO THE SECURITIES MARKETS AND THIS OFFERING
THERE MAY BE SALES OF A SUBSTANTIAL AMOUNT OF OUR COMMON STOCK AS SOON AS 90
DAYS AFTER THIS OFFERING BY OUR STOCKHOLDERS, INCLUDING OUR EXECUTIVE OFFICERS
AND DIRECTORS, AND THESE SALES COULD CAUSE OUR STOCK PRICE TO 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.
As of December 31, 1999, our executive officers, directors and
substantially all of our stockholders, who held an aggregate of 55,391,841
shares of our common stock, or over 97.9% of our total outstanding shares, had
executed lock-up agreements that prevent them from selling or otherwise
disposing of our common stock for a period of 180 days from the date of this
prospectus, without the prior written approval of Morgan Stanley & Co.
Incorporated. These lock-up agreements will expire on August 1, 2000, and an
aggregate of 46,129,693 shares will be eligible for sale, in some cases subject
only to the volume, manner of sale and notice requirements of Rule 144 under the
Securities Act.
Notwithstanding the 180-day lock-up period, 25% of the shares, or
13,847,960 shares, subject to these lock-up restrictions, including 3,644,690
shares held by our executive officers and directors, may be released from these
restrictions beginning 90 days from the date of this prospectus, or May 3, 2000.
This release will occur if the last reported sale price of our common stock is
at least two times the initial public offering price per share for 20 of the 30
trading days preceding the 90th day after the date of this prospectus. Of these
shares to be released on May 3, 2000, 11,315,945 will be eligible for sale, in
some cases subject only to the volume, manner of sale and notice requirements of
Rule 144.
Sales of a substantial number of shares of our common stock after this
offering could cause our stock price to fall. In addition, the sale of these
shares could impair our ability to raise capital through the sale of additional
stock.
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The 769,230 shares of common stock that we agreed to sell to MCI WorldCom
Venture Fund and Microsoft will be "restricted securities" and the one year
holding period for these shares will expire one year from the date of sale. We
anticipate that the date of sale will occur in February 2000. However, each of
MCI WorldCom Venture Fund and Microsoft may, beginning 180 days after the
completion of this offering, exercise their registration rights which will
enable them to sell all of their shares in the open market.
MANAGEMENT MAY APPLY THE PROCEEDS OF THIS OFFERING TO USES THAT DO NOT INCREASE
OUR PROFITS OR MARKET VALUE AND THIS MAY CAUSE THE VALUE OF YOUR STOCK TO
DECLINE
Our management will have considerable discretion in the application of the
net proceeds of this offering, and you will not have the opportunity, as part of
your investment decision, to assess whether the proceeds are being used
appropriately. The net proceeds may be used for corporate purposes that do not
increase our profitability or our market value. Pending application of the
proceeds, they may be placed in investments that do not produce income or that
lose value.
THERE HAS BEEN NO PRIOR MARKET FOR OUR COMMON STOCK AND A PUBLIC MARKET FOR OUR
SECURITIES MAY NOT DEVELOP OR BE SUSTAINED, WHICH COULD MAKE IT MORE DIFFICULT
FOR YOU TO SELL YOUR STOCK
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, and the market price might fall below the initial
public offering price. The initial public offering price may bear no
relationship to the price at which the common stock will trade subsequent to the
completion of this offering. The initial public offering price was determined
based on negotiations between us and the representatives of the underwriters,
based on factors that may not be indicative of future market performance.
INSIDERS WILL CONTINUE TO HAVE SUBSTANTIAL CONTROL OVER US AFTER THIS OFFERING
AND COULD DELAY OR PREVENT A CHANGE IN OUR CORPORATE CONTROL, WHICH MAY
NEGATIVELY AFFECT YOUR INVESTMENT
We anticipate that our executive officers, directors and entities
affiliated with them will, in the aggregate, beneficially own approximately 65%
of our outstanding common stock following the completion of this offering. These
stockholders, if acting together, would be able to influence significantly all
matters requiring approval by our stockholders, including the election of
directors and the approval of mergers or other business combination
transactions.
INVESTORS WILL EXPERIENCE IMMEDIATE DILUTION AND YOUR INVESTMENT MAY BE
NEGATIVELY AFFECTED
The initial public offering price of our common stock is substantially
higher than the book value per share of our outstanding common stock immediately
after the offering. Accordingly, if you purchase our common stock in this
offering, you will incur immediate dilution of approximately $32.32 in the book
value per share of our common stock from the price you pay for our common stock.
PROVISIONS OF OUR CHARTER DOCUMENTS, DELAWARE LAW AND A LICENSE WE HAVE WITH A
THIRD PARTY MAY HAVE ANTI-TAKEOVER EFFECTS THAT COULD PREVENT A CHANGE IN
CONTROL WHICH COULD NEGATIVELY AFFECT YOUR INVESTMENT
Provisions of Delaware law and of our amended and restated certificate of
incorporation and bylaws could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders. For a
further description of these provisions, see "Description of Capital Stock --
Delaware Law and Certain Provisions of Our Certificate of Incorporation and
Bylaws." In addition, if we are acquired by certain specified companies, our
license from Fujitsu would be subject to termination, which could discourage
those companies from making a bid to acquire us.
19
<PAGE> 20
WE EXPECT TO EXPERIENCE SIGNIFICANT VOLATILITY IN OUR STOCK PRICE, WHICH COULD
CAUSE YOU TO LOSE ALL OR PART OF YOUR INVESTMENT
We expect the market price of our common stock to fluctuate significantly
in response to a number of company specific factors, some of which are beyond
our control, including:
- quarterly variations in our operating results;
- changes in financial estimates by securities analysts;
- changes in market valuations of Internet-related companies;
- announcements by our competitors of new products or of significant
acquisitions, strategic partnerships or joint ventures;
- any loss by us of a major customer;
- additions or departures of key management or engineering personnel;
- any deviations in our net revenues or in losses from levels expected by
securities analysts;
- future sales of our common stock; and
- volume fluctuations, which are particularly common among highly volatile
securities of Internet-related companies.
20
<PAGE> 21
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this prospectus constitute
forward-looking statements. These statements involve known and unknown risks,
uncertainties, and other factors that may cause our or our industry's 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. In some
cases, you can identify forward-looking statements by terminology such as "may,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," "continue" or the negative of these terms or other
comparable terminology.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of these statements. We
are under no duty to update any of the forward-looking statements after the date
of this prospectus to conform these statements to actual results.
CONCURRENT SALE OF STOCK TO CORPORATE INVESTORS
Concurrently with the completion of this offering, we will sell to
Microsoft Corporation and MCI WorldCom Venture Fund, an affiliate of MCI
WorldCom, Inc., an aggregate of 769,230 shares of our common stock for $13.00
per share. Both MCI WorldCom Venture Fund and Microsoft are entitled to
registration rights for these shares. See "Description of Capital
Stock -- Registration Rights."
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<PAGE> 22
USE OF PROCEEDS
We estimate that our net proceeds from the sale of the 6,000,000 shares of
common stock we are offering will be approximately $198.9 million, or $229.0
million if the underwriters exercise their over-allotment option in full, after
deducting underwriting discounts and commissions and after deducting estimated
offering expenses. The primary purposes of this offering are to obtain
additional equity capital, create a public market for our common stock and
facilitate future access to public markets.
We intend to use the net proceeds we receive from the offering for general
corporate purposes, including capital expenditures and working capital. Although
we may use a portion of the net proceeds to acquire technology or businesses
that are complementary to our business, there are no current plans in this
regard. Pending their use, we plan to invest the net proceeds in short-term,
interest-bearing, investment grade securities.
DIVIDEND POLICY
We have not paid any cash dividends since our inception and do not intend
to pay any cash dividends in the foreseeable future. Our credit agreements
prohibit the payment of dividends without prior approval of the lenders.
22
<PAGE> 23
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1999.
The pro forma information reflects (1) the conversion of all shares of preferred
stock outstanding as of December 31, 1999 into 35,019,134 shares of common stock
on completion of this offering, (2) the exercise of warrants to purchase 337,500
shares of common stock at an exercise price of $4.00 and (3) the sale of 769,230
shares of common stock to two corporate investors at a price of $13.00 per share
for an aggregate of $9,999,990 in a private placement that will close
contemporaneously with this offering. The pro forma as adjusted information also
reflects our receipt of the net proceeds from the sale of the shares of common
stock in this offering after deducting the underwriting discounts and
commissions and estimated offering expenses.
The outstanding share information excludes:
- 3,401,427 shares of common stock issuable on exercise of outstanding
options as of December 31, 1999 with a weighted average exercise price of
$1.40 per share;
- 29,347 shares of common stock issuable upon exercise of an outstanding
warrant with an exercise price of $3.83 per share;
- 1,245,117 shares of stock available for future grants under our 1998
Stock Plan as of December 31, 1999 and an additional 7,500,000 shares of
stock reserved for issuance under our 1998 Stock Plan subsequent to
December 31, 1999; and
- 525,000 shares of stock to be reserved for issuance under our Employee
Stock Purchase Plan that will become effective upon the closing of this
offering.
- 300,000 shares of stock to be reserved for issuance under our 1999
Director Option Plan that will become effective upon the closing of this
offering.
You should read this table with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the financial statements and
the related notes. See "Management -- Employee and Director Benefit Plans."
<TABLE>
<CAPTION>
DECEMBER 31, 1999
------------------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------------ ------------- ---------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
<S> <C> <C> <C>
Long-term obligations, excluding current portion......... $ 1,320 $ 1,320 $ 1,320
Redeemable convertible preferred stock, $.001 par value
per share, 38,100,000 shares authorized, 35,019,134
shares issued and outstanding, actual; no shares issued
and outstanding, pro forma and no shares authorized,
issued and outstanding, pro forma as adjusted.......... 30,408 -- --
Other stockholders' equity (deficit):
Preferred stock, $.001 par value, none authorized,
issued and outstanding actual and pro forma;
10,000,000 shares authorized, no shares issued and
outstanding, pro forma as adjusted.................. -- -- --
Common stock, $.001 par value per share, 75,000,000
shares authorized, actual and pro forma, 300,000,000
shares authorized, pro forma as adjusted; 20,403,456
shares issued and outstanding, actual; 56,529,320
shares issued and outstanding, pro forma; 62,529,320
shares issued and outstanding, pro forma as
adjusted............................................ 20 57 63
Additional paid-in capital............................. 93,007 134,728 333,577
Notes receivable from stockholders..................... (2,633) (2,633) (2,633)
Deferred stock compensation............................ (50,689) (50,689) (50,689)
Accumulated deficit.................................... (50,203) (50,203) (50,203)
-------- -------- --------
Total other stockholders' equity (deficit).......... (10,498) 31,260 230,115
-------- -------- --------
Total capitalization.............................. $ 21,230 $ 32,580 $231,435
======== ======== ========
</TABLE>
23
<PAGE> 24
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 net tangible book value per share of our
common stock after this offering. We calculate pro forma net tangible book value
per share by dividing the net tangible book value, tangible assets less total
liabilities, by the number of outstanding shares of common stock.
Our pro forma net tangible book value at December 31, 1999, was $31.3
million, or $.55 per share, based on 56,529,320 shares of our common stock
outstanding after giving effect to the conversion of all outstanding shares of
our preferred stock into common stock upon the closing of this offering, the
exercise of warrants to purchase 337,500 shares of common stock at an exercise
price of $4.00 per share prior to this offering, and the sale of 769,230 shares
of common stock to two corporate investors at $13.00 per share, for an aggregate
of $9,999,990 in a private placement contemporaneously with this offering.
After giving effect to the sale of the 6,000,000 shares of common stock by
us at the initial public offering price of $36.00 per share, less the
underwriting discounts and commissions and our estimated offering expenses, our
pro forma net tangible book value at December 31, 1999, would be $230.1 million,
or $3.68 per share. This represents an immediate increase in the pro forma net
tangible book value of $3.13 per share to existing stockholders and an immediate
dilution of $32.32 per share to new investors purchasing shares at the initial
public offering price of $36.00 per share. The following table illustrates this
per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $36.00
Pro forma net tangible book value per share at December
31, 1999............................................... $ .55
Increase per share attributable to new investors.......... 3.13
-----
Pro forma net tangible book value per share after this
offering.................................................. 3.68
------
Dilution per share to new investors in this offering........ $32.32
======
</TABLE>
The following table shows on a pro forma basis at December 31, 1999, after
giving effect to the conversion of all outstanding shares of our preferred stock
into an aggregate of 35,019,134 shares of common stock upon the closing of this
offering, the exercise of warrants to purchase 337,500 shares of common stock at
an exercise price of $4.00 per share prior to this offering, and the sale of
769,230 shares of common stock to two corporate investors at $13.00 per share,
for an aggregate of $9,999,990 in a private placement contemporaneously with
this offering. The table also shows the 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:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------ -------------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ---------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders........ 56,529,320 90.4% $ 44,455,000 17.1% $ .79
New investors................ 6,000,000 9.6 216,000,000 82.9 36.00
---------- ----- ------------ ------
Total................... 62,529,320 100.0% $260,455,000 100.0%
========== ===== ============ ======
</TABLE>
The above information is based on shares outstanding as of December 31,
1999. It excludes 3,401,427 shares of common stock reserved for issuance upon
exercise of outstanding options at December 31, 1999 with a weighted average
exercise price of $1.40 per share and 29,347 shares of common stock issuable
upon exercise of an outstanding warrant with an exercise price of $3.83 per
share. It also excludes 8,745,117 shares available for issuance under our 1998
Stock Plan, including 7,500,000 shares authorized in January 2000, 1999 Employee
Stock Purchase Plan and 1999 Director Stock Option Plan. Assuming the exercise
of all options and warrants outstanding as of December 31, 1999, our pro forma
net tangible book value at December 31, 1999 would be $36.1 million, or $.60 per
share, which would represent an immediate increase in the pro forma net tangible
book value of $2.96 per share to existing stockholders and an immediate dilution
of $32.44 per share to new investors.
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<PAGE> 25
SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read together
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and the related notes
included elsewhere in this prospectus. The consolidated statement of operations
data set forth below for the period from October 24, 1997 (inception) to June
30, 1998, for the year ended June 30, 1999 and for the six months ended December
31, 1999 and the consolidated balance sheet data as of June 30, 1998, June 30,
1999 and December 31, 1999 have been derived from our consolidated financial
statements included elsewhere in this prospectus, which have been audited by
Ernst & Young LLP, independent auditors. In our opinion, all necessary
adjustments, consisting only of normal recurring adjustments, have been included
to present fairly the unaudited results when read in conjunction with the
consolidated audited financial statements and the related notes appearing
elsewhere in this prospectus. The historical results are not necessarily
indicative of results to be expected for any future period. For an explanation
of the determination of the shares used to compute net loss per share, see note
2 of notes to consolidated financial statements.
<TABLE>
<CAPTION>
PERIOD FROM SIX MONTHS ENDED
OCTOBER 24, 1997 ---------------------------
(INCEPTION) TO YEAR ENDED DECEMBER 31, DECEMBER 31,
JUNE 30, 1998 JUNE 30, 1999 1998 1999
---------------- ------------- ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenue.................................. $ -- $ 510 $ -- $ 10,916
Cost of revenue.............................. -- 531 -- 8,194
------- -------- -------- --------
Gross profit (loss)........................ -- (21) -- 2,722
Operating expenses:
Research and development................... 515 4,086 1,427 2,988
Sales and marketing........................ 125 956 265 1,676
General and administrative................. 131 723 244 2,129
Stock compensation......................... 362 3,464 673 15,697
------- -------- -------- --------
Total operating expenses................ 1,133 9,229 2,609 22,490
------- -------- -------- --------
Loss from operations......................... (1,133) (9,250) (2,609) (19,768)
Other income (expense), net.................. (4) 29 2 (26)
------- -------- -------- --------
Net loss..................................... (1,137) (9,221) (2,607) (19,794)
Preferred stock accretion.................... -- -- -- (20,051)
------- -------- -------- --------
Net loss attributable to common
stockholders............................... $(1,137) $ (9,221) $ (2,607) $(39,845)
======= ======== ======== ========
Basic and diluted net loss per common
share...................................... $ (7.20) $ (4.97) $ (4.14) $ (6.41)
Weighted-average shares used in computing
basic and diluted net loss per common
share...................................... 158 1,857 630 6,215
Pro forma basic and diluted net loss per
common share (unaudited)................... $ (.39) $ (1.02)
Weighted-average shares used in computing pro
forma basic and diluted net loss per common
share (unaudited).......................... 23,628 39,110
</TABLE>
<TABLE>
<CAPTION>
AS OF JUNE 30, AS OF
------------------ DECEMBER 31,
1998 1999 1999
------ -------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments........... $2,874 $ 3,724 $ 14,379
Working capital............................................. 2,637 2,660 14,313
Total assets................................................ 3,339 6,816 28,152
Long-term obligations, excluding current portion............ 341 563 1,320
Redeemable convertible preferred stock...................... 3,529 10,357 30,408
Total other stockholders' equity (deficit).................. (805) (6,534) (10,498)
</TABLE>
25
<PAGE> 26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial
condition and results of operations together with "Selected Financial Data" and
our consolidated financial statements and related notes appearing elsewhere in
this prospectus. This discussion and analysis contains forward-looking
statements that involve risks, uncertainties and assumptions. The actual results
may differ materially from those anticipated in these forward-looking statements
as a result of certain factors, including, but not limited to, those presented
under "Risk Factors" and elsewhere in this prospectus.
OVERVIEW
Avanex designs, manufactures and markets fiber optic-based products, known
as photonic processors, which are designed to increase the performance of
optical networks. We were founded in October 1997, and through April 1999, we
were primarily engaged in research and development activities and in hiring
additional employees. A substantial portion of our operating expenses during
this period was related to the design and development of our photonic processors
and the testing of prototype designs. We began making volume shipments of our
initial product during the quarter ended October 1, 1999.
Our revenues currently are derived from sales of two products, PowerFilter
and PowerMux. We commenced shipments of our PowerFilter in April 1999. To date,
we have generated nearly all of our limited product revenues from sales of
PowerFilter to a limited number of customers. Sales of PowerFilter accounted for
95% of our net revenue in the quarter ended June 30, 1999 and 99% of our net
revenue in the quarter ended October 1, 1999 and the quarter ended December 31,
1999. We first shipped PowerMux in April 1999. In September 1999, we began
shipping beta test units of our PowerShaper product.
To date, we have generated a substantial portion of our revenues from a
limited number of customers. We have focused our initial sales and marketing
efforts primarily on large communications service providers and optical systems
manufacturers. In the fiscal year ended June 30, 1999, Osicom accounted for 33%
of our net revenue, MCI WorldCom accounted for 32% of net revenue and Hitachi
accounted for 29% of net revenue. Sales to MCI WorldCom accounted for 92% of our
total net revenue for the quarter ended October 1, 1999 and 85% of net revenue
for the quarter ended December 31, 1999. While we are seeking to diversify our
customer base, we anticipate that our operating results for any given period
will continue to depend on a small number of customers.
The market for photonic processors is new and evolving and the volume and
timing of orders are difficult to predict. A customer's decision to purchase our
products typically involves a commitment of its resources and a lengthy
evaluation and product qualification process. This initial evaluation and
product qualification process typically takes several months and includes
technical evaluation, integration, testing, planning and implementation into the
equipment design. Long sales and implementation cycles for our products, as well
as the practice of customers in the communications industry to sporadically
place large orders with short lead times, may cause our revenues, gross margins
and operating results to vary significantly and unexpectedly from quarter to
quarter.
We market and sell our products primarily through our direct sales and
marketing organization. To date, most of our direct sales have been in North
America. However, we have recently launched sales and marketing efforts
internationally through an independent sales representative in Italy and two
distributors in Japan.
We are engaged in continuing efforts to expand our manufacturing
capabilities. In November 1999, we moved from an approximately 14,000 square
foot facility to an approximately 54,000 square foot facility in Fremont,
California. We increased the number of our manufacturing employees from 36 as of
June 30, 1999 to 88 as of October 1, 1999 and to 163 as of December 31, 1999. In
addition, we have entered into a contract manufacturing relationship with CMI to
manufacture and supply fiber optic subcomponents from its manufacturing facility
in China. Currently, we perform manufacturing, final assembly, testing, quality
26
<PAGE> 27
assurance, manufacturing engineering, documentation control and repairs of our
products at our Fremont facility.
We generally recognize revenue when we ship products, some of which are
evaluation units, to our customers and there are no significant uncertainties
with respect to customer acceptance. Evaluation units consist of prototype units
sent to customers for evaluation. The customers have the right of return through
the end of the evaluation period. We recognize revenue on these shipments at the
end of the evaluation period if the units have not been returned. We accrue for
estimated warranty costs at the time related revenue is recognized. Currently,
all of our product sales provide for pricing and payment in U.S. dollars.
Our cost of revenue consists of raw material, direct labor and
manufacturing overhead. In addition, we rely on a single or limited source of
suppliers to manufacture some key components used in our products and, in the
past, the outsourcing of some subassemblies. A significant portion of our cost
of revenue is related to these temporary outsourcing arrangements.
Our gross margins will primarily be affected by the following factors:
- changes in our pricing policies and those of our competitors;
- mix of products sold;
- mix of sales channels through which our products are sold;
- mix of domestic and international sales;
- costs incurred in establishing additional manufacturing lines and
facilities; and
- changes in manufacturing volume.
We expect cost of revenue, as a percentage of revenue, to fluctuate from
period to period.
Research and development expenses consist primarily of salaries and related
personnel costs, fees paid to consultants and outside service providers,
non-recurring engineering charges and prototype costs related to the design,
development, testing, pre-manufacturing and enhancement of our products. We
expense our research and development costs as they are incurred. We believe that
research and development is critical to our strategic product development
objectives. We further believe that, in order to meet the changing requirements
of our customers, we will need to fund investments in several development
projects in parallel. As a result, we expect our research and development
expenses to increase in dollar amount in the future.
Sales and marketing expenses consist primarily of marketing, sales,
customer service and application engineering support, as well as costs
associated with promotional and other marketing expenses. We intend to expand
our direct and indirect sales operations substantially, both domestically and
internationally, in order to increase market awareness of our products. We
expect that sales and marketing expenses will increase substantially in dollar
amount over the next year as we hire additional sales and marketing personnel,
initiate additional marketing programs to support our products and establish
sales offices in additional domestic and international locations. We also expect
to significantly expand our customer service and support organization.
General and administrative expenses consist primarily of salaries and
related expenses for executive, finance, accounting, and human resources
personnel, allocated facilities, recruiting expenses, professional fees and
other corporate expenses. We expect general and administrative expenses to
increase in dollar amount as we add personnel and incur additional costs related
to the growth of our business and our operation as a public company.
Stock compensation expense is a result of us granting stock purchase rights
or stock options to our employees, directors or consultants with purchase or
exercise prices per share subsequently determined to be below the deemed fair
value per share of our common stock for accounting purposes at the dates of
purchase or grant. We are amortizing deferred stock compensation over the period
in which our right to repurchase restricted stock purchase rights lapse or over
the vesting period of the applicable options, which, in each case, is generally
a maximum of four years. We expect to record additional deferred stock
compensation expense for the quarter ended March 31, 2000.
27
<PAGE> 28
In connection with the sale of Series D preferred stock in September and
October 1999 to existing preferred stockholders, we recorded a non-cash charge
of $20.1 million for the six months ended December 31, 1999 to accrete the value
of the Series D preferred stock to its deemed fair value under applicable
accounting rules. This non-cash charge was recorded as an increase in
accumulated deficit with a corresponding credit to additional paid-in capital
and was recognized at the date of issuance, which was the period in which the
shares became eligible for conversion.
In connection with the sale of 769,230 shares of common stock to two
corporate investors, subject to completion of our initial public offering, we
will record an accretion charge equal to the difference between the initial
public offering price and $13.00 per share multiplied by 769,230 shares of
common stock.
Despite growing revenue, we have not been profitable for any quarter since
October 24, 1997 (inception). As of December 31, 1999, we had an accumulated
deficit of $50.2 million. These losses have resulted primarily from developing
our products, increasing manufacturing capacity, promoting brand recognition,
developing our sales channels, establishing our management team and amortizing
of deferred stock compensation. As of December 31, 1999, we had net operating
loss carryforwards for federal income tax purposes of approximately $9.0
million, which expire in years 2013 through 2020.
RESULTS OF OPERATIONS
Because we first began shipping our products in April 1999, we believe our
results of operations for the periods prior to that time are not meaningful, as
we were a development stage company. Our results of operations for these periods
primarily reflect research and development of our products.
SIX MONTHS ENDED DECEMBER 31, 1998 AND 1999
Net Revenue. Net revenue for the six months ended December 31, 1999 was
$10.9 million. One customer, MCI WorldCom, which placed a large order in July
1999, accounted for 88% of net revenue while revenues from the other large
customers remained relatively constant in dollar amount. We did not have any
revenue in the comparable period ended December 31, 1998.
Cost of Revenue. Cost of revenue for the six months ended December 31, 1999
was $8.2 million. Cost of revenue for the six months ended December 31, 1999 as
a percentage of net revenue was 75%. Because we had no revenue in the six months
ended December 31, 1999, we had no cost of revenue during that period.
Research and Development. Research and development expenses for the six
months ended December 31, 1999 were $3.0 million, or 27.4% of net revenue.
Research and development expenses for the six months ended December 31, 1998
were $1.4 million. The increase of $1.6 million over the comparable period in
1998 was primarily due to the $856,000 increase in personnel-related costs, the
$298,000 increase in prototype expenses for PowerMux and PowerShaper and costs
for other development projects and the $328,000 increase in professional
services. Research and development personnel increased by 54 employees from
December 31, 1998 to December 31, 1999. We expect our research and development
expenses to increase in the future.
Sales and Marketing. Sales and marketing expenses for the six months ended
December 31, 1999 were $1.7 million, or 15.4% of net revenue. Sales and
marketing expenses for the six months ended December 31, 1998 were $265,000. The
increase of $1.4 million over the comparable period in 1998 was due to the
$313,000 increase in sales and marketing personnel and related costs, the
$447,000 increase in commission expenses and the $630,000 increase in trade
show, advertising and other customer-related costs. We expect our sales and
marketing expenses to increase in absolute dollar amount, but to decline as a
percentage of net revenue, in the future to support our existing customers and
to acquire new customers.
General and Administrative. General and administrative expenses for the six
months ended December 31, 1999 were $2.1 million, or 19.5% of net revenue.
General and administrative expenses for the six months ended December 31, 1998
were $244,000. The increase of $1.9 million over the comparable period in 1998
was primarily due to the $632,000 increase in personnel and related costs and
the $506,000 increase in professional services for information systems, legal
and facilities management. Additionally, $298,000 of bad
28
<PAGE> 29
debt provision was incurred in the six months ended December 31, 1999, while
none was incurred in the comparable period in 1998. We expect our general and
administrative expenses to increase in absolute dollar amount in the future, but
to decline as a percentage of net revenue.
Stock Compensation. Stock compensation expense for the six months ended
December 31, 1999 was $15.7 million, an increase of $15.0 million over the
comparable period in 1998. From inception through December 31, 1999, we have
expensed a total of $19.5 million of stock compensation, leaving an unamortized
balance of $50.7 million on our December 31, 1999 consolidated balance sheet.
This increase was due to additional employees and the granting of stock options
and stock purchase rights.
Other Income (Expense), Net. Other income (expense) for the six months
ended December 31, 1999 was $26,000 of expense as compared to $2,000 of income
for the comparable period in 1998. This was primarily due to interest expense
associated with borrowings under our line of credit. The expenses are offset by
higher interest income due to larger cash balances from the proceeds of our
preferred stock financing in September and October 1999.
YEARS ENDED JUNE 30, 1998 AND 1999
For ease of reference, we refer to the period from October 24, 1997
(inception) through June 30, 1998 as fiscal 1998 and to the fiscal year ended
June 30, 1999 as fiscal 1999.
Net Revenue. We did not recognize any revenue until the quarter ended June
30, 1999. Net revenue for fiscal 1999 was $510,000. In fiscal 1999, Osicom
accounted for 33% of net revenue, MCI WorldCom accounted for 32% of net revenue
and Hitachi accounted for 29% of net revenue.
Cost of Revenue. Cost of revenue for fiscal 1999 was $531,000. Cost of
revenue for fiscal 1999 included higher component and manufacturing costs
associated with our lower initial production volume, as well as overhead costs
that were spread over a relatively low number of units produced. As a percentage
of net revenue, cost of revenue for fiscal 1999 was 104%.
Research and Development. Research and development expenses for fiscal 1999
were $4.1 million, or 44% of total operating expenses. Research and development
expenses for fiscal 1998 were $515,000, or 45% of total operating expenses. The
increase in dollar amount in fiscal 1999 over fiscal 1998 was primarily due to
the significant increase in personnel and related costs, which amounted to an
increase of $855,000 over fiscal 1998, prototype expenses for PowerMux,
PowerShaper and a network testing model, which amounted to an increase of
$621,000 over fiscal 1998, and process development for PowerFilter, which
amounted to an increase of $1.7 million over fiscal 1998. Research and
development personnel at the end of fiscal 1999 increased by 18 employees over
the end of fiscal 1998.
Sales and Marketing. Sales and marketing expenses for fiscal 1999 were
$956,000, or 10% of total operating expenses. Sales and marketing expenses for
fiscal 1998 were $125,000, or 11% of total operating expenses. This increase in
dollar amount was primarily due to an increase in the number of sales and
marketing personnel, which increased to two employees from one employee over
fiscal 1998, sales commissions, which amounted to an increase of $195,000 over
fiscal 1998 when no sales commissions were paid, increased marketing expenses
and other customer-related costs, which amounted to an increase of $574,000 over
fiscal 1998 when no marketing expenses were incurred.
General and Administrative. General and administrative expenses for fiscal
1999 were $723,000, or 8% of total operating expenses. General and
administrative expenses for fiscal 1998 were $131,000, or 12% of total operating
expenses. This increase was primarily due to an increase in the number of
general and administrative personnel, which increased by four employees over
fiscal 1998, and increased legal, accounting, recruiting and facilities costs
incurred in connection with our growing business activities, which amounted to
an increase of $318,000 over fiscal 1998.
Stock Compensation. Stock compensation expense for fiscal 1999 was $3.5
million, or 38% of total operating expenses. Stock compensation expense for
fiscal 1998 was $362,000, or 32% of total operating
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expenses. This increase was due to additional employees and additional grants of
stock options and stock purchase rights.
Other Income (Expense), Net. Other income (expense), net, consists
primarily of interest on our cash investments and interest expense related to
our financing obligations. Other income (expense) for fiscal 1999 was $29,000 in
income, as compared to $4,000 in expense for fiscal 1998. This was caused by an
increase in interest income due to larger cash balances resulting from the
proceeds from the sale of our preferred stock in private financings, which was
partially offset by interest charges on capital lease obligations and bank debt.
QUARTERLY RESULTS OF OPERATIONS
The following table presents our operating results for the last six
quarters. The information for each of these quarters is unaudited but has been
prepared on the same basis as the audited consolidated 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 results when read in
conjunction with the audited consolidated financial statements and the related
notes appearing elsewhere in this prospectus. These operating results are not
necessarily indicative of the results of any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, OCTOBER 1, DECEMBER 31,
1998 1998 1999 1999 1999 1999
------------- ------------ --------- -------- ---------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Net revenue................... $ -- $ -- $ -- $ 510 $ 4,417 $ 6,499
Cost of revenue............... -- -- -- 531 3,431 4,763
------- ------- ------- ------- -------- --------
Gross profit (loss)........... -- -- -- (21) 986 1,736
Operating expenses:
Research and development.... 473 954 1,432 1,227 950 2,038
Sales and marketing......... 116 149 203 488 714 962
General and
administrative........... 132 112 150 329 614 1,515
Stock compensation.......... 323 350 746 2,045 6,107 9,590
------- ------- ------- ------- -------- --------
Total operating
expenses.......... 1,044 1,565 2,531 4,089 8,385 14,105
------- ------- ------- ------- -------- --------
Loss from operations.......... (1,044) (1,565) (2,531) (4,110) (7,399) (12,369)
Other income (expense), net... 7 (5) 21 6 (71) 45
------- ------- ------- ------- -------- --------
Net loss...................... (1,037) (1,570) (2,510) (4,104) (7,470) (12,324)
Preferred stock accretion..... -- -- -- -- (14,961) (5,090)
------- ------- ------- ------- -------- --------
Net loss attributable to
common stockholders......... $(1,037) $(1,570) $(2,510) $(4,104) $(22,431) $(17,414)
======= ======= ======= ======= ======== ========
</TABLE>
Net Revenue. Our first volume shipments of our initial product began in the
quarter ended October 1, 1999. Net revenue for the quarter ended June 30, 1999
was $510,000, for the quarter ended October 1, 1999 was $4.4 million and for the
quarter ended December 31, 1999 was $6.5 million. Net revenue increased
primarily due to the sales of our PowerFilter product to MCI WorldCom for
deployment in its network. We shipped products and evaluation units to five
customers in the quarter ended June 30, 1999, seven customers in the quarter
ended October 1, 1999 and 12 customers in the quarter ended December 31, 1999.
Evaluation units consist of prototype units sent to customers for evaluation.
The customers have the right of return through the end of the evaluation period.
We recognize revenue on these shipments at the end of the evaluation period if
the units have not been returned.
Cost of Revenue. Cost of revenue for the quarter ended June 30, 1999 was
$531,000, for the quarter ended October 1, 1999 was $3.4 million and for the
quarter ended December 31, 1999 was $4.8 million. As a percentage of net
revenue, cost of revenue for the quarter ended June 30, 1999 was 104%, compared
to 78% for the quarter ended October 1, 1999 and 73% for the quarter ended
December 31, 1999. This decrease in the
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cost of revenue as a percentage was primarily attributable to fixed
manufacturing costs being allocated over a larger revenue base and the decreased
cost of materials associated with the expansion of our manufacturing capacity to
produce subcomponents internally.
Research and Development. Research and development expenses have fluctuated
over the last six quarters. In each of the quarters ended September 30, 1998,
December 31, 1998 and March 31, 1999, research and development expenses
increased in absolute dollar amount primarily due to the increase in personnel
and related costs, prototype expenses for our PowerMux and PowerShaper products
and process development for our PowerFilter product. In each of the quarters
ended June 30, 1999 and October 1, 1999, research and development expenses
decreased in dollar amount due to the completion of a network testing model and
lower process development and prototyping costs for our PowerFilter product as
this product was gradually transitioned to manufacturing. In the quarter ended
December 31, 1999, research and development expenses increased in dollar amount
due to significant increases in personnel and related costs, the commencement of
manufacturing prototypes for PowerMux and development costs for the PowerShaper
and other projects.
Sales and Marketing. Sales and marketing expenses increased in each of the
last six quarters. These increases were primarily due to an increase in the
number of sales and marketing personnel, sales commissions, marketing expenses
and other customer-related costs.
General and Administrative. General and administrative expenses have
generally increased over the last six quarters. General and administrative
expenses increased in the quarters ended October 1, 1999, and December 31, 1999
primarily due to an increase in the number of personnel, costs related to the
move to a new and larger facility and costs related to building an
infrastructure for a public company, which includes increased legal, accounting,
recruiting and information systems costs.
Our revenues and operating results are likely to vary significantly from
quarter to quarter. A number of factors are likely to cause these variations,
including:
- fluctuations in demand for and sales of our products, which will depend
on the speed and magnitude of the transition to an all-optical network;
- cancellations of orders and shipment rescheduling;
- our ability to significantly expand our manufacturing capacity at our new
facility in Fremont, California, which commenced operations in November
1999;
- the ability of Concord Micro-Optics, Inc., or CMI, to timely produce and
deliver subcomponents from its facility in China in the quantity and of
the quality we require;
- the practice of companies in the communications industry to sporadically
place large orders with short lead times;
- competitive factors, including introductions of new products and product
enhancements by potential competitors, entry of new competitors into the
photonic processor market, including Lucent Technologies, Nortel Networks
and Fujitsu, and pricing pressures;
- our ability to develop, introduce, manufacture and ship new and enhanced
fiber optic products in a timely manner without defects;
- our ability to control expenses, particularly in light of our limited
operating history;
- availability of components for our products and increases in the price of
these components;
- mix of our products sold; and
- economic conditions specific to the communications and related
industries.
A high percentage of our expenses, including those related to
manufacturing, engineering, sales and marketing, research and development and
general and administrative functions, are essentially fixed in the short term.
As a result, if we experience delays in generating and recognizing revenue, our
quarterly operating results are likely to be seriously harmed. As we expand our
manufacturing capacity, we will incur expenses in
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one quarter relating to the expansion and related yield issues that may not
result in offsetting revenue until a subsequent quarter. New product
introductions can also result in a mismatching of research and development
expenses and sales and marketing expenses that are incurred in one quarter with
revenues that are not received until a subsequent quarter when the new product
is introduced. If growth in our revenues does not outpace the increase in our
expenses, our results of operations could be seriously harmed.
Due to these and other factors, we believe that quarter-to-quarter
comparisons of our operating results will not be meaningful. You should not rely
on our results for one quarter as any indication of our future performance. It
is likely that in future quarters our operating results may be below the
expectations of public market analysts or investors. If this occurs, the price
of our common stock would likely decrease.
LIQUIDITY AND CAPITAL RESOURCES
From inception on October 24, 1997 through December 31, 1999, we have
financed our operations primarily through private sales of approximately $30.4
million of convertible preferred stock. We have also financed our operations
through bank borrowings as well as through equipment lease financing. As of
December 31, 1999, we had outstanding equipment lease financing and bank
borrowings of $3.7 million.
At December 31, 1999, we had cash, cash equivalents and short-term
investments of $14.4 million, an increase from $3.7 million at June 30, 1999,
and $2.9 million at June 30, 1998. Most of the increase came from financing
activities, offset by cash used in operations and, to a lesser extent, the
purchase of equipment. The increase was primarily due to the receipt of $26.9
million in proceeds from the sale of preferred stock in February, September and
October 1999.
Cash used in operating activities was $590,000 in fiscal 1998, $5.4 million
in fiscal 1999 and $6.9 million for the six months ended December 31, 1999. The
increase was primarily due to the increase in our net loss from $1.1 million in
fiscal 1998, to $9.2 million in fiscal 1999, to $19.8 million for the six months
ended December 31, 1999, and, to a lesser extent, inventory purchases and
increased accounts receivable. This was offset in part by increased accounts
payable, accrued expenses and non-cash charges.
Cash used in investing activities was $301,000 in fiscal 1998, $2.8 million
in fiscal 1999 and $13.7 million for the six months ended December 31, 1999,
which was primarily used for the investment in marketable securities, production
equipment, research and development equipment, computers and facilities to
support the expansion of our operations.
We generated $3.8 million in cash from financing activities in fiscal 1998,
$7.1 million in fiscal 1999 and $21.1 million in the six months ended December
31, 1999, primarily from private sales of convertible preferred stock and
borrowings under revolving lines of credit. We financed capital purchases
primarily through leases or equipment credit lines. In addition, we had
capitalized lease obligations outstanding of $123,000 at June 30, 1998, $768,000
at June 30, 1999 and $1.8 million at December 31, 1999. In July 1999, we
obtained a revolving credit line from a financial institution, which allows for
maximum borrowings of up to $3.8 million at an interest rate equal to the prime
rate plus .75%. During the six months ended December 31, 1999, we drew down $2.2
million under this facility to pay off in full a $735,000 outstanding bank debt
and for working capital needs. This line of credit requires that we comply with
specified covenants.
As of December 31, 1999, we did not have any material commitments for
capital expenditures. However, we expect to incur capital expenditures as we
expand our manufacturing operations in the near future. Our capital requirements
also depend on market acceptance of our products, the timing and extent of new
product introductions and delivery, and the need for us to develop, market, sell
and support our products on a worldwide basis. From time to time, we may also
consider the acquisition of, or evaluate investments in, products and businesses
complementary to our business. Any acquisition or investment may require
additional capital. Although we believe that the net proceeds from this
offering, together with our current cash balances, will be sufficient to fund
our operations for at least the next 12 months, we cannot assure you that we
will not seek additional funds through public or private equity financing or
from other sources within this time frame or that additional funding, if needed,
will be available on terms acceptable to us, or at all. We cannot forecast our
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<PAGE> 33
liquidity position for more than a 12-month period, given the growth of our
business, particularly during the last six months, and the emerging nature of
our market.
YEAR 2000 COMPLIANCE
Impact of the Year 2000 Computer 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
date-sensitive software may recognize a date represented as "00" as the year
1900 rather than the year 2000. Despite the passage of January 1, 2000, this
could still result in a system failure or miscalculation causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
State of Readiness of Our Products. The year 2000 problem does not directly
affect our passive optical products. However, our products are generally
integrated into larger networks involving sophisticated hardware and software
products supplied by other vendors. 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 disruption in our
business based on year 2000 problems in other companies' products or based on
issues arising from the integration of multiple products within the overall
network, although we have not experienced any year 2000 problems to date.
State of Readiness of Our Internal Systems. Our business may be affected by
year 2000 issues related to non-compliant internal systems developed by us or by
third-party vendors. We are in the process of implementing new enterprise
resource planning software, which we believe is year 2000 compliant. Although we
did not survey our third party vendors, we are not aware of any year 2000
problem relating to any of our material internal systems. We have not tested and
do not plan to test our systems for year 2000 compliance. We do not believe that
we have any significant systems that contain embedded chips that are not year
2000 compliant.
Our internal operations and business also depend upon the
computer-controlled systems of suppliers, customers, service providers and third
parties, including our Internet-based management information system. We believe
that, absent a systemic failure outside our control, such as a prolonged loss of
electrical or telephone service, year 2000 problems at these third parties will
not have a material impact on our operations.
If our suppliers, vendors, distributors, customers and service providers
fail to correct any year 2000 problems that may yet occur, these failures could
result in an interruption in, or a failure of, our normal business activities or
operations. 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. Due to the
general uncertainty inherent in the year 2000 problem with regard to our third-
party suppliers and vendors, we continue to be unable to determine at this time
whether year 2000 failures could harm our business and our financial results.
Year 2000 issues may have affected and may continue to affect our
customers' purchasing plans if they need to expend significant resources to fix
their existing systems to become year 2000 compliant. This situation may reduce
funds available to purchase our products.
Cost. We do not anticipate that costs associated with remediating our
internal systems will be significant.
Risks. Although to date we have not experienced any year 2000 problems with
regard to our internal systems, any failure of our internal systems to be year
2000 compliant could temporarily prevent us from processing orders, issuing
invoices and developing products and could require us to devote significant
resources to correcting these problems. Due to the general uncertainty inherent
in the year 2000 computer problem, resulting from the uncertainty of the year
2000 readiness of third-party suppliers and vendors, we are unable to determine
at this time whether the consequences of year 2000 failures will have a material
impact on our business, results of operations or financial condition.
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Contingency Plans. We have not developed a contingency plan to address any
situation that may result if we are unable to solve our year 2000 issues, and we
do not anticipate the need to do so. If we are forced to use a contingency plan,
the failure to have one could harm our business.
Disclaimer. The discussion of our expectations relating to year 2000
compliance are forward-looking statements. Our ability to achieve year 2000
compliance and the level of associated incremental costs could be adversely
affected by, among other things, availability and cost of programming and
testing resources, third party suppliers' ability to modify software and other
unanticipated problems.
RECENTLY ISSUED 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. SFAS No. 133 establishes accounting and
reporting standards for derivative financial instruments and hedging activities
related to those instruments, as well as other hedging activities. Because we do
not currently hold any derivative instruments or engage in hedging activities,
we expect the adoption of SFAS No. 133 will not have a material impact on our
financial position, results of operations or cash flows. We will be required to
adopt SFAS No. 133 in fiscal 2001.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to financial market risk, including changes in interest rates
and marketable equity security prices, relates primarily to our investment
portfolio and outstanding debt obligations. We typically do not attempt to
reduce or eliminate our market exposure on our investment securities because a
substantial majority of our investments are in fixed-rate short-term securities.
We do not have any derivative financial instruments. Due to the short-term
nature of our investments, we believe that there is no material risk. In
addition, substantially all of our outstanding indebtedness is either fixed-rate
debt or short-term variable-rate debt. Therefore, no quantitative tabular
disclosures are required.
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BUSINESS
OVERVIEW
Avanex designs, manufactures and markets fiber optic-based products, known
as photonic processors, which are miniaturized, or micro-optic, devices that
perform optical signal processing and are designed to increase the performance
of optical networks. Our photonic processors offer communications service
providers and optical systems manufacturers greater levels of performance and
miniaturization, reduced complexity and increased cost-effectiveness as compared
to current alternatives. We believe photonic processors will enable the next
generation, all-optical network, which is necessary to support the increasing
demand for bandwidth. Our photonic processors enable communications service
providers and optical systems manufacturers to cost-effectively maximize the
capacity of optical networks. Our products are designed to optimize optical
network performance, provide a flexible, scalable and cost-effective optical
transport solution, and facilitate the deployment of next generation service and
applications such as virtual private networking and business-to-business
electronic commerce.
Our objective is to be the leading provider of innovative fiber optic-based
solutions that enable our customers to deploy and optimize fiber optic networks.
In order to achieve this objective, our strategy is to leverage our technology
leadership and expertise to develop new products and expand customer
relationships. We also intend to expand our manufacturing facilities, automate
our manufacturing processes and extend awareness of our brand. Our marketing
strategy is currently based on a push-pull approach in which we target optical
systems manufacturers and communications service providers. With our push
approach, we target optical systems manufacturers that can buy our products and
then resell them as part of their optical solutions. Using our pull approach, we
target communications service providers that can create demand for our products
by directly purchasing, or requiring that their systems incorporate, our
products. We believe this approach will drive demand for our products and help
enable the transition to the next-generation, all-optical network.
INDUSTRY BACKGROUND
INCREASE IN BANDWIDTH DEMAND
The proliferation of the Internet and the increase in activities such as
electronic commerce, the transmission of large data files, Internet-based
businesses and telecommuting have caused a significant increase in the volume of
traffic across the communications infrastructure. According to Ryan, Hankin &
Kent, a leading market research and consulting firm, Internet traffic will
increase from 350,000 terabytes, or trillions of bytes, per month at the end of
1999, to over 15 million terabytes per month in 2003. This market research
suggests that, at the end of 1999, the volume of Internet data traffic will have
surpassed the volume of voice traffic. With this increase in traffic,
communications vendors have focused on delivering improvements that provide more
network bandwidth and increased transmission speed. Consequently, the increase
in performance of communications networks, including the Internet, has attracted
new users, more applications and a greater demand for bandwidth. Thus, the need
for additional network capacity and performance has created a business
environment in which network improvements and increases in available bandwidth
are constantly matched by advances in the applications and services generating
this demand.
EVOLUTION OF THE OPTICAL NETWORK
The communications infrastructure was originally built for voice traffic.
This voice network was designed using circuit-switched technology that provides
each data stream, such as a telephone call between two points, with a dedicated
channel, or circuit, for the duration of the call. This approach is efficient
for voice communications, which are low bit, or data, rate transmission among
fixed geographic locations, and symmetrical, or involving the exchange of
relatively equal amounts of information between parties. The circuit-switched
network approach, however, is inefficient for pure data transmissions, which are
characterized by large bursts of data traffic followed by long periods of
silence. This inefficiency is heightened by the fact that data traffic is often
asymmetrical and among multiple geographic locations.
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In an effort to overcome the limitations of circuit-switched networks,
service providers have implemented various enhancements such as advanced
switching technology and equipment. In addition, the medium over which data
traffic is transmitted, or transport layer is being upgraded from electrical to
optical transmission. In contrast to electrical transmission over copper wires,
optical transmission technology transfers data in the form of pulses of light
along optical fibers, which are bundled together in fiber optic cable. Optical
transmission provides significantly greater quality and capacity than electrical
transmission.
Meeting the demand for bandwidth by deploying additional fiber optic cable
is both costly and complicated. Furthermore, the costs associated with laying
the cable underground and the purchasing of rights-of-way increase significantly
when the fiber optic cable is deployed in metropolitan areas. Therefore,
additional enhancements to the communications infrastructure have been
developed, including dense wavelength division multiplexing, or DWDM, which
greatly increases the capacity of the existing fiber optic infrastructure.
DWDM technology allows the transmission of data on different wavelength
channels, or a specified range of wavelengths, down the same optical fiber so
that at the destination, the different wavelength channels can be separated and
the different data streams extracted. As a result, DWDM technology can increase
the bandwidth of a single optical fiber by an amount equal to the number of
different wavelength channels that can be transmitted down the optical fiber.
However, current DWDM technology has limitations. One limitation is caused by
the fact that as the number of different wavelength channels traveling down the
same optical fiber increases, the closer the wavelengths will be to each other.
Because current light sources, such as lasers, emit light across an imprecise
wavelength range, the number of different wavelength channels that can be
transmitted down a single fiber is limited because these channels interfere with
one another, preventing extraction of the different data streams at the
destination. Another limitation results from the fact that different wavelengths
of light, which compose the wavelength channels, travel down the optical fiber
at different velocities and reach the destination at different times, making it
difficult to extract the data streams. This is known as chromatic dispersion,
and this effect increases with the distance the wavelength channels travel down
an optical fiber. Therefore, the distance a wavelength channel can travel down
an optical fiber is limited in current DWDM technologies.
Despite the improvements in the existing communications infrastructure,
such as the DWDM technology described above, we believe a transition to a
next-generation, all-optical network must occur in order to support increasing
bandwidth demand.
TECHNOLOGICAL CHALLENGES OF THE TRANSITION TO AN ALL-OPTICAL NETWORK
High Cost and Under-utilization of Available Bandwidth. In order to
optimize their investments in the existing fiber optic infrastructure, service
providers require a low-cost solution that allows a large number of wavelength
channels carrying data to travel simultaneously over the same optical fiber.
Although current DWDM technology provides a partial solution, this technology is
expensive and the number of wavelength channels that can be transmitted
simultaneously is relatively low. Additionally, current DWDM technology requires
that wavelength channels be transmitted with a large space between each channel.
Therefore, as depicted in the following diagram, bandwidth is under-utilized
because wavelength channels are not densely packed.
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OPTICAL SIGNAL
Total Available Bandwidth
[Optical Signal Diagram]
[At the top of the diagram is the caption "Optical Signal". Across the top of
the diagram is a horizontal line with arrows at each end. The label above the
line is "Total Available Bandwidth." Beneath this line are three vertical boxes,
each bearing the label "Wavelength Channel," with an arch over each box. Beneath
these boxes is a horizontal line with the label "Bandwidth" beneath each
"Wavelength Channel" box and the label "Unused Bandwidth" beneath the space
between the "Wave Channel" boxes, which are under the arches.]
By utilizing a greater portion of the available bandwidth for data transmission,
communications service providers can increase the efficiency of their optical
networks by placing a greater number of wavelength channels into a single
optical fiber.
The Necessity of Opto-electrical Conversion. Another technological
limitation of the current optical transmission system is the pervasiveness of
the process known as opto-electrical conversion. Opto-electrical conversion is
the conversion of the incoming optical signal into an electrical signal and back
into an outgoing optical signal. This conversion is required in order to
regenerate the signal to overcome the limitations of chromatic dispersion and
attenuation and in order to drop data from or add data to the composite optical
signal.
- Chromatic Dispersion. Chromatic dispersion occurs because different
wavelengths of optical signals transmitted over a single optical fiber
travel at different velocities. Because these wavelengths travel at
different velocities, the resulting wavelength delays distort the signal
quality. This signal distortion can only be avoided by regenerating the
signal after it has travelled a short distance.
- Attenuation. As optical signals travel over fiber, the signals degenerate
and are eventually lost due to a phenomenon known as attenuation. As
communications service providers attempt to send signals over even longer
distances, the attenuation worsens, and the signal is lost. Therefore,
the signal requires regeneration after traveling a short distance.
- Adding or Dropping of Data. As composite optical signals are transmitted
across the network, it is often necessary to have some data dropped off
from or added to this signal at a given location. This process is known
as add/drop multiplexing and is required because composite optical
signals contains data with different destinations. In order to remove
data from or add data to a composite optical signal, that signal must be
converted to an electrical signal and then reconverted back to a
composite optical signal, even if that signal does not otherwise require
regeneration at that location.
Opto-electrical conversion currently occurs at multiple points in the
network, and in different types of network equipment. This process is costly for
the following reasons:
- The equipment is specific to a particular bit rate, protocol and signal
format and therefore is neither scalable nor flexible enough to handle
other transmission speeds, protocols or signal formats.
- It requires expensive equipment throughout the network.
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- The equipment occupies valuable space.
- The equipment consumes significant electrical power and generates excess
heat.
These costs increase as more wavelength channels are added to a single
optical fiber in DWDM systems because each channel of a DWDM system must undergo
this conversion process. Thus, opto-electrical conversion presents one of the
most significant technological challenges of the current communications
infrastructure.
COST CHALLENGES OF THE TRANSITION TO AN ALL-OPTICAL NETWORK
Deploying an all-optical network is costly because optical products are
more expensive to manufacture and deploy than electrical equipment. The cost of
developing optical technology and products is high due to the infancy of the
technology and its related industry. Because of the emerging nature of the
industry, manufacturing yields are low, which also results in additional costs.
Furthermore, once a product is developed and manufactured, it is often too
bulky, complex and inflexible to be cost-effective.
DEPLOYMENT CHALLENGES OF THE TRANSITION TO AN ALL-OPTICAL NETWORK
Users of optical systems require miniaturized products because their
systems are often deployed in locations where space is limited. Few optical
product manufacturers have the ability to manufacture miniaturized, or
micro-optic, products that consistently meet standard specifications. In order
to develop an all-optical network, an optical solutions provider must understand
not only the optical systems, but also the network in which these optical
systems are to be deployed. Traditionally, the optical component manufacturers
have focused on developing optical packaging expertise while systems
manufacturers and service providers have focused on developing network
deployment and optical design expertise.
Despite the advances in optical technology, several challenges still exist,
which prevent the widespread deployment of existing optical solutions. As a
result of these limitations, the current network is a patchwork of various
solutions placed throughout the network operating on multiple protocols over
multiple layers on both optical and electrical signals.
THE AVANEX SOLUTION
Avanex designs, manufactures and markets fiber optic-based products, known
as photonic processors, which are designed to deliver increased performance,
miniaturization, scalability, reduced complexity and lower cost as compared to
current alternatives. Our solutions bring photonic processing capabilities to
the transport layer of the network and significantly reduce the need for
opto-electrical conversion. Unlike existing component technologies, our photonic
processors perform optical signal processing, or change the signal according to
predetermined algorithms. Our photonic processors also differ from conventional
optical systems in that they do not require software and electronics. We believe
our photonic processors enable service providers and optical systems
manufacturers to cost-effectively maximize the bandwidth of optical networks.
Our solutions provide the following key benefits:
Optimize Optical Network Performance. Our photonic processors are designed
to maximize the capacity of optical fiber and the efficiency and reliability of
optical transmission. Our photonic processors are designed to enable the
transmission of data at smaller spacings between wavelength channels, at higher
bit rates and across greater distances than currently available solutions. These
design features enable the use of greater fiber optic bandwidth for the
transport of data than can be delivered with alternative DWDM solutions
available today. We also enable variable chromatic dispersion compensation,
which minimizes transmission errors and increases the distance an optical signal
can travel before being regenerated.
Provide a Flexible and Scalable Solution. Applying our expertise in
networking design, we have developed solutions that are flexible, modular and
designed to be easily deployed into existing and future networks. Our solution
is scalable because our photonic processors are designed to work equally well in
small and large optical networks, as well as facilitate easy upgrading of an
optical system to a higher number of channels. Our photonic processors provide
functionality that accommodates existing protocols, including the
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telecommunications standard by which optical signals are transmitted down the
optical fiber using a common timing signal, known as synchronous optical
networks, or SONET, the standard by which Internet data are transferred down the
communication network, known as Internet protocol, or IP, and the standard by
which packets of data are transferred down a network at irregular intervals,
known as asynchronous transfer mode, or ATM. Our photonic processors are
designed to meet the demands placed on today's network, but can be easily
expanded to meet future demand.
Provide a Cost-Effective Optical Transport Solution. Our solutions are
designed to enable the transition to the next-generation, all-optical network
without the large capital investments or complex system design challenges
typically encountered in network deployment. The optical signal processing
capabilities of our photonic processors allow us to offer lower cost solutions
than those currently available. Through our micro-optic packaging, or
miniaturization, and integration, or the combination of multiple optical
components in a single package, our customers can use our products to optimize
the utilization of limited networking equipment space. Our photonic processors
also reduce the need for expensive opto-electrical conversion at numerous points
along the transmission path. In addition, our products are designed to be used
within the existing communications infrastructure as well as in the
next-generation, all-optical network, which protects existing infrastructure
investments and facilitates network development efforts.
Facilitate the Deployment of Next-Generation Services and Applications. Our
solutions bring processing capabilities for the first time to the transport
layer of the network. We believe these capabilities will enable our customers to
offer a new set of services and applications, including voice transmissions over
the Internet, virtual private networking and business-to-business e-commerce.
These new offerings could provide our customers with potential new revenue
streams and opportunities for further competitive differentiation.
THE AVANEX STRATEGY
Our objective is to be the leading provider of innovative, fiber
optic-based solutions that enable our customers to deploy and optimize fiber
optic networks. Key elements of our strategy include:
Leverage Technology Leadership and Expertise. We believe that we have a
unique combination of superior network design and system architecture knowledge
as well as advanced optical packaging technologies. We have filed 25 patent
applications in the United States and four patent applications internationally.
We intend to continue to focus our product development efforts on providing
fiber optic-based solutions that address the need for an unlimited number of
low-cost wavelengths, transported at very high data rates and at very long
distances. In developing new products, we intend to leverage our expertise in
designing solutions that are cost-effective, scalable and flexible. We plan to
increase our research and development efforts, including the expansion of The
Photonics Center, which is a 6,000 square foot customer demonstration and
testing facility in Richardson, Texas, as well as evaluate externally-developed
technology opportunities as they become available.
Expand Existing and Develop New Customer Relationships. We currently
provide our photonic processors to customers in the communications industry,
including communications service providers such as MCI WorldCom and optical
systems manufacturers such as Hitachi, Osicom and Cerent, which was recently
acquired by Cisco Systems. We intend to leverage our existing relationships with
these and other existing customers and develop new relationships with potential
customers in the service providers and optical systems manufacturers markets. We
also intend to provide a range of optical solutions that meet the demands of our
target markets.
Expand Sales and Marketing Efforts. Our marketing strategy is based on a
push-pull approach. With our pull approach, we target communications service
providers who can create demand for our products by purchasing our products
directly or by requiring that the systems they purchase incorporate our
products. With our push approach, we target optical systems providers who can
buy our products and then resell them as a part of their optical solutions. We
plan to expand our North American direct sales team, which will include customer
representatives, a technical sales force and application engineers. We intend to
expand our international presence by increasing both our direct sales force and
establishing relationships with international distributors.
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<PAGE> 40
Expand Manufacturing Capabilities. We intend to continue to develop our
manufacturing and packaging expertise to enable us to consistently design,
develop and manufacture miniaturized, reliable and cost-effective products. We
intend to continue to invest in our manufacturing capabilities, as well as
expand our manufacturing facilities so that we can meet the needs of our target
markets. Our manufacturing is cell-based, or partitioned according to
similarities in responsibilities. We believe this type of manufacturing
organization allows us to expand our facilities more efficiently, both in terms
of cost and time. We are automating our testing process and plan to extend this
automation to other parts of the manufacturing process.
Enhance the Avanex Brand. We plan to enhance the Avanex brand throughout
the communications industry by engaging in a range of marketing programs to
position us as the leading provider of fiber optic-based solutions that power
the next generation, all-optical network. These activities will include
participation in industry conferences and trade shows, advertisements in print
publications, direct marketing and Internet-based marketing. We also plan to
build awareness through product demonstrations and customer education and
training at The Photonics Center.
TECHNOLOGY
Our optical signal processing technology is designed to solve the inherent
complexity of, and limitations on, bandwidth, speed and distance in conventional
network and long-haul optical transmission systems. Our products incorporate
several core optical technologies that we believe will enable the
next-generation, all-optical network. These include:
Integrated/Tuned Dielectric Filter. Integrated/tuned dielectric filter
technology allows certain wavelength channels, or optical signals, to pass
through multiple filters while reflecting unwanted optical signals. These
filters are used in DWDM systems to separate, or demultiplex, incoming optical
signals and combine, or multiplex, outgoing optical signals. These filters can
be tuned, or adjusted, to different frequencies, reducing the number of types of
filters needed in a DWDM system. This technology enables the placement of
multiple filters in a single package, reducing the size of the DWDM system and
signal loss.
Spectral Segmentation Technology. Traditional DWDM technology multiplexes
and demultiplexes wavelength channels individually. Our proprietary spectral
segmentation technology enables the multiplexing and demultiplexing of
wavelength channels in groups. This allows for more efficient and flexible
packaging and less degradation of the optical signal due to the need for fewer
subcomponents in the DWDM system. Our PowerMux product incorporates this
technology in the dense multiplexing and demultiplexing of wavelength channels
in a DWDM system.
Variable Chromatic Dispersion Compensation Technology. Chromatic dispersion
occurs because different wavelengths of optical signals transmitted over a
single optical fiber travel at different speeds. Chromatic dispersion
deteriorates the quality of optical signals in high bit rate transmission
systems. The farther the optical signal travels, the more it gets distorted. Our
dispersion compensation technology, utilized in our PowerShaper product,
corrects for chromatic dispersion by compensating for the differences in
wavelength speed. Our technology allows one single product to function across
multiple wavelength channels and can compensate, or correct for, different
levels of chromatic dispersion.
PRODUCTS
Our photonic processors are designed to increase the performance of optical
networks. Our photonic processors differ from full optical systems in that they
are micro-optics-based devices that do not require software and electronics.
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<PAGE> 41
Our current product line consists of the PowerFilter, the PowerMux and the
PowerShaper. The following table sets forth these products as well as some of
our products in development and their capabilities:
<TABLE>
<CAPTION>
PRODUCT DESCRIPTION BENEFIT STATUS
------- ----------- ------- ------
<S> <C> <C> <C>
PowerFilter Integrated tunable wavelength - Reduced signal loss Shipping
filter multiplexer and
demultiplexer - Fewer types of filters
needed
PowerMux High density wavelength - Accommodates large number of Shipping
division multiplexer processor wavelength channels
- More efficient use of
bandwidth for data
transmission
- Low cost per wavelength
channel
PowerShaper Fixed and variable chromatic - Compact packaging Beta Testing
dispersion compensator
- Broadband chromatic
dispersion compensation
- Optimizes chromatic
dispersion compensation
PowerExchange Reconfigurable optical - Real time configuration of Beta Testing
add-drop multiplexer optical add-drop
multiplexing
SuperPowerShaper Variable chromatic slope - Extends the wavelength Beta Testing
dispersion compensator channels of high bit-rate
transmissions
</TABLE>
PowerFilter. One of the limitations of current optical filters is that too
much of the incoming optical signal is lost during the sequential filtering
process, a phenomenon known as insertion loss. Our PowerFilter technology is
designed to correct much of this inefficiency, increasing transmission distance
and improving system performance. The central piece of the filter technology is
a thin film dielectric filter-based device, which offers wavelength-tuning
capabilities. Wavelength tuning allows a single filter to filter multiple
wavelength channels. Our proprietary packaging schemes also consolidate filter
types and parts. This, in turn, provides an added advantage of cost savings on
materials.
PowerMux. PowerMux is a next generation DWDM product. It is capable of
multiplexing optical signals at smaller spacings between wavelength channels, at
higher bit rates and across greater distances than currently available
solutions. The PowerMux allows DWDM multiplexing and demultiplexing of optical
signals at the origin and destination of a transmission path, in addition to
offering optical add-drop multiplexing at any point in the transmission path,
known as OADM. We believe this product allows our customers to use more fiber
optic bandwidth for the transport of data than can be delivered with alternative
DWDM equipment available today.
PowerShaper. PowerShaper, currently in the beta testing stage, is a
broadband chromatic dispersion compensation processor and is specifically
designed to correct the inherent bandwidth and distance limitations in optical
transmission systems resulting from chromatic dispersion. The PowerShaper can
act as a fixed or variable dispersion compensator, which will permit system
providers to optimize their network for improved network performance.
PowerShaper is designed to correct for chromatic dispersion by reshaping the
individual optical signals at the receiving end of the optical fiber and
preventing them from mixing and corrupting the transmission data.
We cannot assure you that we will be able to successfully introduce or
market products that are currently in the beta testing stage and we are unable
to determine when these products will be marketable. We also
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cannot assure you that these products will achieve market acceptance. Please see
"Risk Factors -- If We Are Unable to Develop Products and Product Enhancements
That Achieve Market Acceptance, Sales of Our Products Will Suffer and We Will
Not Be Successful."
CUSTOMERS
Our target customer base includes communications service providers and
optical systems manufacturers. Customers who have placed orders for commercial
shipment include MCI WorldCom, Hitachi, Osicom, Lucent and Cerent, which
recently agreed to be acquired by Cisco Systems.
We began recognizing revenues from sales of our photonic processors in the
quarter ended June 30, 1999. In the fiscal year ended June 30, 1999, sales to
Osicom, MCI WorldCom and Hitachi accounted for 33%, 32%, and 29% of net revenue,
respectively. In the quarter ended October 1, 1999, sales to MCI WorldCom
accounted for 92% of net revenue, and in the quarter ended December 31, 1999,
accounted for 85% of net revenue. We expect that the majority of our revenues
will continue to depend on sales of our photonic processors to a small number of
customers.
MARKETING, SALES AND CUSTOMER SUPPORT
We are implementing a marketing strategy that is based on a push-pull
approach. Using the pull approach, we target communications service providers,
who can create demand for our products by purchasing our products directly or by
requiring that their systems incorporate our products. Using the push approach,
we target optical systems providers, who can buy our products and then resell
them as a part of their optical solutions. Our marketing efforts are centered
around demonstration and education of our products' performance at trade shows
and The Photonics Center, continued publicity through paid advertising and
direct mail and Internet-based communication and promotion.
We sell and market our products through a combination of direct sales and
country-specific distributors. Our direct sales organization currently consists
of one sales representative operating in the United States, three regional sales
directors operating in the western, central and eastern regions of the United
States, one manufacturer's representative in Italy and two distributors in
Japan. The sales organization is supported by three customer service
representatives and one sales analyst.
We focus our direct sales efforts on service providers and optical systems
manufacturers. The direct sales account managers cover the market on an assigned
account basis and work as a team with account-oriented systems engineers. We
also have application engineers that provide our customers with assistance on
the evolution of their networks as it relates to the deployment of our products.
These engineers help in defining the features that are required for our products
to be successful in specific applications.
In order to further our international sales objectives, we have established
relationships with two distributors in Japan. These distributors have expertise
in deploying complex telecommunications equipment in their markets and provide
basic support required by our international customers.
We believe that support services are essential to the successful
installation and ongoing support of our products. We deliver these services
directly to major customers and indirectly through our international
distributors. We currently have three people in customer service and support
located in our Fremont, California corporate headquarters.
THE PHOTONICS CENTER
To help market our technology and product performance and enable our
push-pull marketing strategy, we have established The Photonics Center in
Richardson, Texas, which is a leading-edge customer testing, demonstration and
training facility that enables deployment of our products in a simulated
network. As a result, we benefit from immediate feedback from our current and
potential customers about our photonic processors. The Photonics Center also
provides testing capabilities for the development of products and prototypes. In
addition, we believe that The Photonics Center shortens our products' evaluation
cycle with potential customers because they receive initial evaluation
information on our products before these products
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are shipped to the customer location for full testing and evaluation. This
initial information gives the potential customer a better understanding of the
product before delivery to their location, which we believe gives us an
advantage in the sales process.
MANUFACTURING
We currently manufacture all of our products in our Fremont, California
facility. We intend to devote significant resources to expanding our
manufacturing capacity and expect to continue to hire significant numbers of new
manufacturing employees.
The manufacturing of photonic processors requires the use of a highly
skilled manual workforce performing critical functions such as optical assembly,
optical alignment, soldering and component integration. We invest significant
resources in training and maintaining the quality of our manufacturing work
force. Furthermore, we developed proprietary automated testing equipment for
consistency in testing results and for efficiency. We also have grouped our
manufacturing operations into several product-specific or customer-specific
cells. We believe this provides a highly flexible and efficient operating
capability, and is designed to meet customer expectations for high volume
capacity, high quality and on-time delivery.
If we are unable to expand our manufacturing capacity on a timely basis to
meet demand or if we do not accurately project demand, we will have excess
capacity or insufficient capacity, either of which will seriously harm our
business.
We emphasize quality assurance throughout the entire supply-chain and
manufacturing processes. We also install stringent quality control processes and
procedures, including incoming material inspection, in-process testing and
outgoing inspection.
We have entered into a five-year agreement with CMI under which a
subsidiary of CMI, organized under the laws of the People's Republic of China,
manufactures optical subcomponents for us in limited quantities at a small
facility in Tianjin, China. They are building a new, larger manufacturing
facility in Tianjin, which will not be operational until at least the quarter
ending September 29, 2000. We cannot assure you that this larger facility will
be completed on time or at all. Under the agreement with CMI, we have granted
licenses to CMI to make in China and the United States, and to use and sell
worldwide, the licensed components. We also granted them a license to use some
of our technical information and manufacturing process know-how in China and the
United States. These licenses are exclusive in China and non-exclusive
elsewhere. As a result, CMI can manufacture and sell optical components based on
our technology to third parties, including our potential competitors.
We expect CMI to build a significant portion of our subcomponents and
products in the future. These activities will extend to full production and
include activities such as material procurement, assembly, test and control. We
will design, specify and monitor all of the tests that are required to meet our
quality standards. We believe this arrangement with CMI will allow us to operate
without dedicating additional space to these manufacturing operations and will
conserve the working capital that would otherwise be required for funding
additional inventory. See "Risk Factors -- Because We Expect to Depend on a
Third Party Located in China to Manufacture Subcomponents and Products for Us,
We May Have Difficulties Obtaining a Sufficient Amount of High Quality Products,
Which Would Delay Our Ability to Fulfill Customers Orders."
We currently purchase several key components used in our photonic
processors from single or limited sources of supply, including Nippon Sheet
Glass, Hoya USA, Inc., CMI, Sumitomo Corporation of America, Casix, Inc. and
Browave Corporation. These key components include filters, lenses and specialty
glass. We have no guaranteed supply arrangement with these suppliers. The
inability to obtain sufficient quantities of these components may result in
delays or reductions in product shipments, which would harm our business.
QUALITY
We have established a quality assurance plan to improve our company-wide
quality system to ensure that our customers' requirements are consistently met.
This system is based on the international standard
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ISO 9001. While we are not currently registered as ISO 9001 compliant, we are
currently working toward obtaining ISO 9001 registration, which we believe will
provide a further competitive strength.
PRODUCT DEVELOPMENT
We have assembled a team of engineers and prototype production operators
with significant experience in optics, data networking and communications. We
believe our engineering team possesses expertise in the areas of optics,
micro-optic design, network system design and system-level software design. Our
product development efforts focus on enhancing our first generation of photonic
processors, developing additional optical network products and continuing to
develop next generation technology to support the growth in network bandwidth
requirements.
As of December 31, 1999, we had 59 people in our product development group.
We have made, and will continue to make, a substantial investment in research
and development. Our research and development expenses totaled $515,000 for the
period from October 24, 1997 (inception) through June 30, 1998, $4.1 million for
the fiscal year ended June 30, 1999 and $3.0 million for the six months ended
December 31, 1999.
Our industry is characterized by very rapid technological change, frequent
new product introductions and enhancements, changes in customer demands and
evolving industry standards. While we have developed, and expect to continue to
develop, most new products and enhancements to existing products internally,
from time to time we may be required to license technology from third parties to
develop new products or product enhancements. These licenses may not be
available to us on commercially reasonable terms.
COMPETITION
The markets we are targeting are new and rapidly evolving, and we expect
these markets to become highly competitive in the future. While we do not have
any direct competitors in the photonic processor market today, we anticipate
that other companies will in the future expand into our markets and introduce
competitive products. We also face indirect competition from public and private
companies providing products that address the same fiber optic network problems
that our products address. The development of alternative solutions to optical
transmission problems by competitors, particularly systems companies who also
manufacture components, could significantly limit our growth.
Some companies in the optical systems and component industry may compete
with us in the future, including Lucent Technologies, Nortel Networks, Alcatel,
Fujitsu, JDS Uniphase and E-Tek Dynamics. These are large public companies that
have longer operating histories and significantly greater financial, technical,
marketing and other resources than we have. As a result, these competitors are
able to devote greater resources to the development, promotion, sale and support
of their products. In addition, our competitors that have large market
capitalizations or cash reserves are much better positioned than we are to
acquire other companies in order to gain new technologies or products that may
displace our product lines. Any of these acquisitions could give our competitors
a strategic advantage. Many of our potential competitors have significantly more
established sales and customer support organizations than we do. In addition,
many of our competitors have much greater name recognition and have more
extensive customer bases, better developed distribution channels and broader
product offerings than our company. These companies can leverage their customer
bases and broader product offerings and adopt aggressive pricing policies to
gain market share. We expect to encounter potential customers that, due to
existing relationships with our competitors, are committed to the products
offered by these competitors. As a result, these potential customers may not
consider purchasing our products.
Existing and potential customers are also our potential competitors. These
customers may develop or acquire additional competitive products or technologies
in the future, which may cause them to reduce or cease their purchases from us.
In addition, customers who are also competitors may unfairly disparage our
products in order to gain a competitive advantage.
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As a result of these factors, we expect that competitive pressures may
result in price reductions, reduced margins and loss of market share.
INTELLECTUAL PROPERTY
Our success and ability to compete depend substantially upon our internally
developed technology. We have filed 25 U.S. patent applications, six of which
were jointly filed, and four foreign patent applications, one of which was
jointly filed. Our engineering teams have significant expertise in photonic,
micro-optic and systems-level design.
While we rely on patent, copyright, trade secret and trademark law to
protect our technology, we also believe that factors such as the technological
and creative skills of our personnel, new product developments, frequent product
enhancements and reliable product maintenance are essential to establishing and
maintaining a technology leadership position. We cannot assure you that others
will not develop technologies that are similar or superior to our technology.
We license technology from Fujitsu that is critical to our PowerShaper
product, which we expect to introduce in the second half of the fiscal year
ending June 30, 2000. The license agreement requires us to pay a royalty to
Fujitsu in exchange for receiving a non-exclusive and non-transferable license
to use Fujitsu patents to make, use, lease or sell licensed products. The
license agreement expires, unless earlier terminated, when the last patent
expires. Currently, the latest issued patent under this agreement will expire on
October 10, 2017, and this license agreement will terminate on that date, unless
more patents are added under this license agreement. The license agreement is
subject to termination upon the acquisition of more than a 50% interest in us by
certain major communications system suppliers. Thus, if we are acquired by any
of these specified companies, we will lose this important license. The existence
of this license termination provision may have an anti-takeover effect in that
it would discourage those specified companies from making a bid to acquire us.
We generally enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and generally control access to
and distribution of our proprietary information. Despite these efforts to
protect our proprietary rights, unauthorized parties may attempt to copy or
otherwise obtain and use our products or technology. Policing unauthorized use
of our products is difficult, and there can be no assurance that the steps taken
by us will prevent misappropriation of our technology, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as do
the laws of the United States.
Substantial litigation regarding intellectual property rights exists in the
networking industry, and we expect that optical communications products may be
increasingly subject to third-party infringement claims as the number of
competitors in our industry segments grows and the functionality of products in
different industry segments overlaps. In addition, we believe that many of our
competitors in the communications business have filed or intend to file patent
applications covering aspects of their technology on which they may claim our
technology infringes. We can not make any assurances that other third parties
will not claim infringement by us with respect to our products and our
associated technology. Any such claims, with or without merit, could be
time-consuming to defend, result in costly litigation, divert management's
attention and resources, cause product shipment delays or require us to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to us, if at all. A
successful claim of product infringement against us and failure or inability by
us to license the infringed or similar technology could seriously harm our
business. Although we carry general liability insurance, our insurance may not
cover potential claims of this type or may not be adequate to indemnify us for
all liability that may be imposed.
EMPLOYEES
As of December 31, 1999, we had 251 full-time employees, 59 of whom were
engaged in product development, 163 in manufacturing, six in quality, six in
sales, marketing, application support and customer service, and 17 in finance,
administration and operations. None of our employees are represented by a labor
union. We have not experienced any work stoppages and we consider our relations
with our employees to be good.
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Our future performance depends in significant part upon the continued
service of our key technical, sales and senior management personnel, none of
whom is bound by an employment agreement requiring service for any defined
period of time. The loss of the services of one or more of our key employees
could have a material adverse effect on our business, financial condition and
results of operations. Our future success also depends on our continuing ability
to attract, train and retain highly qualified technical, sales and managerial
personnel. Competition for these personnel is intense, particularly in the San
Francisco Bay Area where our headquarters are located, and we can not make any
assurances that we can retain our key personnel in the future.
FACILITIES
In September 1999, we leased one building in Fremont, California for our
corporate headquarters, totaling approximately 54,000 square feet, which
includes sales and marketing, research and development, administration and
manufacturing. This lease will expire in October 2009. Under the same lease, we
were granted a right of first refusal until April 2000, which we have exercised,
to lease an adjacent building, approximately 91,000 square feet, at a
predetermined rate. We also lease approximately 6,000 square feet of office
space in Richardson, Texas for sales and the operation of The Photonics Center.
This lease expires in February 2006.
LEGAL PROCEEDINGS
We are not currently subject to any material legal proceedings. On December
6, 1999, E-Tek Dynamics, Inc. filed a complaint against us in the Santa Clara
Superior Court alleging that we have participated in the illegal recruiting of
E-Tek employees. We believe that the complaint is without merit and we intend to
vigorously defend against it. We believe this complaint will not have a material
effect on our business.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
Our executive officers and directors as of December 31, 1999, are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Walter Alessandrini......... 52 President, Chief Executive Officer and Director
Xiaofan (Simon) Cao......... 36 Senior Vice President, Product Development and Director
Paul Jiang.................. 41 Vice President, Manufacturing and Vendor Management
Jessy Chao.................. 32 Vice President, Finance, and Chief Financial Officer
Anthony Florence............ 57 Vice President, Corporate Marketing and Investor Relations
Peter Maguire............... 49 Vice President, Worldwide Sales
James Pickering............. 58 Vice President, Quality
Margaret Quinn.............. 46 Vice President, Human Resources and Administration
Todd Brooks................. 39 Director
Vint Cerf................... 56 Director
Federico Faggin............. 58 Director
Michael Goguen.............. 35 Director
Seth Neiman................. 45 Director
Gregory Reyes, Jr........... 38 Director
Joel Smith.................. 54 Director
</TABLE>
Walter Alessandrini has served as one of our directors and as our President
and Chief Executive Officer since March 1999. Dr. Alessandrini was President and
Chief Executive Officer of Pirelli Cables and Systems North America LLC, a
manufacturer of cables and communications systems, from November 1996 to March
1999. From November 1990 to November 1996, he was President and Chief Executive
Officer of Union Switch & Signal Inc., a manufacturer of rail transportation
signaling and control systems. Dr. Alessandrini received a doctorate degree in
Mechanical Engineering from the University of Genoa, Italy.
Xiaofan (Simon) Cao, one of our co-founders, has served as one of our
directors since October 1997 and as our Senior Vice President, Product
Development since June 1998. He was our President and Chief Executive Officer
from October 1997 to June 1998. From October 1996 to October 1997, Dr. Cao
served as Vice President, Sales and Marketing of Oplink Communications, Inc., a
producer of components and modules for fiber optic networks. From May 1992 to
September 1996, Dr. Cao was a Senior Technical Service Manager for E-Tek
Dynamics, Inc., a producer of components and modules for fiber optic networks.
Dr. Cao received a B.S. degree in Physics from Zhongshan University, China, M.S.
degrees in Physics and Electrical Engineering from the University of Southern
California and Ph.D. degrees in Physics and Electrical Engineering from the
University of Southern California.
Paul Jiang, one of our co-founders, has served as our Vice President,
Manufacturing and Vendor Management since February 1998. Mr. Jiang was a Senior
Manager at E-Tek Dynamics, Inc. from January 1994 to January 1998. Mr. Jiang
received a B.S. degree in Optics from University of La Verne.
Jessy Chao, one of our co-founders, has served as our Vice President,
Finance and Chief Financial Officer since October 1999. He was our Director of
Finance and Business Operations from February 1998 to October 1999. Mr. Chao was
the Accounting and Finance Manager for E-Tek Dynamics, Inc. from September 1992
to January 1998. Mr. Chao received a B.S. degree in Accounting from San Jose
State University.
Anthony Florence has served as our Vice President, Corporate Marketing and
Investor Relations since November 1999. Mr. Florence was Vice President,
Corporate and Investor Relations, and Office of the Chairman at Ansaldo Signal
N.V., a company involved in the global signaling, automation and control systems
industry, from November 1996 to November 1999. From November 1993 to November
1996, Mr. Florence served as Vice President, Corporate Planning, Marketing and
Investor Relations for Union Switch &
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Signal Inc. Mr. Florence received a B.A. degree in English from Wheeling College
and an M.A. degree in English from the University of Dayton.
Peter Maguire has served as our Vice President, Worldwide Sales since June
1999. Mr. Maguire was the Vice President, Sales for the IXC Market at Fujitsu
Network Communications, Inc., a manufacturer of fiber optic communication
equipment, from May 1999 to June 1999. From July 1992 to May 1999, he was Vice
President, Sales for Pirelli Cables and Systems North America LLC. Mr. Maguire
received a B.S. degree in Business Administration and an M.B.A. degree from
American States University.
James Pickering has served as our Vice President, Quality since September
1999. Mr. Pickering was Vice President, Quality at Etec Systems, Inc., a
manufacturer of semiconductor mask-making equipment, from March 1997 to
September 1999. From December 1989 to March 1997, he was Vice President,
Customer Satisfaction at Union Switch & Signal Inc. Mr. Pickering received a
B.S. degree in Industrial Technology from Northeastern University and an M.B.A.
degree from Babson College.
Margaret Quinn has served as our Vice President, Human Resources and
Administration since October 1999. Ms. Quinn was a principal at HRMQ, a human
resources consulting company, from January 1999 to October 1999. From August
1997 to January 1999, she was Director of International Customer Support at
Nellcor Puritan Bennett Incorporated, a manufacturer of respiratory monitoring
systems. Ms. Quinn served as a human resources consultant at Nellcor Puritan
Bennett from October 1996 to August 1997. Prior to that, Ms. Quinn served as the
Director of Human Resources for Cyrix Corporation, a manufacturer of
microprocessors, from April 1992 to May 1996. Ms. Quinn received a B.A. degree
in Spanish Literature from Mills College.
Todd Brooks has served on our board of directors since February 1998. Mr.
Brooks has been a general partner at the Mayfield Fund, a venture capital firm,
since February 1999. From April 1995 to January 1999, Mr. Brooks served as a
managing principal with JAFCO America Ventures, a venture capital firm. Mr.
Brooks also served as an equity research analyst for Franklin-Templeton Funds,
an investment corporation, from August 1993 to April 1995. Mr. Brooks currently
serves as a director of several private companies. Mr. Brooks received a B.S.
degree from Texas A&M University, M.S. degrees in Electrical Engineering and
Chemical Engineering from the University of California at Berkeley and an M.B.A.
degree from the Harvard Business School.
Vint Cerf has served on our board of directors since December 1999. Dr.
Cerf has served as the Senior Vice President for Internet Architecture and
Technology for MCI WorldCom Corporation, a telecommunications company, since
September 1998. From January 1996 to September 1998, Dr. Cerf was the Senior
Vice President for Internet Architecture and Engineering at MCI Communications
Corporation, a telecommunications company. Dr. Cerf was Senior Vice President
for Data Architecture at MCI Telecommunications Corporation, a
telecommunications company, from February 1994 to December 1995. Dr. Cerf
received a B.S. degree in Math from Stanford University, an M.S. degree in
Computer Science from the University of California, Los Angeles, and a Ph.D.
degree in Computer Science from the University of California, Los Angeles.
Federico Faggin has served on our board of directors since December 1999.
Dr. Faggin has served as Chairman of the board of directors of Synaptics, Inc.,
a creator of human interface technologies and products using neural networks and
mixed signal technologies, from January 1999 to the present. From 1986 to
January 1999, Dr. Faggin served as a director, President and Chief Executive
Officer of Synaptics. Dr. Faggin is also a director of Integrated Device
Technology, Inc., a producer of integrated circuits, GlobeSpan Inc., a producer
of DSL integrated circuits, and several other private companies. Dr. Faggin
received a doctorate degree in Physics from the University of Padua, Italy.
Michael Goguen has served on our board of directors since February 1998. He
has held various positions at Sequoia Capital, a venture capital firm, since
July 1996 and has been a general partner since July 1997. From May 1995 to July
1996, Mr. Goguen was a Director of Software at Bay Networks, Inc., a computer
network system provider. Prior to that, Mr. Goguen was a Director of Software at
Centillion Network Inc. a network equipment manufacturing company, from August
1994 to May 1995. Mr. Goguen currently serves as
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a director of several private companies. Mr. Goguen received a B.S. degree in
Electrical Engineering from Cornell University and an M.S. degree in Electrical
Engineering from Stanford University.
Seth Neiman has served on our board of directors since February 1998. Since
August 1994, he has held various positions at Crosspoint Venture Partners, a
venture capital firm, and has been a general partner of Crosspoint since January
1996. Mr. Neiman is also a director of Brocade Communications Systems, Inc.,
Foundry Networks, Inc., and several private companies. Mr. Neiman received a
B.A. degree in Philosophy from Ohio State University.
Gregory Reyes, Jr. has served on our board of directors since December
1999. Mr. Reyes has served as a director and President and Chief Executive
Officer of Brocade Communications Systems, Inc., a developer of products for
storage area networks, from July 1998 to the present. From January 1994 to June
1998, Mr. Reyes served as President, Chief Executive Officer and Chairman of the
board of directors of Wireless Access, Inc., a wireless data communications
products company. Mr. Reyes has also served as a director of Proxim, Inc., a
wireless networking company, from April 1998 to the present. Mr. Reyes received
a B.S. in Business Administration from Saint Mary's College.
Joel Smith has served on our board of directors since December 1999. Mr.
Smith has served as the President of Bank of America East, a financial
institution, from October 1998 to the present. From July 1991 to October 1998,
Mr. Smith served as President of Nations Bank Carolinas, a financial
institution. Mr. Smith served on the board of directors of Ansaldo Signal, N.V.
from November 1996 to April 1999. Mr. Smith received a B.A. degree from the
University of the South in Sewanee, Tennessee.
BOARD OF DIRECTORS
Our board of directors currently consists of nine members. Upon completion
of this offering, 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, before the
consummation of the offering, three of the nominees to the board of directors
will be elected to a one-year term, three will be elected to two-year terms and
three will be elected to a three-year term. After that, directors will be
elected for three-year terms. Dr. Alessandrini and Messrs. Goguen and Reyes, Jr.
have been designated Class I Directors, whose terms expire at the 2000 annual
meeting of stockholders. Messrs. Cerf, Neiman and Brooks have been designated
Class II Directors, whose terms expire at the 2001 annual meeting of
stockholders. Dr. Cao and Messrs. Faggin and Smith have been designated the
Class III Directors, whose term expires at the 2002 annual meeting of
stockholders. 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 -- Delaware Law and Certain Provisions of Our Certificate of
Incorporation and Bylaws."
Our board of directors appoints our executive officers on an annual basis
to serve until their successors have been elected and qualified. There are no
family relationships among any of our directors or officers.
BOARD COMMITTEES
Compensation Committee. We established a compensation committee in April
1999. The compensation committee currently consists of Messrs. Brooks, Goguen
and Neiman. 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.
Audit Committee. We established an audit committee in December 1999. The
audit committee currently consists of Messrs. Faggin, Reyes, Jr. and Smith. The
audit committee reviews our internal accounting procedures and consults with and
reviews the services provided by our independent accountants.
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<PAGE> 50
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Our compensation committee currently consists of Messrs. Brooks, Goguen and
Neiman. In December 1999, Dr. Alessandrini, our President and Chief Executive
Officer, resigned from the compensation committee. Other than Dr. Alessandrini,
none of the members of our compensation committee is currently or has been, at
any time since the time of our formation, one of our officers or employees. None
of our executive officers currently serves or in the past has served as a member
of the board of directors or compensation committee of any entity that has one
or more executive officers serving on our board or compensation committee. Mr.
Brooks is a general partner of the Mayfield Fund, a holder of approximately 9.3%
of our outstanding stock that has purchased shares of our Series C preferred
stock and Series D preferred stock. Mr. Goguen is a general partner of Sequoia
Capital, a holder of approximately 17.9% of our outstanding stock that has
purchased shares of our Series A preferred stock, Series B preferred stock,
Series C preferred stock and Series D preferred stock. Mr. Neiman is a partner
of Crosspoint Venture Partners, a holder of approximately 17.9% of our
outstanding stock that has purchased shares of our Series A preferred stock,
Series B preferred stock, Series C preferred stock and Series D preferred stock.
See "Certain Transactions." Prior to the formation of the compensation
committee, compensation decisions were made by our entire board of directors.
Dr. Alessandrini did not participate in decisions with respect to his
compensation.
DIRECTOR COMPENSATION
We do not currently compensate our directors in cash for their service as
members of the board of directors, although if expenses are incurred in
connection with attending board of directors and committee meetings these
expenses are reimbursed. Some of our non-employee directors have received grants
of options to purchase shares of our common stock. See "Principal Stockholders"
and "Certain Transactions -- Stock Option Grants to Certain Directors." Our 1999
Director Option Plan provides for the automatic grant of non-statutory stock
options to nonemployee directors. For further information regarding the
provisions of the 1999 Director Option Plan, see "-- Employee and Director
Benefit Plans."
LIMITATIONS ON DIRECTORS' LIABILITY AND INDEMNIFICATION
Our certificate of incorporation limits the liability of directors to the
maximum 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:
- any breach of their duty of loyalty to the corporation or its
stockholders;
- acts or omissions not in good faith or that 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.
Our certificate of incorporation and bylaws provide that we will indemnify
our directors and officers and may indemnify our employees and other agents to
the fullest extent permitted by law. We believe that indemnification under our
bylaws covers at least negligence on the part of indemnified parties. Our bylaws
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
the bylaws would permit indemnification.
We have entered into agreements to indemnify our directors and executive
officers, in addition to the indemnification provided for in our bylaws. These
agreements, among other things, provide for indemnification for judgments,
fines, settlement amounts and expenses, including attorneys' fees incurred by
the director, or executive officer in any action or proceeding, including any
action by or in our right, arising out of the person's services as a director or
executive officer, any of our subsidiaries or any other company or enterprise to
which
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the person provides services at our request. We believe that these provisions
and agreements are necessary to attract and retain qualified persons as
directors and executive officers.
The limitation on 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 presents the compensation earned, awarded or paid for
services rendered to us in all capacities for the fiscal year ended June 30,
1999 by our Chief Executive Officer, our former acting Chief Executive Officer
and our three other most highly compensated executive officers who earned more
than $100,000 in salary and bonus during the fiscal year ended June 30, 1999. No
other executive officer earned more than $100,000 in salary and bonus during the
fiscal year ended June 30, 1999.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
AWARDS
ANNUAL COMPENSATION -----------------------------
----------------------------------- SECURITIES
OTHER ANNUAL RESTRICTED STOCK UNDERLYING
NAME AND PRINCIPAL POSITIONS SALARY BONUS COMPENSATION AWARDS OPTIONS
---------------------------- -------- ------- ------------ ---------------- ----------
<S> <C> <C> <C> <C> <C>
Walter Alessandrini........................ $ 74,038(1) $37,500(1) $ 26,604(2) $ --(3) --
President and Chief Executive Officer
Simon Cao.................................. 138,544 -- -- --(4) --
Senior Vice President, Product
Development
Paul Jiang................................. 125,381 -- -- --(5) --
Vice President, Manufacturing and Vendor
Management
Peter Maguire.............................. 1,904(6) 100,000(6) -- -- --
Vice President, Worldwide Sales
William Lanfri............................. --(7) -- -- --(7) 112,500
Former Acting Chief Executive Officer
</TABLE>
- ------------
(1) Dr. Alessandrini joined us in March 1999. He is currently compensated at an
annual salary of $275,000 with an annual performance-based bonus of
$150,000.
(2) Represents relocation expenses paid to Dr. Alessandrini through June 30,
1999.
(3) In April 1999, Dr. Alessandrini purchased 5,215,589 shares of restricted
stock at $.05 per share through June 30, 1999. These shares are subject to
our right of repurchase that lapses over four years and lapses as to
one-fourth of his shares on March 22, 2000, with the repurchase right
lapsing ratably monthly after that date. As of June 30, 1999, Dr.
Alessandrini held 5,215,589 shares of restricted common stock, which had an
aggregate fair market value of $521,559. Dividends, if any, paid on this
stock will be subject to the same escrow restrictions as the underlying
shares.
(4) In January 1998, Dr. Cao purchased 2,700,000 shares of restricted stock at
$.0007 per share. These shares are subject to our right of repurchase that
lapses over four years and lapsed as to one-fourth of his shares having
vested on January 13, 1999, with the repurchase right lapsing ratably
monthly after that date. As of June 30, 1999, Dr. Cao held 2,700,000 shares
of restricted common stock, which had an aggregate fair market value of
$270,000. Dividends, if any, paid on this stock will be subject to the same
escrow restrictions as the underlying shares.
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(5) In February 1998, Mr. Jiang exercised an option to purchase 1,800,000 shares
of stock at $.0007 per share, subject to our right to repurchase any
unvested shares in the event of the termination of his employment. These
shares vest over four years with one-fourth of his shares having vested on
February 3, 1999 and the remaining shares vesting ratably monthly
thereafter. As of June 30, 1999, Mr. Jiang held 2,250,000 shares of
restricted common stock, which had an aggregate fair market value of
$225,000. Dividends, if any, paid on this stock will be subject to the same
escrow restrictions as the underlying shares.
(6) Mr. Maguire joined us on June 28, 1999 and received $1,904 in salary during
the fiscal year ended June 30, 1999. He is currently compensated at an
annual salary of $165,000. In connection with the start of his employment
with us, he received a $100,000 bonus. If he terminates his employment or if
we terminate his employment for cause, he must repay this bonus. However,
the amount of the bonus that must be repaid is reduced by $8,333 per full
month that he remains employed by us.
(7) Mr. Lanfri did not receive a salary during the fiscal year ended June 30,
1999. In August 1998, Mr. Lanfri exercised an option to purchase 341,101
shares of our common stock at an exercise price of $.013 per share, but the
unvested shares remained subject to our right of repurchase in the event of
the termination of his employment. In March 1999, Mr. Lanfri exercised an
option to purchase 112,500 shares of our common stock at an exercise price
of $.03 per share. As of June 30, 1999, and in connection with Mr. Lanfri's
resignation as our acting Chief Executive Officer in March 1999, Mr. Lanfri
held 415,703 shares of fully vested common stock, which had an aggregate
fair market value of $41,570. Dividends, if any, paid on this vested stock
will go to Mr. Lanfri. The remaining 37,899 shares of common stock subject
to repurchase have been repurchased by us at their original exercise price.
OPTION GRANTS IN LAST FISCAL YEAR
The following table shows information regarding stock options granted
during the fiscal year ended June 30, 1999 to our Chief Executive Officer,
former acting Chief Executive Officer and three other most highly compensated
executive officers. Options were granted with an exercise price per share equal
to the fair market value of our common stock on the date of grant, as determined
by our board of directors. In determining the fair market value on the date of
each grant, our board of directors considered a number of factors, including our
operating results and financial condition as of the date of grant, key
developments affecting our business and, where relevant, the most recent price
at which we sold our preferred stock in financing transactions with independent
investors.
The potential realizable value is based on the assumption that our common
stock appreciates at the annual rate shown, compounded annually, from the date
of grant until the expiration of the ten-year term. These numbers are calculated
based on Securities and Exchange Commission requirements and do not reflect
projections or estimates of future stock price growth. Potential realizable
values are computed by:
- multiplying the number of shares of common stock underlying each option
by $36.00 per share, the initial public offering price per share;
- assuming that the total stock value derived from that calculation
compounds at the annual 5% or 10% rate shown in the table for the entire
ten-year term of the option; and
- subtracting from that result the total option exercise price.
Actual gains, if any, on stock option exercises will be dependent on the
future performance of the common stock.
The percentage of total options granted is based on an aggregate of
1,069,050 options granted by us during the fiscal year ended June 30, 1999, to
our employees, including the executive officers listed in the table below. In
addition to the options granted during the fiscal year ended June 30, 1999, we
sold 10,510,589 shares of our common stock under restricted stock purchase
agreements during the fiscal year ended June 30, 1999. None of the executive
officers listed in the table below, other than William Lanfri, were issued
options to
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purchase our common stock in the fiscal year ended June 30, 1999. Dr.
Alessandrini purchased restricted shares of our common stock under the 1998
Stock Plan in the fiscal year ended June 30, 1999.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE VALUE
------------------------------------------------------------- AT ASSUMED ANNUAL RATES
NUMBER OF % OF TOTAL OF STOCK APPRECIATION
SECURITIES OPTIONS GRANTED EXERCISE FOR OPTION TERM
UNDERLYING TO EMPLOYEES PRICE PER EXPIRATION --------------------------
NAME OPTIONS GRANTED DURING PERIOD SHARE DATE 5% 10%
---- --------------- --------------- ------------ ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Walter Alessandrini... -- -- $ -- -- $ -- $ --
Simon Cao............. -- -- -- -- -- --
Paul Jiang............ -- -- -- -- -- --
Peter Maguire......... -- -- -- -- -- --
William Lanfri........ 112,500 10.52% .03 12/07/08 6,593,649 10,501,282
</TABLE>
In December 1998, we granted Mr. Lanfri an option to purchase 112,500
shares of our common stock. This option vested ratably over three months
beginning on January 1, 1999. In March 1999, this option fully vested and Mr.
Lanfri exercised this option.
AGGREGATE OPTION EXERCISES DURING LAST FISCAL YEAR
The following table presents information concerning option exercises by our
Chief Executive Officer, former acting Chief Executive Officer and three other
most highly compensated executive officers for the fiscal year ended June 30,
1999. None of the executive officers listed in the table below held unexercised
options at June 30, 1999. For a list of purchases of restricted shares of our
common stock by the executive officers listed in the table below, please see
"Certain Transactions."
<TABLE>
<CAPTION>
SHARES ACQUIRED VALUE
NAME ON EXERCISE REALIZED
---- --------------- --------
<S> <C> <C>
Walter Alessandrini......................................... -- $ --
Simon Cao................................................... -- --
Paul Jiang.................................................. -- --
Peter Maguire............................................... -- --
William Lanfri.............................................. 415,702 7,043
</TABLE>
In June 1998, we granted Mr. Lanfri an option to purchase 341,101 shares of
our common stock. Of the shares subject to this option, 227,401 shares vested
ratably over six months beginning on August 1, 1998. The remaining 113,700
shares subject to this option were designated by our board of directors as
"bonus shares." The bonus shares either were to vest in one lump sum on July 1,
2004 or were to vest earlier at the sole discretion of our board of directors.
In August 1998, Mr. Lanfri exercised this option to purchase 341,101 shares of
our common stock, but the unvested shares remained subject to our right of
repurchase. Upon Mr. Lanfri's resignation as our acting Chief Executive Officer
in March 1999, our board of directors accelerated the lapsing of our right of
repurchase as to 75,801 shares of Mr. Lanfri's bonus shares and we repurchased
from him, at the original exercise price, the 37,899 shares that remained
subject to repurchase. See "-- Employment Agreements and Change-of-Control
Arrangements" for a description of Mr. Lanfri's employment agreement with us.
EMPLOYEE AND DIRECTOR BENEFIT PLANS
1998 STOCK PLAN
Our 1998 Stock Plan provides for the grant of incentive stock options to
employees, including officers and employee directors, and for the grant of
nonstatutory stock options and stock purchase rights to employees, directors and
consultants. The 1998 Stock Plan was adopted by our board of directors and
approved by our stockholders in January 1998. Our board of directors and
stockholders approved amendments to the 1998 Stock Plan to increase the number
of shares reserved under the 1998 Stock Plan in March 1999, July 1999, October
1999 and January 2000.
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<PAGE> 54
As of December 31, 1999, a total of 8,745,117 shares of our common stock
were available for future grant under the 1998 Stock Plan. This amount includes
amounts returned to the 1998 Stock Plan, and annual increases which will be
added to the 1998 Stock Plan, beginning on July 1, 2000, equal to the lesser of
6,000,000 shares, 4.9% of our outstanding shares or a lesser amount determined
by our board. The 1998 Stock Plan has 29,550,000 shares of our common stock
reserved for issuance, of which options to acquire 3,401,427 shares have been
issued and are outstanding as of December 31, 1999 and a total of 17,403,457
shares have been issued and are outstanding pursuant to the exercise of options
and stock purchase rights granted under the 1998 Stock Plan.
Administration. Our board of directors or a committee of our board of
directors administers the 1998 Stock Plan. The administrator of our 1998 Stock
Plan has the power to determine, among other things:
- the terms of the options or stock purchase rights granted, including the
exercise price of the option or stock purchase right;
- the number of shares subject to each option or stock purchase right;
- the exercisability of each option or stock purchase right; and
- the form of consideration payable upon the exercise of each option or
stock purchase right.
Options. The exercise price of all incentive stock options granted under
the 1998 Stock Plan must be at least equal to the fair market value of the
common stock on the date of grant. The exercise price of nonstatutory stock
options and stock purchase rights granted under the 1998 Stock Plan is
determined by the administrator, but with respect to nonstatutory stock options
intended to qualify as "performance-based compensation" within the meaning of
Section 162(m) of the Internal Revenue Code, the exercise price must be at least
equal to the fair market value of our common stock on the date of grant. With
respect to any participant who owns stock representing more than 10% of the
voting power of all classes of our outstanding capital stock, the exercise price
of any incentive stock option granted must be at least equal 110% of the fair
market value on the grant date and the term of the incentive stock option must
not exceed five years. The term of all other options granted under the 1998
Stock Plan may not exceed 10 years.
During any fiscal year, each optionee may be granted options to purchase a
maximum of 1,500,000 shares. In addition, in connection with an optionee's
initial employment with us, the optionee may be granted an option covering an
additional 4,500,000 shares.
Options granted under the 1998 Stock Plan must generally be exercised
within three months after the end of the optionee's status as an employee,
director or consultant of ours, or within 12 months after the optionee's
termination by death or disability, but in no event later than the expiration of
the option's term.
Transferability of Options. Options and stock purchase rights granted under
the 1998 Stock Plan are generally not transferable by the optionee, and each
option and stock purchase right is exercisable during the lifetime of the
optionee only by the optionee.
Stock Purchase Rights. In the case of stock purchase rights, unless the
administrator determines otherwise, the restricted stock purchase agreement
shall grant us a repurchase option exercisable upon the voluntary or involuntary
termination of the purchaser's employment or consulting relationship with us for
any reason, including death or disability. The purchase price for shares
repurchased under 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 us. The repurchase option shall lapse at a rate determined
by the administrator.
Adjustments upon Merger or Asset Sale. The 1998 Stock Plan provides that in
the event of our merger with or into another corporation, or a sale of
substantially all of our assets, each option and stock purchase right shall be
assumed or an equivalent option substituted for by the successor corporation. If
the outstanding options and stock purchase rights are not assumed or substituted
for by the successor corporation, the optionees will become fully vested in and
have the right to exercise the options or stock purchase rights. If an option or
stock purchase right becomes fully vested and exercisable in the event of a
merger or sale of assets,
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the administrator must notify the optionee that the option or stock purchase
right is fully exercisable for a period of 15 days from the date of the notice,
and the option or stock purchase right will terminate upon the expiration of the
15-day period.
Amendment and Termination of the 1998 Stock Plan. The administrator will
have the authority to amend, suspend or terminate the 1998 Stock Plan, as long
as this action does not affect any shares of common stock previously issued and
sold or any option previously granted under the 1998 Stock Plan. Unless earlier
terminated, the 1998 Stock Plan will terminate automatically 10 years from the
date of obtaining stockholder approval of the amended plan in December 1999.
1999 EMPLOYEE STOCK PURCHASE PLAN
Our 1999 Employee Stock Purchase Plan was adopted by our board of directors
and approved by our stockholders in January 2000. A total of 525,000 shares of
our common stock has been reserved for issuance under the 1999 Employee Stock
Purchase Plan, plus automatic annual increases beginning on July 1, 2000 equal
to the lesser of 750,000 shares, 1% of the outstanding shares on that date or an
amount determined by our board of directors. As of the date of this prospectus,
no shares have been issued under the 1999 Employee Stock Purchase Plan.
Structure of the 1999 Employee Stock Purchase Plan. The 1999 Employee Stock
Purchase Plan, which is intended to qualify under Section 423 of the Internal
Revenue Code, contains consecutive, six-month offering periods. The offering
periods generally start on the first trading day on or after February 1st and
August 1st of each year, except for the first offering period, which commences
on the first trading day on or after the effective date of this offering and
ends on the last trading day on or before July 31, 2000.
Eligibility. Employees are eligible to participate if they are customarily
employed by us or any of our participating subsidiaries for at least 20 hours
per week and more than five months in any calendar year. However, employees may
not be granted an option to purchase stock under the 1999 Employee Stock
Purchase Plan if they either:
- immediately after grant, own stock representing 5% or more of the total
combined voting power or value of all classes of our capital stock; or
- hold rights to purchase stock under our employee stock purchase plans
which accrue at a rate which exceeds $25,000 worth of stock for each
calendar year.
Purchases. The 1999 Employee Stock Purchase Plan permits participants to
purchase our common stock through payroll deductions of up to 10% of the
participant's "compensation." Compensation is defined as the participant's base
straight time gross earnings and commissions, exclusive of payments for shift
premium, bonuses, incentive compensation, incentive payments and other
compensation. The maximum number of shares a participant may purchase during
each offering period is 3,000 shares.
Amounts deducted and accumulated by the participant are used to purchase
shares of common stock at the end of each offering period. The price of stock
purchased under the 1999 Employee Stock Purchase Plan is generally 85% of the
lower of the fair market value of the common stock either:
- at the beginning of the offering period; or
- at the end of the offering period.
Participants may end their participation at any time during an offering
period, and they will be paid their payroll deductions to date. Participation
ends automatically upon termination of employment with us.
Transferability of Rights. Rights granted under the 1999 Employee Stock
Purchase Plan are not transferable by a participant other than by will, the laws
of descent and distribution or as otherwise provided under the 1999 Employee
Stock Purchase Plan.
Merger or Asset Sale. The 1999 Employee Stock Purchase Plan provides that,
in the event we merge with or into another corporation or if there is a sale of
substantially all of our assets, each outstanding option
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may be assumed or substituted for by the successor corporation. If the successor
corporation refuses to assume or substitute for the outstanding options, the
offering period then in progress will be shortened and a new exercise date will
be set.
Amendment and Termination of the 1999 Employee Stock Purchase Plan. The
1999 Employee Stock Purchase Plan will terminate in 2009. Our board of directors
has the authority to amend or terminate the 1999 Employee Stock Purchase Plan,
except that no action may impair any outstanding rights to purchase stock under
the 1999 Employee Stock Purchase Plan.
1999 DIRECTOR OPTION PLAN
Non-employee directors are entitled to participate in our 1999 Director
Option Plan. The 1999 Director Option Plan was adopted by our board of directors
and approved by our stockholders in January 2000, but it will not become
effective until the date of this offering. The 1999 Director Option Plan has a
term of 10 years, unless terminated sooner by our board of directors. A total of
300,000 shares of our common stock have been reserved for issuance under the
1999 Director Option Plan, plus automatic annual increases beginning on January
1, 2001 equal to the lesser of 150,000 shares, .25% of the outstanding shares on
that date or an amount determined by our board of directors.
Option Grants. The 1999 Director Option Plan generally provides for an
automatic initial grant of an option to purchase 40,000 shares of our common
stock to each non-employee director on the date which the later of the following
events occur:
- the effective date of the 1999 Director Option Plan; or
- the date when a person first becomes a non-employee director.
A non-employee director who owns, either directly or indirectly, our
securities representing 1% or more of our total voting power will not receive an
initial grant under the 1999 Director Option Plan and will only be eligible for
a subsequent grant when his or her ownership percentage drops below 1% of our
total voting power.
After the initial grant, each non-employee director will automatically be
granted subsequent options to purchase 10,000 shares of our common stock each
year on the date of our annual stockholders' meeting, if on such date he or she
has served on our board of directors for at least six months. Each initial
option grant and each subsequent option grant shall have a term of 10 years.
Each initial option grant will vest as to 25% of the shares subject to the
option on each anniversary of its date of grant. Each subsequent option grant
will fully vest on the anniversary of its date of grant. The exercise price of
all options will be 100% of the fair market value per share of our common stock
on the date of grant.
Options granted under the 1999 Director Option Plan must be exercised
within three months of the end of the optionee's tenure as a director of the
Company, or within 12 months after such director's termination by death or
disability, but in no event later than the expiration of the option's 10 year
term.
Transferability of Options. No option granted under the 1999 Director
Option Plan is transferable by the optionee other than by will or the laws of
descent and distribution, and each option is exercisable, during the lifetime of
the optionee, only by the optionee.
Merger, Asset Sale and Change of Control. The 1999 Director Option Plan
provides that in the event of our merger with or into another corporation, or a
sale of substantially all of our assets, the successor corporation shall assume
each option or substitute an equivalent option. If outstanding options are not
assumed or substituted for by the successor corporation, each option will become
fully exercisable for a period of thirty days from the date our board of
directors notifies the optionee of the option's full exercisability, after which
period the option shall terminate. In the event of a change of control each
outstanding option will become fully vested and exercisable.
Amendment and Termination of the 1999 Director Option Plan. The
administrator will have the authority to amend, suspend or terminate the 1999
Director Option Plan, so long as no action affects any shares of common stock
previously issued and sold or any option previously granted under the 1999
Director
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Option Plan. Unless terminated sooner, the 1999 Director Option Plan will
terminate automatically 10 years from the effective date of the plan.
401(K) PLAN
In November 1998, we adopted the Avanex Corporation 401(k) Profit Sharing
Plan, or our 401(k) Plan, which covers all of our eligible employees who have
completed three months of service and have attained age 21. The 401(k) Plan
excludes from participation all collectively bargained and non-resident alien
employees. The 401(k) Plan is intended to qualify under Section 401(a) of the
Internal Revenue Code of 1986 and the 401(k) Plan trust is intended to qualify
under Section 501(a) of the Internal Revenue Code. All contributions to the
401(k) Plan by eligible employees or by us, and the investment earnings thereon
are not taxable to such employees until withdrawn, and any contributions we may
make are expected to be deductible by us when made. Our eligible employees may
elect to reduce their eligible compensation by up to 15%, subject to statutorily
prescribed limits, and to have such compensation reductions contributed on their
behalf to the 401(k) Plan. The 401(k) Plan permits, but does not require, us to
make matching contributions to the 401(k) Plan. To date, we have not made any
matching contributions.
EMPLOYMENT AGREEMENTS AND CHANGE-OF-CONTROL ARRANGEMENTS
From time to time, we have entered into employment agreements with our
executive officers, including the executive officers listed in the "Summary
Compensation Table."
Walter Alessandrini. In March 1999, Walter Alessandrini accepted our offer
of employment. The offer letter provides that Dr. Alessandrini is entitled to
receive an annual salary of $275,000 and a bonus of $150,000 during his first
year of employment, to be paid based on the achievement of performance-based
milestones. His employment with us is on an at-will basis. In connection with
this offer letter, in April 1999, Dr. Alessandrini purchased, at a price of $.05
per share, 5,215,589 shares of our common stock, under a restricted stock
purchase agreement. These shares are subject to a right of repurchase that
lapses over a four-year period and as to one-fourth of these shares on March 22,
2000, with the repurchase right lapsing ratably monthly after that date. Any
shares as to which the repurchase right has not lapsed are subject to repurchase
by us in the event of the termination of his employment.
The offer letter also provided that we would loan Dr. Alessandrini up to
$300,000 in connection with the purchase of a home. For further discussion of
this loan, please see "Certain Transactions -- Loans to Executive Officers." The
offer letter also provides that if we terminate his employment with us without
cause then he will receive six months of salary and bonus and our right to
repurchase his shares under this offer letter will lapse as to a number of
shares equal to the greater of:
- one-fourth of these shares, if he is terminated before March 22, 2000; or
- an additional one-eighth of these shares if he is terminated on or after
March 22, 2000.
In addition, the offer letter provides that if he cannot serve as our Chief
Executive Officer for any period of time due to a legal restraint or litigation
in connection with a Confidentiality and Non-Competition Agreement that he
entered into with his previous employer, Pirelli Cables and Systems North
America, LLC, then we shall pay him up to $100,000 in salary in monthly
installments for up to six months during the period that he is not serving as
our Chief Executive Officer.
In October 1999, Dr. Alessandrini purchased 521,559 shares of our common
stock, at a price of $.39 per share, under a restricted stock purchase
agreement. These shares are subject to a right of repurchase that lapses over a
four-year period and as to one-fourth of his shares on March 22, 2000 with the
repurchase right lapsing ratably monthly after that date. Each of the restricted
stock purchase agreements relating to these purchases provides that, upon a
change of control, the lapsing of our right of repurchase will be accelerated so
that at least 50% of the common stock purchased under each restricted stock
purchase agreement will not be subject to our right of repurchase. In addition,
upon an involuntary termination of his employment without cause, upon or within
12 months of a change of control, our right of repurchase will lapse as to all
of the common stock subject to repurchase under each of his restricted stock
purchase agreements.
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Simon Cao. On January 2, 1998, Simon Cao accepted our offer of employment.
Initially, Dr. Cao was entitled to receive an annual salary of $125,000. On
September 8, 1998, Dr. Cao agreed to amend his initial offer letter to increase
his annual salary to $140,000. In August 1999, our board of directors increased
his annual salary to $180,024. His employment with us is on an at-will basis. In
connection with this offer letter, in January 1998, Dr. Cao purchased, at a
price of $.0007 per share, 2,700,000 shares of our common stock, under a
restricted stock purchase agreement. These shares are subject to a right of
repurchase that lapses over a four-year period and lapsed as to one-fourth of
these shares on January 13, 1999 with the repurchase right lapsing ratably
monthly after that date.
In August 1999, Dr. Cao purchased, at a price of $.10 per share, 900,000
shares of our common stock and in October 1999 purchased, at a price of $.39 per
share, 1,020,726 shares of our common stock, in each case under a restricted
stock purchase agreement. These shares are subject to a right of repurchase that
lapses over a four-year period and lapses as to one-fourth of the shares
purchased in August 1999, on June 17, 2000 and as to one-fourth the shares
purchased in October 1999, on October 8, 2000. The repurchase right lapses
ratably monthly after these dates. Each of the restricted stock purchase
agreements relating to these purchases provide that, upon a change of control,
the lapsing of our repurchase right will be accelerated so that at least 50% of
the common stock purchased under each restricted stock purchase agreement will
not be subject to our right of repurchase. In addition, upon an involuntary
termination of his employment without cause, upon or within 12 months of a
change of control, our right of repurchase will lapse as to all of the common
stock subject to repurchase under each of his restricted stock purchase
agreements.
Paul Jiang. In January 1998, Paul Jiang accepted our offer of employment.
His offer letter provided that he was entitled to receive an annual salary of
$115,000. On September 8, 1998, Mr. Jiang agreed to amend his initial offer
letter to increase his annual salary to $126,500. In August 1999, our board of
directors increased his annual salary to $140,000. His employment with us is on
an at-will basis. In connection with this offer letter, in January 1998, Mr.
Jiang was granted an option to purchase 1,800,000 shares of our common stock, at
an exercise price of $.0007 per share, which he exercised in February 1998 under
a restricted stock purchase agreement. These shares are subject to a right of
repurchase that lapses over a four-year period and lapsed as to one-fourth of
these shares on February 3, 1999 with the purchase right lapsing ratably monthly
after that date.
In July 1999, Mr. Jiang purchased 450,000 shares of our common stock, at a
price of $.03 per share, under a restricted stock purchase agreement. These
shares are subject to a right of repurchase that lapses over a four year period
and lapsed as to one-fourth of the shares purchased on February 8, 1999 with the
purchase right lapsing ratably monthly after that date. In November 1999, Mr.
Jiang purchased 150,000 shares of our common stock, at a price of $2.67 per
share, under a restricted stock agreement. These shares are subject to a right
of repurchase that lapses over a four-year period and as to one-fourth of his
shares on November 22, 2000 with the repurchase right lapsing monthly after that
date. Each of the restricted stock purchase agreements relating to these
purchases provide that, upon a change of control, the lapsing of our repurchase
right will be accelerated so that at least 50% of the common stock purchased
under each restricted stock purchase agreement will not be subject to our right
of repurchase. In addition, upon an involuntary termination of his employment
without cause, upon or within 12 months of a change of control, our right of
repurchase will lapse as to all of the common stock subject to repurchase under
each of his restricted stock purchase agreements.
Peter Maguire. In June 1999, Peter Maguire accepted our offer of
employment. His offer letter provided that he is entitled to receive an annual
salary of $165,000 and a bonus of $100,000 during his first year of employment.
If he terminates his employment or if we terminate his employment for cause, he
must repay this bonus. However, the amount of the bonus that must be repaid is
reduced by $8,333 per full month that he remains employed by us. His offer
letter provided that he receives a sales commission, to be negotiated annually,
equal to .5% of our sales made by June 30, 2000. This commission will be paid
upon the collection of the sales and on a quarterly basis. His employment with
us is on an at-will basis.
In connection with this offer letter, in July 1999, Mr. Maguire purchased
at a price of $.10 per share, 825,000 shares of our common stock, under a
restricted stock purchase agreement. These shares are subject to a right of
repurchase that lapses over a four-year period and lapses as to one-fourth of
the shares on June 28, 2000 with the repurchase right lapsing ratably monthly
after this date. The restricted stock purchase
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agreement relating to this purchase provides that, upon a change of control, the
lapsing of our repurchase right will be accelerated so that at least 50% of the
common stock purchased under this restricted stock purchase agreement will not
be subject to our right of repurchase. In addition, upon an involuntary
termination of his employment without cause, upon or within 12 months of a
change of control, our right of repurchase will lapse as to all of the common
stock subject to repurchase under his restricted stock purchase agreement.
William Lanfri. In June 1998, William Lanfri entered into an employment
agreement with us to serve as our acting Chief Executive Officer. As
consideration for his services, Mr. Lanfri was granted an option to purchase
112,500 shares of our common stock, at a price of $.03 per share. These shares
vested ratably over a three-month period beginning on January 1, 1999. In March
1999, this option was fully vested and he purchased 112,500 shares of our common
stock.
In June 1998, Mr. Lanfri was granted an additional option to purchase
341,101 shares of our common stock. Of the shares subject to this option,
227,401 shares vested ratably over a six-month period beginning in August 1998.
The remaining 113,700 shares subject to this option were designated by our board
of directors as "bonus shares." The bonus shares either were to vest in one lump
sum on July 1, 2004 or were to vest earlier at the sole discretion of our board
of directors. Our board of directors intended to vest these bonus shares if Mr.
Lanfri met certain performance milestones. In August 1998, Mr. Lanfri exercised
this option to purchase 341,101 shares of our common stock, but unvested shares
remained subject to our right of repurchase upon termination of his employment.
Upon Mr. Lanfri's resignation as our acting Chief Executive Officer in March
1999, our board of directors accelerated the lapsing of our repurchase right as
to 75,801 shares of Mr. Lanfri's bonus shares and we repurchased from him the
remaining 37,899 shares of common stock that remained subject to repurchase.
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CERTAIN TRANSACTIONS
Since our inception in October 1997, there has not been, nor is there
currently proposed, any transaction or series of similar transactions to which
we were or are to be a party in which the amount involved exceeds $60,000, and
in which any director, executive officer, holder of more than 5% of our common
stock or any member of the immediate family of any of these people had or will
have a direct or indirect material interest other than compensation agreements
and other arrangements, which are described where required in "Management," and
the transactions described below.
SALES OF OUR COMMON STOCK AND PREFERRED STOCK
Common Stock. The following table summarizes the private placement
transactions in which we sold common stock to our directors, executive officers,
5% stockholders and persons and entities affiliated with them. The price per
share for each of the following common stock purchases was equal to the fair
market value of our common stock on the date of each purchase. In determining
the fair market value of our common stock, our board of directors, in each case,
took into consideration a number of factors, including our operating results and
financial condition at the time of each purchase, key developments affecting our
business and, where relevant, the most recent price of our preferred stock in
connection with financing transactions with independent investors.
<TABLE>
<CAPTION>
SHARES OF
DATES OF PRICE PER COMMON
PURCHASER PURCHASE SHARE STOCK
--------- --------- --------- ---------
<S> <C> <C> <C>
Walter Alessandrini.............................. 4/30/99* $ .05 5,215,589
10/8/99* .39 521,559
Simon Cao........................................ 1/13/98 .0007 2,700,000
8/4/99* .10 900,000
10/12/99 .39 1,020,726
Paul Jiang....................................... 2/4/98 .0007 1,800,000
7/22/99* .03 450,000
11/26/99* 2.67 150,000
Peter Maguire.................................... 8/4/99* .10 825,000
William Lanfri................................... 8/31/98 .013 341,102
3/31/99 .03 112,500
Jessy Chao....................................... 2/5/98 .0007 1,350,000
11/26/99* 2.67 150,000
James Pickering.................................. 10/1/99* .39 263,880
Anthony Florence................................. 11/19/99* 2.33 195,000
</TABLE>
- ------------
* The purchaser signed a secured full recourse promissory note as consideration
for this purchase. For a description of these promissory notes, please see
"-- Loans to Executive Officers."
Series A Preferred Stock. On February 10, 1998, we sold our Series A
preferred stock at a price of $.149 per share. Each share of Series A preferred
stock is convertible into one share of common stock. Purchasers included the
following directors, 5% stockholders and persons and entities affiliated with
them:
<TABLE>
<CAPTION>
SHARES OF SERIES A
PURCHASER PREFERRED STOCK
--------- ------------------
<S> <C>
Entities affiliated with Crosspoint Venture Partners...... 2,250,000
Entities affiliated with Sequoia Capital.................. 2,250,000
Entities affiliated with JAFCO America Ventures, Inc. .... 2,250,000
</TABLE>
Crosspoint Venture Partners is a holder of more than 5% of our stock. Seth
Neiman, one of our directors, is a partner of Crosspoint Venture Partners.
Sequoia Capital is a holder of more than 5% of our stock. Michael Goguen, one of
our directors, is a general partner of Sequoia Capital. JAFCO America Ventures,
Inc. is a holder of more than 5% of our stock.
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Series B Preferred Stock. On June 29, 1998, we sold Series B preferred
stock at a price of $.27 per share. Each share of Series B preferred stock is
convertible into one share of common stock. Purchasers included the following
directors, 5% stockholders and persons and entities affiliated with them:
<TABLE>
<CAPTION>
SHARES OF SERIES B
PURCHASER PREFERRED STOCK
--------- ------------------
<S> <C>
Entities affiliated with Crosspoint Venture Partners...... 3,127,500
Entities affiliated with Sequoia Capital.................. 3,127,500
Entities affiliated with JAFCO America Ventures, Inc...... 3,127,500
</TABLE>
Series C Preferred Stock. On February 19, 1999 and March 25, 1999, we sold
our Series C preferred stock, at a price of $.504 per share. Each share of
Series C preferred stock is convertible into one share of common stock.
Purchasers included the following officers, directors, 5% stockholders and
persons and entities affiliated with them:
<TABLE>
<CAPTION>
SHARES OF
SERIES C
DATES OF PREFERRED
PURCHASER PURCHASE STOCK
--------- -------- ---------
<S> <C> <C>
Entities affiliated with Crosspoint Venture
Partners............................................ 2/19/99 3,174,603
Entities affiliated with Sequoia Capital.............. 2/19/99 3,174,603
Entities affiliated with JAFCO America Ventures,
Inc. ............................................... 2/19/99 1,194,127
Entities affiliated with the Mayfield Fund............ 3/25/99 4,464,285
William Lanfri........................................ 2/19/99 588,000
</TABLE>
The Mayfield Fund is a holder of more than 5% of our stock. Todd Brooks,
one of our directors, is a general partner of the Mayfield Fund. William Lanfri
was our former acting Chief Executive Officer.
Series D Preferred Stock. On September 14, 1999 and October 15, 1999, we
sold our Series D preferred stock, at a price of $3.83 per share. Each share of
Series D preferred stock is convertible into one share of common stock.
Purchasers included the following officers, directors, 5% stockholders and
persons and entities affiliated with them:
<TABLE>
<CAPTION>
SHARES OF
SERIES D
DATES OF PREFERRED
PURCHASER PURCHASE STOCK
--------- -------- ---------
<S> <C> <C>
Entities affiliated with Crosspoint Venture
Partners............................................ 9/14/99 1,542,387
Entities affiliated with Sequoia Capital.............. 9/14/99 1,542,387
Entities affiliated with JAFCO America Ventures,
Inc. ............................................... 10/15/99 1,327,683
Entities affiliated with the Mayfield Fund............ 9/14/99 805,142
</TABLE>
EMPLOYMENT AGREEMENTS WITH FOUNDERS
We were founded in October 1997 by Simon Cao, Paul Jiang and Jessy Chao.
Jessy Chao. In February 1998, Jessy Chao accepted our offer of employment.
His offer letter provided that he was entitled to receive an annual salary of
$90,000. In September 1998, Mr. Chao agreed to amend his initial offer letter to
increase his annual salary to $99,000. His employment with us is on an at-will
basis. In connection with this offer letter, in February 1998, Mr. Chao was
granted an option to purchase 1,350,000 shares of our common stock, at an
exercise price of $.0007 per share, which he exercised in February 1998 under a
restricted stock purchase agreement. These shares are subject to a right of
repurchase that lapses over a four-year period and lapsed as to one-fourth of
these shares on February 3, 1999 with the repurchase right lapsing ratably
monthly after that date.
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In November 1999, Mr. Chao purchased 150,000 shares of our common stock, at
a price of $2.67 per share, under a restricted stock purchase agreement. These
shares are subject to a right of repurchase that lapses over a four-year period
and as to one-fourth of his shares on November 22, 1999 with the repurchase
right lapsing ratably monthly after that date. Each of the restricted stock
purchase agreements relating to these purchases provide that, upon a change of
control, the lapsing of our right of repurchase will be accelerated so that at
least 50% of the common stock purchased under each restricted stock purchase
agreement will not be subject to our right of repurchase. In addition, upon an
involuntary termination of his employment without cause, upon or within 12
months of a change of control our right of repurchase will lapse as to all of
the common stock subject to repurchase under his restricted stock purchase
agreements.
For a description of our employment agreements with Dr. Cao and Mr. Jiang,
please see "Employment Agreements and Change-of-Control Arrangements."
LOANS TO EXECUTIVE OFFICERS
Walter Alessandrini. In April 1999, in connection with Walter
Alessandrini's purchase of 5,215,589 shares of our common stock, we loaned Dr.
Alessandrini $278,165 under a secured full recourse promissory note with an
annual interest rate of 4.99% compounded semi-annually. Principal and interest
on the note become due and payable on April 30, 2003. The note also provides
that we may accelerate payment of the amounts outstanding under the loan in the
event he ceases to be an employee or consultant of ours.
In April 1999, in connection with his purchase of a home, we loaned Dr.
Alessandrini $300,000 under a secured full recourse loan with an annual interest
rate of 4.9%. Principal and interest on this note become due and payable on the
earlier of six months from that date on which he can sell shares of our common
stock for an amount equal to the principal and interest owed on the note, or the
termination of his employment with us.
In October 1999, in connection with Dr. Alessandrini's purchase of 521,559
shares of our common stock, we loaned Dr. Alessandrini $201,669 pursuant to a
secured full recourse promissory note which has an annual interest rate of 6.02%
compounded semi-annually. Principal and interest on the note become due and
payable on October 31, 2003. The note also provides that we may accelerate
payment of the amounts outstanding under the loan in the event he ceases to be
an employee or consultant of ours. The largest principal amount outstanding of
Mr. Alessandrini's loans during the fiscal year ended June 30, 1999 was $578,165
and the principal amount outstanding on December 31, 1999 was $779,834.
Simon Cao. In August 1999, in connection with Simon Cao's purchase of
900,000 shares of our common stock, we loaned Dr. Cao $90,000 under a secured
full recourse promissory note with an annual interest rate of 5.96% compounded
semi-annually. Principal and interest on the note were to become due and payable
on August 4, 2003. The note also provides that we may accelerate payment of the
amounts outstanding under the loan in the event he ceases to be an employee or
consultant of ours. In August 1999, in consideration for his continued
employment with us, we agreed to forgive 25% of the principal and accrued
interest under the note on each one-year anniversary of August 4, 1999 for so
long as Dr. Cao remains our employee as of each anniversary.
In October 1999, in connection with Dr. Cao's purchase of 1,020,726 shares
of our common stock, we loaned Dr. Cao $394,681 under a secured full recourse
promissory note with an annual interest rate of 6.02% compounded semi-annually.
Principal and interest on the note become due and payable on October 12, 2003.
The note also provides that we may accelerate payment of the amounts outstanding
under the loan in the event he ceases to be an employee or consultant of ours.
Dr. Cao had no principal amounts outstanding on his loans during the fiscal year
ended June 30, 1999. The principal amount outstanding on his loans on December
31, 1999 was $484,681.
Paul Jiang. In July 1999, in connection with Paul Jiang's purchase of
450,000 shares of our common stock, we loaned Mr. Jiang $11,700 under a secured
full recourse promissory note with an annual interest rate of 5.69% compounded
semi-annually. Principal and interest on the note were to become due and payable
on July 22, 2003. The note also provides that we may accelerate payment of the
amounts outstanding under the loan in the event he ceases to be an employee or
consultant of ours. In July 1999, in consideration for his
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continued employment with us, we agreed to forgive 25% of the principal and
accrued interest under the note on each one-year anniversary of July 22, 1999
for so long as Mr. Jiang remains our employee as of each anniversary.
In November 1999, in connection with Mr. Jiang's purchase of 150,000 shares
of our common stock, we loaned Mr. Jiang $400,000 under a secured full recourse
promissory note with an annual interest rate of 6.2% compounded semi-annually.
Principal and interest on the note become due and payable on November 22, 2004.
The note also provides that we may accelerate payment of the amounts outstanding
under the loan in the event he ceases to be an employee or consultant of ours.
Mr. Jiang had no principal amounts outstanding on his loans during the fiscal
year ended June 30, 1999. The principal amount outstanding on his loans on
December 31, 1999 was $411,700.
Peter Maguire. In August 1999, in connection with Peter Maguire's purchase
of 825,000 shares of our common stock, we loaned him $82,500 under a secured
full recourse promissory note with an annual interest rate of 5.96% compounded
semi-annually. Principal and interest on the note become due and payable on
August 4, 2003. The note also provides that we may accelerate payment of the
amounts outstanding under the loan in the event he ceases to be an employee or
consultant of ours. Mr. Maguire had no principal amounts outstanding on his loan
during the fiscal year ended June 30, 1999. The principal amount outstanding on
his loan on December 31, 1999 was $82,500.
Jessy Chao. In November 1999, in connection with Jessy Chao's purchase of
150,000 shares of our common stock, we loaned Mr. Chao $400,000 under a secured
full recourse promissory note with an annual interest rate of 6.2% compounded
semi-annually. Principal and interest on the note become due and payable on
November 22, 2004. The note also provides that we may accelerate payment of the
amounts outstanding under the loan in the event he ceases to be an employee or
consultant of ours. Mr. Chao had no principal amounts outstanding on his loan
during the fiscal year ended June 30, 1999. The principal amount outstanding on
his loan on December 31, 1999 was $400,000.
James Pickering. In October 1999, in connection with James Pickering's
purchase of 263,880 shares of our common stock, we loaned him $102,034 under a
secured full recourse promissory note with an annual interest rate of 5.54%
compounded semi-annually. Principal and interest on the note become due and
payable on October 1, 2004. The note also provides that we may accelerate
payment of the amounts outstanding under the loan in the event he ceases to be
an employee or consultant of ours. Mr. Pickering had no principal amounts
outstanding on his loan during the fiscal year ended June 30, 1999. The
principal amount outstanding on his loan on December 31, 1999 was $102,034.
Anthony Florence. In November 1999, in connection with Anthony Florence's
purchase of 195,000 shares of our common stock, we loaned him $455,000 under a
secured full recourse promissory note with an annual interest rate of 5.99%
compounded semi-annually. Principal and interest on the note become due and
payable on November 19, 2004. The note also provides that we may accelerate
payment of the amounts outstanding under the loan in the event he ceases to be
an employee or consultant of ours.
In November 1999, in connection with Mr. Florence's employment offer, we
loaned Mr. Florence $125,000 under an unsecured full recourse promissory note
with an annual interest rate of 5.57%. Principal and interest on the note become
due and payable on the earliest of six months from that date on which he can
sell shares of our common stock for an amount equal to the principal and
interest owed on the note, or May 19, 2001, or the termination of Mr. Florence's
employment with us. Mr. Florence had no principal amounts outstanding on his
loans during the fiscal year ended June 30, 1999. The principal amount
outstanding on his loans on December 31, 1999 was $580,000.
STOCK OPTION GRANTS TO CERTAIN DIRECTORS
In December 1999, we granted to each of Vint Cerf, Federico Faggin, Gregory
Reyes, Jr. and Joel Smith options to purchase 40,000 shares of our common stock
at $3.34 per share. These options were granted under our 1998 Stock Plan. Each
of these options vests over a four year period with one-fourth of the shares
under each option vesting on December 10, 2000 and the remaining shares vesting
ratably monthly after that date.
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OTHER TRANSACTIONS
In June 1999, in connection with Peter Maguire beginning his employment
with us, we paid him a bonus of $100,000. This bonus must be repaid if he
voluntarily terminates his employment with us or we terminate his employment for
cause. The amount of the bonus that must be repaid in this event is reduced by
$8,333 per full month that he remains employed with us.
INDEMNIFICATION
We have entered into indemnification agreements with each of our directors
and officers. These indemnification agreements and our certificate of
incorporation and bylaws require us to indemnify our directors and officers to
the fullest extent permitted by Delaware law. Please see
"Management -- Limitations on Directors' Liability and Indemnification."
CONFLICT OF INTEREST POLICY
We believe that all transactions with affiliates described above were made
on terms no less favorable to us than could have been obtained from unaffiliated
third parties. Our policy is to require that a majority of the independent and
disinterested outside directors on our board of directors approve all future
transactions between us and our officers, directors, principal stockholders and
their affiliates. These transactions will continue to be on terms no less
favorable to us than we could obtain from unaffiliated third parties.
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<PAGE> 65
PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of our common stock as of December 31, 1999, and as adjusted to
reflect the sale of common stock offered by this prospectus, by:
- each of the individuals listed in the "Summary Compensation Table;"
- each of our directors;
- each person, or group of affiliated persons, who is known by us to own
beneficially 5% or more of our common stock; and
- all current directors and executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. As of December 31, 1999, other than Vint
Cerf, Federico Faggin, Gregory Reyes, Jr. and Joel Smith, no individual listed
in the table below owned any options or warrants to purchase any of our common
or preferred stock. Some of the shares held by our executive officers are
subject to our right of repurchase. For a description of this repurchase right,
please see "Management -- Employment Agreements and Change-of-Control
Arrangements" and "Certain Transactions."
Except as indicated in the footnotes to this table and pursuant to
applicable community property laws, each stockholder named in the table has sole
voting and investment power with respect to the shares shown as beneficially
owned by them. This table also includes shares owned by a spouse as community
property. Percentage of ownership is based on 56,529,320 shares of common stock
outstanding on December 31, 1999 and 62,529,320 shares of common stock
outstanding after completion of this offering. This table assumes no exercise of
the underwriters' over-allotment option, gives effect to the conversion of all
outstanding shares of preferred stock, reflects the exercise of warrants to
purchase 337,500 shares of common stock prior to the closing of this offering
and the issuance of 769,230 shares of common stock to two corporate investors.
Unless otherwise indicated, the address of each of the individuals named below
is 40919 Encyclopedia Circle, Fremont, California 94538.
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
BENEFICIALLY OWNED
NUMBER OF SHARES ----------------------------
BENEFICIALLY BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED OFFERING OFFERING
------------------------------------ ---------------- ----------- -----------
<S> <C> <C> <C>
5% STOCKHOLDERS
Entities affiliated with Crosspoint
Venture Partners(1)................... 10,094,490 17.9% 16.1%
2925 Woodside Road
Woodside, CA 94062
Entities affiliated with Sequoia
Capital(2)............................ 10,094,490 17.9 16.1
3000 Sand Hill Road, Bldg. 4, Suite
280,
Menlo Park, CA 94025
Entities affiliated with JAFCO America
Ventures, Inc.(3)..................... 8,689,310 15.4 13.9
505 Hamilton Avenue, Suite 310
Palo Alto, CA 94301
Entities affiliated with the Mayfield
Fund(4)............................... 5,269,427 9.3 8.4
2800 Sand Hill Road, Suite 250
Menlo Park, CA 94025
</TABLE>
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<PAGE> 66
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
BENEFICIALLY OWNED
NUMBER OF SHARES ----------------------------
BENEFICIALLY BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED OFFERING OFFERING
------------------------------------ ---------------- ----------- -----------
<S> <C> <C> <C>
DIRECTORS AND EXECUTIVE OFFICERS
Walter Alessandrini(5)................... 5,711,648 10.1% 9.1%
Simon Cao................................ 3,608,226 6.4 5.8
Paul Jiang(6)............................ 2,160,000 3.8 3.5
Peter Maguire............................ 825,000 1.5 1.3
William Lanfri(7)........................ 890,401 1.6 1.4
Vint Cerf................................ -- * *
Todd Brooks(4)........................... 5,269,427 9.3 8.4
c/o the Mayfield Fund
2800 Sand Hill Road, Suite 250
Menlo Park, CA 94025
Federico Faggin.......................... -- * *
Michael Goguen(2)........................ 10,094,490 17.9 16.1
c/o Sequoia Capital
3000 Sand Hill Road, Bldg. 4, Suite
280
Menlo Park, CA 94025
Seth Neiman(1)........................... 10,094,490 17.9 16.1
c/o Crosspoint Venture Partners
2925 Woodside Road
Woodside, CA 94062
Gregory Reyes, Jr. ...................... -- * *
Joel Smith............................... -- * *
All directors and executive officers as a
group (15 persons).................... 40,537,561 71.7 64.8
</TABLE>
- ------------
* Less than 1% of the outstanding shares of common stock.
(1) Represents 8,552,103 shares held by Crosspoint Venture Partners 1997 and
1,542,387 shares held by Crosspoint Venture Partners LS 1999. The general
partner of Crosspoint Venture Partners 1997 is Crosspoint Associates 1997.
The general partner of Crosspoint Venture Partners LS 1999 is Crosspoint
Associates 1999. The general partners of Crosspoint Associates 1997 and
Crosspoint Associates 1999 are John Mumford, Rich Shapero, Robert Hoff, Don
Milder and Seth Neiman, one of our directors. Each of the general partners
of Crosspoint Associates 1997 and Crosspoint Associates 1999 disclaim
beneficial ownership of the shares held by Crosspoint Venture Partners 1997
and Crosspoint Venture Partners LS 1999, except to the extent of his
pecuniary interest in these shares.
(2) Represents 8,607,692 shares held by Sequoia Capital VII; 618,459 shares held
by Sequoia Capital Franchise Fund; 376,293 shares held by Sequoia Technology
Partners VII, a California Limited Partnership; 174,600 shares held by SQP
1997; 150,518 shares held by Sequoia International Partners; 98,211 shares
held by Sequoia 1997 LLC and 68,718 shares held by Sequoia Capital Franchise
Partners. SC VII-A Management LLC is the general partner of Sequoia Capital
VII, Sequoia Technology Partners VII and Sequoia International Partners. The
general partners of SC VII-A Management are Douglas Leone, Michael Moritz,
Mark Stevens and Thomas Stephenson. Each of the general partners of SC VII-A
Management LLC disclaim beneficial ownership of the shares held by Sequoia
Capital VII, Sequoia Technology Partners VII and Sequoia International
Partners, except to the extent of their pecuniary interest in these shares.
The general partner of Sequoia Capital Franchise Fund and Sequoia Capital
Franchise Partners is SCFF Management LLC. The general partners of SCFF
Management
66
<PAGE> 67
LLC are Douglas Leone, Michael Moritz, Mark Stevens, Thomas Stephenson and
Michael Goguen, one of our directors. Each of the general partners of SCFF
Management LLC disclaim beneficial ownership of the shares held by Sequoia
Capital Franchise Fund and Sequoia Capital Franchise Partners, except to the
extent of his pecuniary interest in these shares.
(3) Represents 5,888,634 shares held by U.S. Information Technology No. 2
Investment Enterprise Partnership, 612,059 shares held by JAFCO Co., Ltd.,
215,234 shares held by JAFCO G6-(A) Investment Enterprise Partnership,
215,234 shares held by JAFCO G6-(B) Investment Enterprise Partnership,
215,234 shares held by JAFCO JS-3 Investment Enterprise Partnership and
215,234 held by JAFCO R-3 Investment Enterprise Partnership. The general
partners of U.S. Information Technology No. 2 Investment Enterprise
Partnership are JAFCO America Ventures, Inc., a California corporation, and
JAFCO Co., Ltd., a Japanese corporation. The general partner of JAFCO G6-(A)
Investment Enterprise Partnership, JAFCO G6-(B) Investment Enterprise
Partnership, JAFCO JS-3 Investment Enterprise Partnership and JAFCO R-3
Investment Partnership is JAFCO Co., Ltd.
(4) Represents 5,005,956 shares held by Mayfield IX and 263,471 shares held by
Mayfield Associates Fund IV. Mayfield IX Management LLC is the general
partner of Mayfield IX and Mayfield Associates Fund IV. The managing
directors of Mayfield IX Management LLC are Yogen K. Dalal, Kevin A. Fong,
A. Grant Heidrich, Mike J. Levinthal, Russell C. Hirsch, Wende S. Hutton,
George A. Pavlov, F. Gib Myers, Bill D. Unger and Van Van Auken. The
non-managing directors of Mayfield IX Management LLC are David J. Ladd,
Allen L. Morgan and Todd A. Brooks, one of our directors. Each of the
managing directors and non-managing directors of Mayfield IX Management LLC
disclaims beneficial ownership of the shares held by Mayfield IX and
Mayfield Associates Fund IV, except to the extent of his pecuniary interest
in these shares.
(5) Represents 5,258,648 shares held by Mr. Alessandrini individually; 225,000
shares held by the Walter Alessandrini Annuity Trust u/i dtd. November 22,
1999, of which Mr. Alessandrini is trustee and has voting and dispositive
power over; 225,000 shares held by the Anna Rita Alessandrini Annuity Trust
u/i dtd. November 22, 1999, of which Mr. Alessandrini is trustee and has
voting and dispositive power over; and 2,000 shares held by the Laura
Graziani-Trust 1999 u/i dtd. December 2, 1999, of which Mr. Alessandrini is
a trustee and has voting and dispositive power over.
(6) Represents 1,860,000 shares held by Mr. Jiang individually and 300,000
shares held by the Eric W.Z. Jiang Trust -- 1999 u/i dtd. October 22, 1999
of which he is a trustee and has voting and dispositive power over.
(7) Represents 632,401 shares held by Mr. Lanfri individually; 15,000 shares
held by the LMR Charitable Remainder Trust of which his wife is trustee and
has voting and dispositive power over; 15,000 shares held by the JAL
Charitable Remainder Trust of which Mr. Lanfri is trustee and has voting and
dispositive power over; and 228,000 shares held by Mr. Lanfri's wife.
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<PAGE> 68
DESCRIPTION OF CAPITAL STOCK
Upon the closing of this offering, we will be authorized to issue
300,000,000 shares of common stock, $.001 par value per share, and 10,000,000
shares of undesignated preferred stock, $.001 par value per share. The following
description of our capital stock does not purport to be complete and is subject
to and qualified by our certificate of incorporation and bylaws, which are
included as exhibits to the Registration Statement of which this prospectus
forms a part, and by the provisions of applicable Delaware law.
COMMON STOCK
As of December 31, 1999, there were 56,529,320 shares of common stock
outstanding, assuming the conversion of all outstanding shares of preferred
stock into common stock, which were held of record by approximately 141
stockholders, and assuming the exercise of warrants to purchase 337,500 shares
of common stock and the issuance of 769,230 shares of common stock to two
corporate investors prior to the closing of this offering.
The holders of common stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding preferred stock, the holders of common stock are
entitled to receive ratably dividends, if any, as may be declared from time to
time by the board of directors out of funds legally available for that purpose.
See "Dividend Policy." In the event of our liquidation, dissolution or winding
up of Avanex, the holders of common stock are entitled to share ratably in all
assets remaining after payment of liabilities, subject to prior distribution
rights of preferred stock, if any, then outstanding. The common stock has no
preemptive or conversion rights or other subscription rights. There are no
redemption or sinking fund provisions applicable to the common stock. All
outstanding shares of common stock are fully paid and nonassessable, and the
shares of common stock to be issued upon the closing of this offering will be
fully paid and nonassessable.
PREFERRED STOCK
The board of directors has the authority, without action by our
stockholders, to designate and issue preferred stock in one or more series and
to designate the rights, preferences and privileges of each series, any or all
of which may be greater than the rights of the common stock. The effect of the
issuance of any shares of preferred stock upon the rights of holders of the
common stock might include, among other things, restricting dividends on the
common stock, diluting the voting power of the common stock, impairing the
liquidation rights of the common stock and delaying or preventing a change in
control of Avanex without further action by the stockholders. We have no present
plans to issue any shares of preferred stock.
WARRANTS
At December 31, 1999, there were warrants outstanding to purchase a total
of 337,500 shares of common stock and a warrant outstanding to purchase a total
of 29,347 shares of Series D preferred stock. The warrant to purchase 29,347
shares of Series D preferred stock will remain outstanding after the completion
of this offering and will become exercisable to purchase an aggregate of 29,347
shares of common stock. It will expire on July 8, 2004, unless earlier
exercised.
REGISTRATION RIGHTS
The holders of 35,788,364 shares of common stock, as converted, and the
holder of a warrant to purchase 29,347 shares of common stock, as converted, or
their permitted transferees are entitled to certain rights with respect to
registration of the shares under the Securities Act at any time after 180 days
following the closing of this offering. Under the terms of the agreements
between us and the holders of the registrable securities, by written consent of
more than 50% of the registrable securities then outstanding, the holders may
require on two occasions that we, at our expense, file a registration statement
under the Securities Act, with respect to the registrable securities, provided
that at least 30% of the registrable securities would be included in the
proposed registration or the anticipated public offering price of the proposed
registration would be at least $15.0 million. In addition, the holders of at
least 30% of the registrable securities then outstanding, at any time
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<PAGE> 69
12 months after the closing of this offering and at our expense, may require
that we register their shares for public resale on Form S-3 or similar
short-form registration, provided that we are eligible to use Form S-3 or
similar short-form registration, and provided further that the value of the
securities to be registered is at least $1.0 million. Furthermore, in the event
we elect to register any of our shares of common stock after this offering for
purposes of effecting any public offering, the holders of registrable securities
are entitled, at our expense, to include their shares of common stock in the
registration, subject to the right of the underwriter to reduce the number of
shares proposed to be registered in view of market conditions.
In addition to the registration rights described above, Microsoft
Corporation and MCI WorldCom Venture Fund, at their own expense, are each
entitled to one demand registration for the 384,615 shares of common stock that
each of them are purchasing contemporaneously with this offering at any time
after 180 days following the closing of this offering.
DELAWARE LAW AND CERTAIN PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND
BYLAWS
Certain provisions of Delaware law and our certificate of incorporation and
bylaws could make it more difficult to acquire us by means of a tender offer, a
proxy contest or otherwise and the removal of incumbent officers and directors.
These provisions, summarized below, are expected to discourage certain types of
coercive takeover practices and inadequate takeover bids and to encourage
persons seeking to acquire control of us to first negotiate with us. We believe
that the benefits of increased protection of our potential ability to negotiate
with the proponent of an unfriendly or unsolicited proposal to acquire or
restructure us outweigh the disadvantages of discouraging takeover or
acquisition proposals because, among other things, negotiation of these
proposals could result in an improvement of their terms.
We are subject to Section 203 of the Delaware General Corporation Law, an
anti-takeover law. In general, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years following the date the person became an
interested stockholder, unless, with exceptions, the business combination or the
transaction in which the person became an interested stockholder is approved in
a prescribed manner. Generally, a business combination includes a merger, asset
or stock sale, or other transaction resulting in a financial benefit to the
interested stockholder. Generally, an interested stockholder is a person who,
together with affiliates and associates, owns, or within three years prior to
the determination of interested stockholder status, did own, 15% or more of a
corporation's voting stock. The existence of this provision would be expected to
have an anti-takeover effect with respect to transactions not approved in
advance by the board of directors, including discouraging attempts that might
result in a premium over the market price for the shares of common stock held by
stockholders.
Our certificate of incorporation and bylaws require that any action
required or permitted to be taken by our stockholders must be effected at a duly
called annual or special meeting of the stockholders and may not be effected by
a consent in writing. In addition, special meetings of our stockholders may be
called only by the board of directors or certain of our officers. Our
certificate of incorporation and bylaws also provide that, beginning upon the
closing of this offering, our board of directors will be divided into three
classes, with each class serving staggered three-year terms, and that certain
amendments of the certificate of incorporation and of the bylaws require the
approval of holders of at least 66.7% of the voting power of all outstanding
stock. These provisions may have the effect of deterring hostile takeovers or
delaying changes in control or management of Avanex.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is BankBoston, N.A.
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<PAGE> 70
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 the common stock.
Upon completion of this offering, we will have outstanding 62,529,320
shares of common stock, which assumes (1) the issuance of 6,000,000 shares of
common stock offered by us, (2) no exercise of the underwriters' over-allotment
option, (3) the issuance of 769,230 shares of common stock to two corporate
investors, (4) the conversion of all shares of preferred stock outstanding as of
December 31, 1999 into 35,019,134 shares of common stock upon completion of this
offering and (5) the exercise of warrants to purchase 337,500 shares of common
stock. All of the 6,000,000 shares sold in this offering will be freely tradable
without restriction or further registration under the Securities Act. If shares
are purchased by our "affiliates" as that term is defined in Rule 144 under the
Securities Act, their sales of shares would be subject to the limitations and
restrictions that are described below.
As of December 31, 1999, the remaining 56,529,320 shares of common stock
held by existing stockholders were issued and sold by us in reliance on
exemptions from the registration requirements of the Securities Act. Of these
shares, 55,391,841 shares will be subject to lock-up agreements, described
below, on the date of this prospectus. On the date of this prospectus, shares
not subject to the lock-up agreements described below may be eligible for sale
pursuant to Rules 144, 144(k) or 701. In addition, holders of stock options
could exercise such options and sell certain of the shares issued upon exercise
as described below.
<TABLE>
<CAPTION>
APPROXIMATE
SHARES ELIGIBLE
RELEVANT DATES FOR FUTURE SALE COMMENT
-------------- --------------- -------
<S> <C> <C>
On the date of this prospectus.......... 6,000,000 Freely tradable shares sold in this offering
180 days after the date of this 46,129,693 All shares subject to lock-up released;
prospectus............................ shares salable under Rules 144, 144(k) and
701
</TABLE>
Some of the shares in the table above, including shares held by executive
officers and directors, listed as not being salable until 180 days after the
date of this prospectus may become salable as soon as the 90th day after the
date of this prospectus as described under "-- Lock-up Agreements" below.
The 769,230 shares of common stock that we agreed to sell to MCI WorldCom
Venture Fund and Microsoft will be "restricted securities" and the one year
holding period for these shares will expire one year from the date of sale. We
anticipate that the date of sale will occur in February 2000. However, each of
MCI WorldCom Venture Fund and Microsoft may, beginning 180 days after the
completion of this offering, exercise their registration rights which will
enable them to sell all of their shares in the open market.
RULE 144
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this prospectus, a person who has beneficially owned 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 625,293 shares immediately after this offering; or
- the average weekly trading volume of the 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 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 three months preceding a sale, and who has
beneficially owned the 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 such shares without
70
<PAGE> 71
complying with the manner of sale, notice filing, volume limitation or notice
provisions of Rule 144. Therefore, unless otherwise restricted, "144(k) 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 shares from us in connection with a
compensatory stock or option plan or other written agreement before the
effective date of this 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 the holding period requirements or other restrictions contained in
Rule 701.
The Securities and Exchange Commission 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, 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.
STOCK OPTIONS
As of December 31, 1999, there were a total of 3,401,427 shares of common
stock subject to outstanding options under our 1998 Stock Plan, 169,717 of which
were vested, and 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 Act to register all of the shares of common
stock issued or reserved for future issuance under our 1998 Stock Plan, as
amended, our 1999 Director Stock Option Plan and our 1999 Employee Stock
Purchase Plan. On the date 180 days after the effective date of the offering, a
total of 567,595 shares of common stock subject to outstanding options will be
vested. After the effective dates of these registration statements, shares
purchased upon exercise of options granted under the 1998 Stock Plan, as
amended, 1999 Director Stock Plan and 1999 Employee Stock Purchase Plan and
would be available for resale in the public market.
LOCK-UP AGREEMENTS
Our officers, directors and substantially all of our stockholders, who hold
an aggregate of approximately 55,391,841 shares of our common stock, have
agreed, subject to limited exceptions, not to offer, pledge, sell, contract to
sell, sell any option or contract to purchase, purchase any option or contract
to sell, grant any option, right or warrant to purchase, or otherwise transfer
or dispose of, directly or indirectly, or enter into any swap or other
arrangement that transfers to another, in whole or in part, any of the economic
consequences of ownership of any shares of common stock or any securities
convertible into or exercisable or exchangeable for shares of common stock for a
period of 180 days after the date of this prospectus, without the prior written
consent of Morgan Stanley & Co. Incorporated.
If the reported last sale price of the common stock on the Nasdaq National
Market is at least twice the initial public offering price per share for 20 of
the 30 trading days ending on the last trading day preceding the 90th day after
the date of this prospectus, 25% of the shares of our common stock, or
13,847,960 shares, subject to the 180-day restriction described above will be
released from these restrictions. The release of these shares will occur on the
later to occur of:
- the 90th day after the date of this prospectus if we make our first
post-offering public release of our quarterly or annual earnings results
during the period beginning on the eleventh trading day after the date of
this prospectus and ending on the day prior to the 90th day after the
date of this prospectus, or
- on the second trading day following the first public release of our
quarterly or annual results occurring on or after the 90th day after the
date of this prospectus, if we do not make our first post-offering public
release as described in the preceding clause.
Morgan Stanley & Co. Incorporated may in its sole discretion choose to
release any or all of these shares from these restrictions prior to the
expiration of either the 90- or 180-day period.
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<PAGE> 72
UNDERWRITERS
Under the terms and subject to the conditions contained in an underwriting
agreement dated the date of this prospectus, the underwriters named below, for
whom Morgan Stanley & Co. Incorporated, Lehman Brothers Inc., FleetBoston
Robertson Stephens Inc. and U.S. Bancorp Piper Jaffray Inc. are acting as
representatives, have severally agreed to purchase, and we have agreed to sell
to them, severally the number of shares indicated below:
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
---- ---------
<S> <C>
Morgan Stanley & Co. Incorporated........................... 2,650,000
Lehman Brothers Inc. ....................................... 883,334
FleetBoston Robertson Stephens Inc. ........................ 883,333
U.S. Bancorp Piper Jaffray Inc. ............................ 883,333
BancAmerica Securities, Inc. ............................... 100,000
Dain Rauscher Incorporated ................................. 100,000
First Albany Corporation ................................... 100,000
First Union Securities, Inc. ............................... 100,000
Edward D. Jones & Co., L.P. ................................ 100,000
Raymond James Associates, Inc. ............................. 100,000
SG Cowen Securities Corporation ............................ 100,000
---------
Total............................................. 6,000,000
=========
</TABLE>
The underwriters are offering the shares of common stock subject to their
acceptance of the shares from us and subject to prior sale. The underwriting
agreement provides that the obligations of the several underwriters to pay for
and accept delivery of the shares of common stock offered by this prospectus are
subject to the approval of certain legal matters by their counsel and to certain
other conditions. The underwriters are obligated to take and pay for all of the
shares of common stock offered by this prospectus, if any such shares are taken.
However, the underwriters are not required to take or pay for the shares covered
by the underwriters' over-allotment option described below.
The underwriters initially propose to offer part of the shares of common
stock directly to the public at the initial public offering price listed on the
cover page of this prospectus and part to certain dealers at a price that
represents a concession not in excess of $1.57 a share under the initial public
offering price. Any underwriter may allow, and such dealers may reallow, a
concession not in excess of $.10 a share to other underwriters or to certain
dealers. After the initial offering of the shares of common stock, the offering
price and other selling terms may from time to time be varied by the
representatives of the underwriters.
We have granted to the underwriters an option, exercisable for 30 days from
the date of this prospectus, to purchase up to an aggregate of 900,000
additional shares of common stock at the initial public offering price listed on
the cover page of this prospectus, less underwriting discounts and commissions.
The underwriters may exercise this option solely for the purpose of covering
over-allotments, if any, made in connection with the offering of the shares of
common stock offered by this prospectus. To the extent this option is exercised,
each underwriter will become obligated, subject to limited conditions, to
purchase approximately the same percentage of additional shares of common stock
as the number listed next to the underwriter's name in the preceding table bears
to the total number of shares of common stock listed next to the names of all
underwriters in the preceding table. If the underwriters' option is exercised in
full, the total price to the public would be $248.4 million, the total
underwriters' discounts and commissions would be $17.4 million and total
proceeds to us would be $231.0 million.
The underwriters have informed us that they do not intend sales to
discretionary accounts to exceed five percent of the total number of shares of
common stock offered by them.
Our common stock has been approved for quotation on the Nasdaq National
Market under the symbol "AVNX."
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<PAGE> 73
Avanex and our directors, executive officers and substantially all of our
stockholders have agreed that, without the prior written consent of Morgan
Stanley & Co. Incorporated on behalf of the underwriters, it will not, during
the period ending 180 days after the date of this prospectus:
- offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase, lend or otherwise transfer or dispose of,
directly or indirectly, any shares of common stock or any securities
convertible into or exercisable or exchangeable for common stock, whether
these shares or any such securities are then owned by the person or are
thereafter acquired, directly from us; or
- enter into any swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of common
stock,
whether any transaction described above is to be settled by delivery of common
stock or such other securities, in cash or otherwise. This lock-up restriction
is subject, in specified circumstances, to earlier release. For a description of
the circumstances leading to this earlier release, please see "Shares Eligible
for Future Sale -- Lock-up Agreements."
The restrictions described in this paragraph do not apply to:
- the sale of shares to the underwriters;
- transactions by any person other than us relating to shares of common
stock or other securities acquired in open market transactions after the
completion of the offering of the shares.
In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the common stock. Specifically, the underwriters may over-allot in
connection with the offering, creating a short position in the common stock for
their own account. In addition, to cover over-allotments or to stabilize the
price of the common stock, the underwriters may bid for, and purchase, shares of
common stock in the open market. Finally, the underwriting syndicate may reclaim
selling concessions allowed to an underwriter or a dealer for distributing the
common stock in the offering if the syndicate repurchases previously distributed
shares of common stock in transactions to cover syndicate short positions, in
stabilization transactions or otherwise. Any of these activities may stabilize
or maintain the market price of the common stock above independent market
levels. The underwriters are not required to engage in these activities and may
end any of these activities at any time.
We and the underwriters have agreed to indemnify each other against certain
liabilities, including liabilities under the Securities Act.
At our request, the underwriters have reserved for sale, at the initial
public offering price, up to approximately 450,000 shares of common stock
offered by this prospectus to our directors, officers, employees, customers and
other business associates. There can be no assurance that any of the reserved
shares will be purchased. The number of shares of common stock available for
sale to the general public will be reduced to the extent these parties purchase
the reserved shares. Any reserved shares that are not so purchased will be
offered by the underwriters to the general public on the same basis as the other
shares offered by this prospectus.
On January 14, 2000, we agreed to sell 384,615 shares of common stock to
each of two corporate investors for $13.00 per share in a private placement.
PRICING OF THE OFFERING
Prior to this offering, there has been no public market for the shares of
common stock. The initial public offering price for the shares of common stock
offered by this prospectus was determined by negotiations between us and the
representatives of the underwriters. Among the factors considered in determining
the initial public offering price were:
- our record of operations, our current financial position and future
prospects;
- the experience of our management;
- sales, earnings and certain of our other financial and operating
information in recent periods; and
- the price-earnings ratios, price-sales ratios, market prices of
securities and financial and operating information of companies engaged
in activities similar to ours.
73
<PAGE> 74
LEGAL MATTERS
The validity of the common stock offered by this prospectus will be passed
upon for us by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo
Alto, California. Certain legal matters will be passed upon for the underwriters
by Fenwick & West LLP, Palo Alto, California. As of the date of this prospectus,
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
418,419 shares of Avanex common stock.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at June 30, 1998 and 1999, and December 31, 1999, for the
period from October 24, 1997 (inception) to June 30, 1998, for the year ended
June 30, 1999, and for the six months ended December 31, 1999, as set forth in
their reports. We have included our consolidated financial statements in the
prospectus and elsewhere in the registration statement in reliance on their
reports given upon the authority of such firm as experts in accounting and
auditing.
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 us and our
common stock, we refer you to the registration statement and the exhibits and
schedule that were filed with the registration statement. Statements contained
in this prospectus about the contents of any contract or any other document that
is filed as an exhibit to the registration statement are not necessarily
complete, and we refer you to the full text of the contract or other document
filed as an exhibit to 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. The Securities and Exchange Commission maintains a 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, we will become subject to the information
and periodic reporting requirements of the Securities Exchange Act and, in
accordance with the requirements of the Securities Exchange Act 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.
74
<PAGE> 75
(THIS PAGE INTENTIONALLY LEFT BLANK)
<PAGE> 76
AVANEX CORPORATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors.............................. F-2
Financial Statements:
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statement of Other Stockholders' Equity
(Deficit)................................................. F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 77
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Avanex Corporation
We have audited the accompanying consolidated balance sheets of Avanex
Corporation as of June 30, 1998 and 1999, and December 31, 1999, and the related
consolidated statements of operations, other stockholders' equity (deficit), and
cash flows for the period from October 24, 1997 (inception) to June 30, 1998,
the year ended June 30, 1999, and the six months ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Avanex
Corporation at June 30, 1998 and 1999, and December 31, 1999, and the
consolidated results of its operations and its cash flows for the period from
October 24, 1997 (inception) to June 30, 1998, the year ended June 30, 1999, and
the six months ended December 31, 1999, in conformity with generally accepted
accounting principles.
Ernst & Young LLP
January 14, 2000
San Jose, California
F-2
<PAGE> 78
AVANEX CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
PRO FORMA
STOCKHOLDERS'
JUNE 30, EQUITY AT
------------------ DECEMBER 31, DECEMBER 31,
1998 1999 1999 1999
------- -------- ------------ -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 2,874 $ 1,756 $ 2,219
Short-term investments.................................... -- 1,968 12,160
Accounts receivable (net of allowance for doubtful
accounts of $30 at June 30, 1999 and $328 December 31,
1999)................................................... -- 272 2,753
Inventories............................................... -- 626 2,693
Employee receivables and other current assets............. 37 468 1,410
------- -------- --------
Total current assets................................ 2,911 5,090 21,235
Property and equipment, net................................. 408 1,671 5,632
Other assets................................................ 20 55 1,285
------- -------- --------
Total assets........................................ $ 3,339 $ 6,816 $ 28,152
======= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Short-term borrowings..................................... $ -- $ 735 $ 1,963
Accounts payable.......................................... 97 990 2,166
Accrued compensation and related expenses................. 66 242 306
Warranty provision........................................ -- 51 604
Other accrued expenses.................................... 44 207 1,309
Deferred revenue.......................................... -- -- 137
Current portion of capital lease obligations.............. 67 205 437
------- -------- --------
Total current liabilities........................... 274 2,430 6,922
Capital lease obligations................................... 56 563 1,320
Long-term debt.............................................. 285 -- --
Commitments
Redeemable convertible preferred stock, $0.001 par value,
38,100,000 shares authorized (none pro forma), issuable in
series (stated at liquidation preference):
Series A, 6,900,000 shares designated, 6,795,120 shares
issued and outstanding at June 30, 1998 and 1999 and
December 31, 1999 (none pro forma)...................... 1,010 1,010 1,010 $ --
Series B, 9,525,000 shares designated, 9,445,116 shares
issued and outstanding at June 30, 1998 and 1999 and
December 31, 1999 (none pro forma)...................... 2,519 2,519 2,519 --
Series C, 16,275,000 shares designated, no shares issued
and outstanding at June 30, 1998; 13,548,253 shares
issued and outstanding at June 30 and December 31, 1999
(none pro forma)........................................ -- 6,828 6,828 --
Series D, 5,400,000 shares designated, no shares issued
and outstanding at June 30, 1998 and 1999; 5,230,645
shares issued and outstanding at December 31, 1999 (none
pro forma).............................................. -- -- 20,051 --
------- -------- -------- --------
Total redeemable convertible preferred stock........ 3,529 10,357 30,408 --
Other stockholders' equity (deficit):
Preferred stock, $0.001 par value, none authorized, issued
and outstanding (10,000,000 shares authorized pro forma)
Common stock, $0.001 par value, 75,000,000 shares
authorized (300,000,000 shares pro forma); 7,050,000
shares issued and outstanding at June 30, 1998;
18,141,290 shares issued and outstanding at June 30,
1999 and 20,403,456 shares issued and outstanding at
December 31, 1999 (55,422,590 shares pro forma)......... 7 18 20 55
Additional paid-in capital................................ 2,105 14,483 93,007 123,380
Notes receivable from stockholders.......................... (6) (326) (2,633) (2,633)
Deferred compensation..................................... (1,774) (10,351) (50,689) (50,689)
Accumulated deficit....................................... (1,137) (10,358) (50,203) (50,203)
------- -------- -------- --------
Total other stockholders' equity (deficit).......... (805) (6,534) (10,498) $ 19,910
------- -------- -------- ========
Total liabilities and stockholders' equity
(deficit)......................................... $ 3,339 $ 6,816 $ 28,152
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 79
AVANEX CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
PERIOD FROM
OCTOBER 24, 1997 SIX MONTHS ENDED
(INCEPTION) TO YEAR ENDED ---------------------------
JUNE 30, JUNE 30, DECEMBER 31, DECEMBER 31,
1998 1999 1998 1999
---------------- ----------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net revenue................................ $ -- $ 510 $ -- $ 10,916
Cost of revenue............................ -- 531 -- 8,194
------- ----------- -------- -----------
Gross profit (loss)........................ -- (21) -- 2,722
Operating expenses:
Research and development................. 515 4,086 1,427 2,988
Sales and marketing...................... 125 956 265 1,676
General and administrative............... 131 723 244 2,129
Stock compensation....................... 362 3,464 673 15,697
------- ----------- -------- -----------
Total operating expenses......... 1,133 9,229 2,609 22,490
------- ----------- -------- -----------
Loss from operations....................... (1,133) (9,250) (2,609) (19,768)
Interest income............................ -- 148 30 239
Interest expense........................... (4) (119) (28) (265)
------- ----------- -------- -----------
Net loss................................... (1,137) (9,221) (2,607) (19,794)
Preferred stock accretion.................. -- -- -- (20,051)
------- ----------- -------- -----------
Net loss attributable to common
stockholders............................. $(1,137) $ (9,221) $ (2,607) $ (39,845)
======= =========== ======== ===========
Basic and diluted net loss per common
share.................................... $ (7.20) $ (4.97) $ (4.14) $ (6.41)
======= =========== ======== ===========
Weighted-average shares used in computing
basic and diluted net loss per common
share.................................... 157,831 1,856,688 629,553 6,215,219
======= =========== ======== ===========
Pro forma basic and diluted net loss per
common share (unaudited)................. $ (0.39) $ (1.02)
=========== ===========
Weighted-average shares used in computing
pro forma basic and diluted net loss per
common share (unaudited)................. 23,627,581 39,109,946
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-4
<PAGE> 80
AVANEX CORPORATION
CONSOLIDATED STATEMENT OF OTHER STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE PERIOD FROM OCTOBER 24, 1997 (INCEPTION) TO DECEMBER 31, 1999
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
NOTES TOTAL
ADDITIONAL RECEIVABLE STOCKHOLDERS'
COMMON PAID-IN FROM DEFERRED ACCUMULATED EQUITY
STOCK CAPITAL SHAREHOLDERS COMPENSATION DEFICIT (DEFICIT)
------ ---------- ------------ ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Issuance of 2,700,000 shares of
common stock to founder......... $ 3 $ (1) $ -- $ -- $ -- $ 2
Issuance of 4,050,000 shares of
common stock upon exercise of
share purchase rights........... 4 5 (6) -- -- 3
Issuance of 300,000 shares of
common stock.................... -- 1 -- -- -- 1
Issuance costs associated with
issuance of preferred shares.... -- (36) -- -- -- (36)
Deferred compensation............. -- 2,136 -- (2,136) -- --
Amortization of deferred
compensation.................... -- -- -- 362 -- 362
Net loss.......................... -- -- -- -- (1,137) (1,137)
--- ------- ------- -------- -------- --------
Balance at June 30, 1998...... 7 2,105 (6) (1,774) (1,137) (805)
Issuance of 11,129,190 shares of
common stock upon exercise of
stock options and share purchase
rights.......................... 11 350 (342) -- -- 19
Issuance costs associated with
issuance of preferred shares.... -- (13) -- -- -- (13)
Repurchase of 37,899 shares of
common stock.................... -- -- -- -- -- --
Forgiveness of stockholders' notes
receivable...................... -- -- 22 -- -- 22
Issuance of common stock options
to consultants.................. -- 539 -- -- -- 539
Deferred compensation............. -- 11,502 -- (11,502) -- --
Amortization of deferred
compensation.................... -- -- -- 2,925 -- 2,925
Net loss.......................... -- -- -- -- (9,221) (9,221)
--- ------- ------- -------- -------- --------
Balance at June 30, 1999...... 18 14,483 (326) (10,351) (10,358) (6,534)
Issuance costs associated with
issuance of preferred shares.... -- (24) -- -- -- (24)
Issuance of 4,877,790 shares of
common stock upon exercise of
stock options and share purchase
rights.......................... 5 2,376 (2,340) -- -- 41
Repurchase of 2,615,625 shares of
common stock.................... (3) (32) 33 -- -- (2)
Issuance of warrants.............. -- 118 -- -- -- 118
Issuance of common stock options
to consultants.................. -- 3,707 -- -- -- 3,707
Preferred stock accretion......... -- 20,051 -- -- (20,051) --
Deferred compensation............. -- 52,328 -- (52,328) -- --
Amortization of deferred
compensation.................... -- -- -- 11,990 -- 11,990
Net loss.......................... -- -- -- -- (19,794) (19,794)
--- ------- ------- -------- -------- --------
Balance at December 31,
1999........................ $20 $93,007 $(2,633) $(50,689) $(50,203) $(10,498)
=== ======= ======= ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 81
AVANEX CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM
OCTOBER 24, 1997 SIX MONTHS ENDED
(INCEPTION) TO YEAR ENDED ---------------------------
JUNE 30, JUNE 30, DECEMBER 31, DECEMBER 31,
1998 1999 1998 1999
---------------- ---------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss........................................... $(1,137) $(9,221) $(2,607) $(19,794)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation..................................... 21 102 120 269
Amortization..................................... 12 278 30 480
Stock compensation expense....................... 364 3,464 673 15,756
Forgiveness of stockholders' notes receivable.... -- 22 -- --
Changes in operating assets and liabilities:
Accounts receivable............................ -- (272) -- (2,481)
Inventories.................................... -- (626) (274) (2,067)
Employee receivables and other current
assets....................................... (37) (431) (28) (942)
Other assets................................... (20) (35) (20) (1,171)
Accounts payable............................... 97 893 481 1,176
Accrued compensation and related expenses...... 66 176 (9) 64
Warranty provision............................. -- 51 -- 553
Other accrued expenses and deferred revenue.... 44 163 112 1,239
------- ------- ------- --------
Net cash used in operating activities.......... (590) (5,436) (1,522) (6,918)
INVESTING ACTIVITIES
Purchases of available-for-sale securities......... -- (3,968) -- --
Maturities of available-for-sale securities........ -- 2,000 -- --
Purchases of held-to-maturity securities........... -- -- -- (17,238)
Maturities of held-to-maturity securities.......... -- -- -- 7,046
Purchases of property and equipment................ (301) (863) (230) (3,494)
------- ------- ------- --------
Net cash used for investing activities....... (301) (2,831) (230) (13,686)
FINANCING ACTIVITIES
Payments on debt and capital lease obligations..... (17) (135) (16) (1,149)
Proceeds from issuance of convertible notes
payable.......................................... 50 -- -- --
Proceeds from short-term and long-term debt........ 285 450 450 2,150
Proceeds from issuance of common stock............. 4 19 -- 41
Repurchases of common stock........................ -- -- -- (2)
Net proceeds from issuance of preferred stock...... 3,443 6,815 -- 20,027
------- ------- ------- --------
Net cash provided by financing activities.... 3,765 7,149 434 21,067
------- ------- ------- --------
Net increase (decrease) in cash and cash
equivalents...................................... 2,874 (1,118) (1,318) 463
Cash and cash equivalents at beginning of period... -- 2,874 2,874 1,756
------- ------- ------- --------
Cash and cash equivalents at end of period......... $ 2,874 $ 1,756 $ 1,556 $ 2,219
======= ======= ======= ========
SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS
Equipment acquired under capital leases............ $ 140 $ 780 $ 286 $ 1,216
======= ======= ======= ========
Conversion of notes payable to convertible
preferred stock.................................. $ 50 $ -- $ -- $ --
======= ======= ======= ========
Common stock issued for notes receivable........... $ 6 $ 342 $ 68 $ 2,340
======= ======= ======= ========
Preferred stock accretion.......................... $ -- $ -- $ -- $ 20,051
======= ======= ======= ========
Warrants issued in connection with securing a line
of credit........................................ $ -- $ -- $ -- $ 118
======= ======= ======= ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid...................................... $ 2 $ 117 $ 11 $ 206
======= ======= ======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 82
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
Avanex Corporation (the "Company") was incorporated on October 24, 1997.
The Company manufactures and markets fiber optic-based products, known as
photonic processors, which are designed to increase the performance of optical
networks.
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary. Intercompany accounts and transactions have
been eliminated in consolidation.
UNAUDITED INTERIM CONSOLIDATED FINANCIAL INFORMATION
The accompanying consolidated financial statements and related notes for
the six months ended December 31, 1998 are unaudited, but include all
adjustments, consisting only of normal recurring adjustments, that the Company
considers necessary for a fair presentation of its consolidated financial
position, operating results, and cash flows for the interim date and the period
presented. Results for the six months ended December 31, 1999 are not
necessarily indicative of results for the entire fiscal year or future periods.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ materially from
those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original
maturities of three months or less when purchased to be cash equivalents. The
Company considers all highly liquid investments with original maturities of
greater than three months but less than one year when purchased to be short-term
investments. Cash equivalents at June 30, 1998 and 1999 and at December 31, 1999
consisted primarily of money market funds.
SHORT-TERM INVESTMENTS
Management determines the appropriate classification of debt securities at
the time of purchase and reevaluates such designation as of each balance sheet
date. Debt securities are classified as held-to-maturity when the Company has
the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at amortized cost.
Debt securities not classified as held-to-maturity are classified as
available-for-sale. Available-for-sale securities are stated at fair value,
based upon quoted market prices of the securities, with the unrealized gains and
losses reported in a separate component of stockholders' equity.
The amortized cost of debt securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization and interest on the securities
are included in interest income. The cost of securities sold is based on the
specific identification method.
Short-term investments at June 30, 1999 and December 31, 1999 consisted
primarily of commercial paper, are classified as available-for-sale and
held-to-maturity, respectively, and are carried at amortized cost.
F-7
<PAGE> 83
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
Gross unrealized gains and losses and realized gains and losses on securities
have not been significant to date. There have been no sales of short-term
investments to date.
CONCENTRATION OF CREDIT RISK
Financial instruments, which subject the Company to potential credit risk,
consist of demand deposit accounts, money market accounts, short-term
investments and trade receivables. The Company maintains its demand deposit
accounts, money market accounts and short-term investments primarily with one
financial institution. The Company invests its excess cash principally in debt
securities. To date, the Company has not incurred losses related to these
investments. The Company sells primarily to large communications vendors. The
Company extends reasonably short collection terms but does not require
collateral. The Company provides reserves for potential credit losses. The
Company has not experienced significant losses to date. Management believes the
financial risks associated with these financial instruments are minimal.
For the year ended June 30, 1999, three customers each individually
accounted for over 10% of net revenue, for an aggregate of approximately 94% of
net revenue. One customer, representing 29% of revenue for the year ended June
30, 1999, is located in Japan. Outstanding receivables from these customers
approximated 98% of total gross accounts receivable at June 30, 1999. For the
six months ended December 31, 1999, one customer individually accounted for
approximately 88% of net revenue. The outstanding receivable from this customer
approximated 71% of total gross accounts receivable at December 31, 1999.
International revenue was not significant for the six months ended December 31,
1999.
REVENUE RECOGNITION
The Company generally recognizes product revenue when the product has been
shipped and there are no significant uncertainties with respect to customer
acceptance. For evaluation units where the customer has the right of return
through the end of the evaluation period, the Company recognizes revenue on
these shipments at the end of the evaluation period if not returned. The Company
accrues for warranty costs at the time revenue is recognized.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is provided on the
straight-line method over the useful lives of the assets, generally two to five
years.
EQUIPMENT UNDER CAPITAL LEASES
The Company leases certain of its equipment and other fixed assets under
capital lease agreements. The assets and liabilities under capital leases are
recorded at the lesser of the present value of aggregate future minimum lease
payments, including estimated bargain purchase options, or the fair value of the
assets under lease. Assets under capital leases are amortized over the shorter
of the lease term or useful life of the assets.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
STOCK-BASED COMPENSATION
Effective in the period ended June 30, 1998, the Company adopted the
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("FAS 123"). In accordance with the provisions of
FAS 123, the Company applies Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB Opinion No. 25") and related
interpretations in
F-8
<PAGE> 84
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
accounting for its stock option grants and share purchase rights to employees.
Accordingly, deferred compensation is recognized for the difference between the
option price or share purchase right at the date of grant and the deemed fair
value of the Company's common shares at that date when the option or share
purchase right exercise price is less than the fair value of the common shares.
Such deferred compensation is amortized over the vesting period, generally a
maximum of four years. Option grants to all others are accounted for under the
fair value method prescribed by FAS 123.
INVENTORIES
Inventories consist of raw materials, work-in-process and finished goods
and are stated at the lower of cost or market. Cost is computed on a currently
adjusted standard basis (which approximates actual costs on a first-in,
first-out basis).
INCOME TAXES
The Company uses the liability method to account for income taxes as
required by Financial Accounting Standards Board (FASB) Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." Under this method,
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities. Deferred tax assets
and liabilities are measured using enacted tax rates and laws that will be in
effect when the differences are expected to reverse.
COMPREHENSIVE INCOME
The Company reports comprehensive income (loss) in accordance with the
FASB's Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income." The comprehensive net loss for the period ended June 30,
1998, the year ended June 30, 1999 and the six months ended December 31, 1999
does not differ from the reported net loss.
CONCENTRATIONS OF SUPPLY
The Company currently purchases several key parts and components used in
manufacture of its products from limited sources of supply.
CONCENTRATIONS OF SALES
The Company's PowerFilter product has accounted for substantially all of
the Company's net revenue for the year ended June 30, 1999 and the six months
ended December 31, 1999.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Advertising expenses
for the period ended June 30, 1998, the year ended June 30, 1999 and the six
months ended December 31, 1999 were none, $76,000 and $347,000, respectively,
and are included in sales and marketing expenses.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of long-term debt obligations is estimated based on current
interest rates available to the Company for debt instruments with similar terms,
degrees of risk, and remaining maturities. The carrying values of these
obligations approximate their fair values.
F-9
<PAGE> 85
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
UNAUDITED PRO FORMA STOCKHOLDERS' EQUITY (DEFICIT)
If the offering contemplated by this prospectus is consummated, all of the
preferred stock outstanding will automatically be converted into common stock.
Unaudited pro forma stockholders' equity (deficit) at December 31, 1999, as
adjusted for the assumed conversion of preferred stock based on the shares of
preferred stock outstanding at December 31, 1999, is set forth on the
consolidated balance sheet.
SEGMENT INFORMATION
The Company has adopted the FASB's Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information." The Company operates in one segment, to manufacture and market
photonic processors.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (FAS 133), which will be effective for the
Company's fiscal year ending June 30, 2001. This statement establishes
accounting and reporting standards requiring that every derivative instrument,
including certain derivative instruments embedded in other contracts, be
recorded in the balance sheet as either an asset or liability measured at its
fair value. The statement also requires that changes in the derivative's fair
value be recognized in earnings unless specific hedge accounting criteria are
met. The Company has not evaluated the impact of FAS 133; however, it believes
the adoption of FAS 133 will not have a material effect on the consolidated
financial position, results of operations, or cash flows as the Company has not
entered into any derivative contracts.
2. NET LOSS PER SHARE
Basic and diluted net loss per common share has been computed using the
weighted-average number of shares of common stock outstanding during the period,
less the weighted-average number of shares of common stock that are subject to
repurchase. Pro forma basic and diluted net loss per common share, as presented
in the consolidated statements of operations, have been computed as described
above and also give effect, to the conversion of the convertible preferred stock
(using the if-converted method) from the original date of issuance. To date, the
Company has not had any issuances of shares or option grants for nominal
consideration as that term is used in the Securities and Exchange Commission's
Staff Accounting Bulletin No. 98.
On January 14, 2000, the Company's stockholders approved a three-for-two
stock split in the form of a stock dividend. Accordingly, all share and
per-share data for all prior periods presented have been restated to reflect
this event.
F-10
<PAGE> 86
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
The following table presents the calculation of basic and diluted net loss
per common share and pro forma basic and diluted net loss per common share (in
thousands, except share and per share amounts):
<TABLE>
<CAPTION>
PERIOD FROM SIX MONTHS ENDED
OCTOBER 24, 1997 YEAR ENDED ----------------------------
(INCEPTION) TO JUNE 30, DECEMBER 31, DECEMBER 31,
JUNE 30, 1998 1999 1998 1999
---------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss attributable to common
stockholders................... $ (1,137) $ (9,221) $ (2,607) $ (39,845)
Basic and diluted:
Weighted-average shares of
common stock outstanding.... 4,327,109 12,850,622 11,829,848 19,092,293
Less: weighted-average shares
subject to repurchase....... (4,169,278) (10,993,934) (11,200,295) (12,877,074)
----------- ------------ ------------ ------------
Weighted-average shares used in
computing basic and diluted net
loss per common share.......... 157,831 1,856,688 629,553 6,215,219
=========== ============ ============ ============
Basic and diluted net loss per
common share................... $ (7.20) $ (4.97) $ (4.14) $ (6.41)
=========== ============ ============ ============
Pro forma unaudited:
Shares used above.............. 1,856,688 6,215,219
Pro forma adjustment to reflect
weighted effect of the
assumed conversion of
preferred stock............. 21,770,893 32,894,727
------------ ------------
Weighted-average shares used in
computing pro forma basic
and diluted net loss per
common share................ 23,627,581 39,109,946
============ ============
Pro forma basic and diluted net
loss per common share....... $ (0.39) $ (1.02)
============ ============
Potentially dilutive securities
excluded from computations
because they are
anti-dilutive............... 5,643,602 2,676,300 1,074,750 3,578,925
=========== ============ ============ ============
</TABLE>
3. CONSOLIDATED BALANCE SHEET DETAILS
Inventories
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
JUNE 30,
------------ DECEMBER 31,
1998 1999 1999
---- ---- ------------
<S> <C> <C> <C>
Raw materials............................................... $-- $364 $1,329
Work-in-process............................................. -- 219 1,364
Finished goods.............................................. -- 43 --
-- ---- ------
$-- $626 $2,693
== ==== ======
</TABLE>
F-11
<PAGE> 87
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
Property and Equipment
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
JUNE 30,
-------------- DECEMBER 31,
1998 1999 1999
---- ------ ------------
<S> <C> <C> <C>
Software and computer equipment............................. $ 34 $ 211 $ 540
Equipment and machinery..................................... 344 1,713 5,427
Furniture and fixtures...................................... 63 160 827
---- ------ -------
441 2,084 6,794
Accumulated depreciation.................................... (33) (413) (1,162)
---- ------ -------
$408 $1,671 $ 5,632
==== ====== =======
</TABLE>
4. RELATED PARTY TRANSACTIONS
On May 20, 1999, the Company loaned $300,000 to an employee for the
purchase of a home. The promissory note, which bears interest at 4.9% per annum,
and accrued interest are payable in full to the Company on the earliest of (i)
six months from the date on which the employee can sell shares of the Company's
common stock for an amount equal to the principal and interest on the note, or
(ii) the termination of employment with the Company.
On November 19, 1999, the Company loaned $125,000 to an employee. The
promissory note, which bears interest at 5.57% per annum, and accrued interest
are payable in full to the Company on the earliest of (i) May 19, 2001, (ii) six
months from the date on which the employee can sell shares of the Company's
common stock for an amount equal to the principal and interest on the note, or
(iii) the termination of employment with the Company.
In connection with the exercise of certain stock options and share purchase
rights granted under the Company's stock option plan, the Company has received
promissory notes equal to the total exercise price of these stock options and
share purchase rights. These full recourse promissory notes, which bear interest
at 4.99% - 6.20% per annum, and accrued interest are payable in full to the
Company, generally four to five years from the date each of the promissory notes
was issued. Promissory notes for the exercise of certain stock options and share
purchase rights totaling $6,000, $326,000, and $2,633,000 were outstanding as of
June 30, 1998, June 30, 1999, and December 31, 1999. These notes are classified
as a reduction of other stockholders' equity (deficit).
5. COMMITMENTS
In September 1999, the Company entered into an operating lease for a new
corporate headquarters and manufacturing facility. The Company has the right of
first refusal on the purchase of the building until April 1, 2000. Upon the
expiration of the lease in October 2009, the Company has an option to extend the
lease term for an additional five year period.
The Company leases equipment under capital leases. Such leases include a
lease facility entered into during May 1999 which made available to the Company
up to $3,000,000 to finance equipment purchases at an interest rate of 14.9% per
annum. As of December 31, 1999, the Company had an outstanding obligation of
$1,101,000 under this facility. Subsequent to December 31, 1999, the Company
drew down an additional $1,545,000 on this lease facility.
F-12
<PAGE> 88
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
As of December 31, 1999, payments due under capital leases and future
minimum lease payments under noncancelable operating leases having initial terms
in excess of one year are as follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
Six months ending June 30, 2000............................. $ 351 $ 641
Year ending June 30,
2001...................................................... 667 1,219
2002...................................................... 717 1,091
2003...................................................... 527 1,109
2004...................................................... -- 1,143
Remaining Years........................................... -- 5,360
------ -------
Total minimum lease payments...................... 2,262 10,563
Amount representing interest................................ (505) --
------ -------
Present value of net minimum lease payments................. 1,757 $10,563
=======
Less current portion........................................ 437
------
Long-term portion........................................... $1,320
======
</TABLE>
At June 30, 1998 and 1999 and December 31, 1999, equipment amounting to
approximately $140,000, $920,000, and $2,136,000 respectively, was capitalized
under capital leases. Related accumulated amortization at June 30, 1998 and 1999
and December 31, 1999 amounted to approximately $12,000, $290,000, and $770,000
respectively. The lease agreements are payable in monthly installments through
February 2003, bearing interest at 12.00%-19.47% per annum, and are fully
secured by the related equipment.
The Company's rental expense under operating leases was approximately
$97,000 for the period from inception (October 24, 1997) through June 30, 1998,
$346,000 for the year ended June 30, 1999, and $466,000 for the six months ended
December 31, 1999.
6. FINANCING ARRANGEMENTS
In July 1999, the Company secured a revolving line of credit from a
financial institution, which allows maximum borrowings up to $3,750,000. The
revolving credit agreement terminates October 1, 2000, at which time all
outstanding principal and interest are due. The line bears interest at the prime
rate plus 0.75%. The Company has pledged all of its assets as collateral for
this line. At December 31, 1999, the Company had outstanding borrowings of
$1,963,000 against this line. This line of credit requires the Company to comply
with specified covenants.
In connection with this line of credit, the Company issued a warrant
agreement to the financial institution, which entitles the holder to purchase
29,347 shares of the Company's common stock with an aggregate purchase price
equal to $112,000, or approximately $3.83 per share. The warrants are
exercisable at anytime, and will expire upon the earlier of (i) the closing of
any acquisition of the Company or (ii) their expiration on July 8, 2004. The
value of the warrants was estimated using the Black-Scholes option pricing model
with the following assumptions: weighted-average risk-free interest rate of
5.5%, contractual life of 5 years, volatility of 0.75 and no dividend yield. The
fair value of this warrant was estimated to be $118,000 and is recorded as
deferred interest expense. This amount is being amortized to interest expense
over the term of the agreement.
This line of credit replaced a previous line of credit with another
financial institution under which the Company had borrowings outstanding as of
June 30, 1998 and 1999 of $285,000 and $735,000.
F-13
<PAGE> 89
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
7. REDEEMABLE CONVERTIBLE PREFERRED STOCK
Series A, B, C, and D preferred stock have a liquidation preference of
$0.149, $0.267, $0.504, and $3.833 per share, respectively, plus all declared
but unpaid dividends. Series A, B, C, and D preferred shareholders are entitled
to noncumulative dividends at the rate of $0.011, $0.021, $0.040, and $0.192 per
share, per annum, respectively, when and if declared by the Board of Directors
and in preference and priority to common stock dividends. No dividends have been
declared or paid by the Company.
The holders of each share of Series A, B, C, and D preferred stock are
entitled to one vote for each share of common stock into which such share may be
converted. Currently, the preferred shareholders, voting as a separate class,
are entitled to elect three directors. The holders of Series A, B, C, and D
preferred stock have the right, at the option of the holder, at any time to
convert their shares into common stock on a one-for-one basis, subject to
adjustments for future dilution. Series A, B, C, and D preferred stock
automatically convert into common stock, at the then applicable conversion rate,
upon a public offering of the Company's common stock at a per share price of not
less than $2.67, with aggregate proceeds in excess of $10,000,000, or upon the
consent of the holders of a majority of the then outstanding shares of preferred
stock.
On December 31 of each year beginning December 31, 2004, at the option of a
majority of the preferred shareholders, a portion of the preferred stock must be
redeemed at the original purchase price. Additionally, in certain circumstances
upon the subsequent issuance of preferred stock, the Company may be required to
redeem a certain number of the preferred shares outstanding.
In connection with the issuance of the Series D preferred stock, the
Company recorded a non-cash charge of $20,051,000 during the six months ended
December 31, 1999 to accrete the value of the preferred stock to its fair value.
This non-cash charge was recorded as an increase in accumulated deficit with a
corresponding credit to additional paid-in capital and was recognized at the
date of issuance which was the period in which the shares became eligible for
conversion.
8. OTHER STOCKHOLDERS' EQUITY
Shares Issued to Founder
In January 1998, the Company issued 2,700,000 shares of stock to one of its
founders pursuant to a restricted stock purchase agreement which permits the
Company to repurchase the shares at the original sales price. These rights
expire at a rate of 25% after one year and 1/48 per month thereafter. At
December 31, 1999, 1,350,000 shares remained subject to repurchase under these
agreements.
Common Stock to be Issued
In January 2000, the Company entered into agreements to sell shares of
common stock in a private placement with two separate corporate investors. Each
corporate investor will acquire 384,615 shares of common stock at $13.00 per
share contemporaneously with the initial public offering.
Stock Option/Rights Plan
The Company adopted the 1998 Stock Plan (the "Option Plan"), under which
officers, employees, directors, and consultants may be granted Incentive Stock
Options ("ISOs") and Nonstatutory Stock Options ("NSOs") to purchase shares of
the Company's common stock.
The Option Plan permits ISOs and NSOs to be granted at an exercise price of
not less than 100% of the fair value on the date of grant as determined by the
Board of Directors. Options that expire (generally ten years from the grant
date) or are canceled are returned to the Option Plan. The term of the Option
Plan is ten years. Options may be granted with different vesting terms as
determined by the Board of Directors. The options generally vest 25% upon
completion of one year of service and 1/48 per month thereafter.
F-14
<PAGE> 90
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
Stock option activity under the Option Plan is as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
----------------------
WEIGHTED-
NUMBER AVERAGE
OF EXERCISE
SHARES PRICE
--------- ---------
<S> <C> <C>
Balance at inception (October 24, 1997)..................... -- --
Options granted........................................... 348,602 $0.01
--------- -----
Balance at June 30, 1998.................................... 348,602 $0.01
Options granted........................................... 1,297,050 $0.03
Options exercised......................................... (618,602) $0.02
Options canceled.......................................... (38,250) $0.05
--------- -----
Balance at June 30, 1999.................................... 988,800 $0.05
--------- -----
Options granted........................................... 2,678,352 $1.84
Options exercised......................................... (116,625) $0.35
Options canceled.......................................... (149,100) $0.57
--------- -----
Balance at December 31, 1999................................ 3,401,427 $1.40
========= =====
</TABLE>
<TABLE>
<CAPTION>
OUTSTANDING
-------------------------------------------------- EXERCISABLE
WEIGHTED -------------------------------
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
RANGE OF AS OF 12/31/99 CONTRACTUAL LIFE EXERCISE PRICE AS OF 12/31/99 EXERCISE PRICE
EXERCISE PRICES -------------- ---------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
$0.000 - $0.013 97,500 9.82 $0.001 92,969 $0.001
$0.027 - $0.027 809,400 9.02 $0.027 28,170 $0.027
$0.053 - $0.200 186,600 9.39 $0.090 45,000 $0.100
$0.387 - $0.387 657,975 9.76 $0.387 78,124 $0.387
$0.720 - $4.333 1,649,952 9.91 $2.858 120,000 $3.792
- --------------- --------- ---- ------ ------- ------
$0.000 - $4.333 3,401,427 9.63 $1.404 364,263 $1.347
</TABLE>
Under the Option Plan, the Company may also grant share purchase rights
either alone, in addition to, or in tandem with other awards granted under the
Option Plan and/or cash awards granted outside the Option Plan. Exercise of
these share purchase rights are made pursuant to restricted stock purchase
agreements containing provisions established by the Board of Directors. These
provisions give the Company the right to repurchase the shares at the original
sales price. This right expires at a rate determined by the Board of Directors,
generally at a rate of 25% after one year and 1/48 per month thereafter. During
the period from October 24, 1997 to June 30, 1998, the year ended June 30, 1999,
and the six months ended December 31, 1999, the Company issued 4,050,000 shares,
10,510,589 shares, and 4,761,165 shares under the Option Plan. Shares subject to
repurchase were 4,050,000 shares as of June 30, 1998, 11,730,902 shares as of
June 30, 1999, and 12,889,566 shares as of December 31, 1999. For the year ended
June 30, 1999 and the six months ended December 31, 1999, the Company
repurchased 37,899 shares and 2,615,625 shares under the Option Plan.
At December 31, 1999, 1,245,117 shares were available for future grant
under the Option Plan which was increased by an additional 7,500,000 shares in
January 2000. In addition, annual increases will be added to the 1998 Stock
Plan, beginning on July 1, 2000, equal to the least of (i) 6,000,000 shares,
(ii) 4.9% of the Company's outstanding shares, and (iii) a lesser amount
determined by the Company's Board of Directors.
The weighted-average deemed fair value of stock options and share purchase
rights granted during 1998 and 1999 was $0.19 and $1.51, respectively. At
December 31, 1999, the weighted-average deemed fair value of stock options and
share purchase rights granted from July 1, 1999 through December 31, 1999 was
$8.87.
F-15
<PAGE> 91
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
For the period from October 24, 1997 to June 30, 1998, the year ended June
30, 1999 and the six months ended December 31, 1999, the Company recorded
deferred stock compensation of $2,136,000, $11,502,000 and $52,328,000,
respectively, representing the difference between the exercise price and the
deemed fair value for accounting purposes of the Company's common stock on the
date such stock options and share repurchase rights were granted. The deemed
fair value was based on the Company's retrospective review of the primary
business factors underlying the value of our common stock on the dates such
grants were made, viewed in light of the Company's initial public offering and
the expected initial public offering price per share. For the period October 24,
1997 to June 30, 1998, the year ended June 30, 1999 and the six months ended
December 31, 1999, the Company recorded amortization of deferred stock
compensation of $362,000, $2,925,000 and $11,990,000, respectively. At December
31, 1999, the Company had $50,689,000 of remaining unamortized deferred
compensation. Such amount is included as a reduction of other stockholders'
equity (deficit) and is being amortized over the vesting period.
For the year ended June 30, 1999 and the six months ended December 31,
1999, the Company recorded stock compensation cost of $539,000 and $3,707,000,
respectively related to common stock options granted to consultants. The value
of the options was estimated using the Black-Scholes option pricing model with
the following assumptions: weighted-average risk free interest rate of 5.50%,
contractual life of ten years, volatility of 0.75 and no dividend yield.
Pro Forma Disclosures of the Effect of Stock-Based Compensation
Pro forma information regarding results of operations and net loss per
share is required by FAS 123, which also requires that the information be
determined as if the Company had accounted for its employee stock options and
share repurchase rights under the fair value method of FAS 123. The fair value
of these options and share repurchase rights was estimated at the date of grant
using the minimum value method with the following weighted-average assumptions:
<TABLE>
<CAPTION>
JUNE 30,
------------------ DECEMBER 31,
1998 1999 1999
------- ------- ------------
<S> <C> <C> <C>
Risk-free interest rate................................... 5.5% 5.5% 5.5%
Dividend yield............................................ -- -- --
Weighted-average expected life............................ 5 years 5 years 5 years
</TABLE>
The option valuation models were developed for use in estimating the deemed
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected life of the option. Because the
Company's employee stock options have characteristics significantly different
from those of traded options and because changes in subjective input assumptions
can materially affect the deemed fair value estimate, in management's opinion,
the existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options.
For purposes of pro forma disclosures, the deemed fair value of the options
is amortized to expense over the options' vesting period. For the period from
October 24, 1997 (inception) to June 30, 1998, the year ended June 30, 1999, and
the six months ended December 31, 1999, the pro forma consolidated net loss
attributable to common stockholders was $(1,147,000), $(9,313,000) and
$(44,374,000), respectively, and the pro forma net loss per common share was
$(7.27), $(5.02) and $(7.14), respectively.
The pro forma impact of options on the consolidated net loss attributable
to common stockholders for the period from October 24, 1997 (inception) to June
30, 1998 and the year ended June 30, 1999 is not representative of the effects
on consolidated net income (loss) attributable to common stockholders for future
years, as future years will include the effects of additional stock option
grants.
F-16
<PAGE> 92
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
1999 Director Option Plan
In January 2000, the Company adopted, subject to completion of the
Company's initial public offering, the 1999 Director Option Plan (the "Director
Option Plan"). Non-employee directors are entitled to participate in the
Director Option Plan. A total of 300,000 shares of the Company's common stock
have been reserved for issuance under the Director Option Plan, plus automatic
annual increases beginning on July 1, 2000 equal to the least of (i) 150,000
shares, (ii) 0.25% of the outstanding shares on that date, and (iii) a lesser
amount determined by the Company's Board of Directors. The Director Option Plan
generally provides for an automatic initial grant of an option to purchase
40,000 shares of our common stock to each non-employee director on the date
which the later of the following events occur: the effective date of the
Director Option Plan; or the date when a person first becomes a non-employee
director. After the initial grant, each non-employee director will automatically
be granted subsequent options to purchase 10,000 shares of common stock each
year on the date of the Company's annual stockholders' meeting. Grants generally
shall have a term of 10 years. Each initial option grant will vest as to 25% of
the shares subject to the option on each anniversary of its date of grant. Each
subsequent option grant will fully vest on the anniversary of its date of grant.
The exercise price of all options will be 100% of the fair market value per
share of the Company's common stock on the date of grant.
1999 Employee Stock Purchase Plan
In January 2000, the Company adopted, subject to completion of the
Company's initial public offering, the 1999 Employee Stock Purchase Plan (the
"Stock Purchase Plan") for its employees. A total of 525,000 shares of the
Company's common stock has been reserved for issuance under the Stock Purchase
Plan, plus automatic annual increases beginning on July 1, 2000 equal to the
least of (i) 750,000 shares, (ii) 1% of the outstanding shares on that date, and
(iii) a lesser amount determined by the Company's Board of Directors. The Stock
Purchase Plan permits participants to purchase the Company's common stock
through payroll deductions of up to 10% of the participant's compensation. The
maximum number of shares a participant may purchase during each offering period
is 3,000 shares. The price of common stock purchased will be 85% of the lower of
the fair market value at the beginning of the offering period and the ending of
the offering period.
Warrants
In December 1998, the Company issued warrants to three individuals in
connection with founding the Company. Each warrant agreement entitles the holder
to purchase 112,500 shares of the Company's common stock with an aggregate
purchase price equal to $1,350,000. The warrants are exercisable at any time,
and the warrants will expire upon the earlier of (i) the closing of any
acquisition of the Company or initial public offering or (ii) their expiration
on December 31, 2003. The Company has reserved 337,500 shares of common stock in
the event of the exercise of these warrants.
Shares Reserved
Common stock reserved for future issuance is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1999
------------
<S> <C>
Option Plan................................................. 4,646,544
Reserved for warrants....................................... 366,847
Conversion of preferred stock............................... 35,019,134
----------
Total common stock reserved for future issuance... 40,032,525
==========
</TABLE>
F-17
<PAGE> 93
AVANEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 IS UNAUDITED)
In January 2000, the Company reserved 7,500,000 additional shares for
future issuance under the Option Plan, and, in addition, reserved shares for
future issuance, subject to completion of its initial public offering, of
300,000 shares related to the 1999 Director Option Plan and 525,000 shares
related to the 1999 Employee Stock Purchase Plan.
9. 401(k) PLAN
The Company maintains a savings and retirement plan under Section 401(k) of
the Internal Revenue Code. All employees are eligible to participate on the
first day of the month following their hire date with the Company. Under the
plan, employees may contribute up to 15% of their pretax salaries per year but
not more than the statutory limits. The Company has not contributed to the plan.
10. INCOME TAXES
There has been no provision for U.S. federal, U.S. state or foreign income
taxes for any period as the Company has incurred operating losses since
inception for all jurisdictions.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets are as follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30,
---------------- DECEMBER 31,
1998 1999 1999
----- ------- ------------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards........................... $ 288 $ 2,330 $ 3,593
Stock option compensation.................................. -- 988 5,640
Other...................................................... 32 480 994
----- ------- -------
Total............................................ 320 3,798 10,227
Valuation allowance........................................ (320) (3,798) (10,227)
----- ------- -------
Net deferred tax assets.................................... $ -- $ -- $ --
===== ======= =======
</TABLE>
Realization of the deferred tax assets is dependent upon future earnings,
if any, the timing and amount of which are uncertain. Accordingly, the net
deferred tax assets have been fully offset by a valuation allowance. The
valuation allowance increased by $320,000, $3,478,000 and $6,429,000 in the
period ended June 30, 1998, the year ended June 30, 1999, and the six months
ended December 31, 1999.
As of December 31, 1999, the Company has net operating loss carryforwards
for federal income tax purposes of approximately $8,982,000, which expire in
years 2013 through 2020. The Company also had net operating loss carryforwards
for state income tax purposes of approximately $8,993,000 expiring in the year
2006. Utilization of the Company's net operating loss may be subject to a
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code and similar state provisions. Such an annual
limitation could result in the expiration of the net operating loss before
utilization.
F-18
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[INSIDE BACK COVER]
[The inside back cover starts with the heading "Avanex Photonic Processors"
followed by the Avanex logo and the word "Avanex(TM)." Down the left hand side
of the page are photographs of a PowerFilter, a PowerMux and a PowerShaper. To
the right of the corresponding photograph of the product is the following text:
"PowerFilter(TM) Optical Multiplexer/Demultiplexer
Features:
o Tuning capability to accommodate different wavelengths
o Improved system performance
o Reduced signal loss
o Fewer types of filters needed
PowerMux(TM) High Density Wavelength Division Multiplexer Processors
Features:
o Accommodates large number of wavelength channels
o Efficient use of the available optical wavelength range
o Low cost per wavelength channel
PowerShaper(TM) Chromatic Dispersion Compensation Processor (In beta
test)
Features:
o Fixed or tunable dispersion compensation
o Compact packaging
o Dispersion compensation across a broad optical wavelength range"
There follows the subheading "The Photonics Center(TM)," with a photograph of a
person in front of a rack of optical equipment. To the right of the photograph
is the following text:
"The Photonics Center(TM) at Avanex provides:
o A leading-edge customer demonstration and training center
o A simulated optical network that demonstrates deployment of Avanex
optical process technology
o Testing capabilities for development of products or prototypes
o Application training for customers"]
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