<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number
CLARENT CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0433687
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
700 Chesapeake Drive
Redwood City, California 94063
(Address of principal executive offices and zip code)
Registrant's telephone number: (650) 306-7511
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
The number of shares outstanding of the Registrant's Common Stock, $0.001 par
value, was 27,594,966 at July 31, 1999.
This report consists of 25 pages of which this page is number 1.
<PAGE>
CLARENT CORPORATION
FORM 10-Q
INDEX
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<TABLE>
<CAPTION>
Page No.
------------------
<S> <C>
Part I: Financial Information
Item 1: Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of June 30, 1999
and December 31, 1998 3
Condensed Consolidated Statements of Operations for the Three
and Six Month Periods Ended June 30, 1999 and 1998 4
Condensed Consolidated Statement of Cash Flows for the
Six Month Periods Ended June 30, 1999 and 1998 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations 9
Item 3: Quantitative and Qualitative Disclosures About Market Risk 14
Part II: Other Information
Item 2: Changes in Securities 24
Item 4: Submission of Matters to a Vote of Security Holders 24
Item 6: Exhibits and Reports on Form 8-K 24
Signatures 25
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
CLARENT CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................... $ 4,273 $ 11,903
Accounts receivable, net..................... 13,227 6,943
Inventories.................................. 5,578 3,620
Prepaid expenses and other current assets.... 729 478
----------- -----------
Total current assets..................... 23,807 22,944
Property and equipment, net..................... 5,104 2,233
Other assets.................................... 396 -
----------- -----------
$ 29,307 $ 25,177
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................. $ 5,547 $ 2,905
Line of credit............................... 5,300 2,500
Deferred revenue............................. 7,637 4,414
Other accrued liabilities.................... 2,857 1,594
Long term debt, current portion.............. 627 -
----------- -----------
Total current liabilities................ 21,968 11,413
Long term debt.................................. 575 -
Stockholders' equity:
Convertible preferred stock.................. 21,356 21,024
Common stock................................. 26,381 2,746
Deferred compensation........................ (9,719) (1,771)
Accumulated other comprehensive loss......... (44) (68)
Accumulated deficit.......................... (31,210) (8,167)
----------- -----------
Total stockholders' equity................... 6,764 13,764
----------- -----------
$ 29,307 $ 25,177
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
CLARENT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Net revenue....................................... $ 9,304 $ 3,083 $ 16,018 $ 5,479
Cost of revenue................................... 4,146 1,396 7,427 2,176
---------- ---------- --------- ----------
Gross profit.................................... 5,158 1,687 8,591 3,303
---------- ---------- --------- ----------
Operating expenses:
Research and development........................ 1,991 698 3,557 1,238
Sales and marketing............................. 5,623 1,553 9,648 2,735
General and administrative...................... 1,272 554 2,629 730
Amortization of compensation.................... 13,662 84 15,642 86
---------- ---------- --------- ----------
Total operating expenses..................... 22,548 2,889 31,476 4,789
---------- ---------- --------- ----------
Loss from operations.............................. (17,390) (1,202) (22,885) (1,486)
Interest expense, net............................. (163) (101) (147) (141)
---------- ---------- --------- ----------
Loss before provision (benefit) for income taxes.. (17,553) (1,303) (23,032) (1,627)
Provision (benefit) for income taxes.............. 11 (1) 11 (1)
---------- ---------- --------- ----------
Net loss.......................................... $ (17,564) $ (1,302) $ (23,043) $ (1,626)
========== ========== ========= ==========
Basic and diluted net loss per share.............. $ (2.73) $ (0.46) $ (3.87) $ (0.63)
========== ========== ========= ==========
Shares used in computing basic and diluted .......
net loss per share.............................. 6,429 2,840 5,951 2,597
========== ========== ========= ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
CLARENT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
------------ ------------
<S> <C> <C>
Operating activities:
Net loss....................................................... $ (23,043) $ (1,626)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation................................................ 869 120
Amortization of compensation................................ 15,642 86
Changes in operating assets and liabilities:
Accounts receivable....................................... (6,284) (3,108)
Inventories............................................... (1,958) (853)
Prepaid expenses and other current assets................. (251) (196)
Other assets.............................................. (396) 5
Accounts payable.......................................... 2,642 393
Deferred revenue.......................................... 3,223 2,273
Other accrued liabilities................................. 1,263 444
----------- -----------
Net cash used in operating activities............................ (8,293) (2,462)
----------- -----------
Investing activities:
Purchases of property and equipment............................ (3,740) (390)
Financing activities:
Proceeds from line of credit................................... 2,800 -
Proceeds from issuance of long term debt....................... 1,202 -
Proceeds from issuance of preferred stock...................... 332 7,058
Proceeds from Series C bridge notes............................ - 2,600
Principal payment on Series C bridge notes..................... - (550)
Proceeds from issuance of common stock......................... 45 13
----------- -----------
Net cash provided by financing activities........................ 4,379 9,121
----------- -----------
Effect of exchange rate changes on cash and cash equivalents..... 24 (16)
----------- -----------
Net increase (decrease) in cash and cash equivalents............. (7,630) 6,253
Cash and cash equivalents at beginning of period................. 11,903 474
----------- -----------
Cash and cash equivalents at end of period....................... $ 4,273 $ 6,727
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
CLARENT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Clarent Corporation (the Company) as of June 30, 1999 and for the three month
and six month periods ended June 30, 1999 and 1998 have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. In the opinion of management, the condensed consolidated financial
statements include all adjustments (consisting only of normal recurring
accruals) that management considers necessary for a fair presentation of the
results of operations for the interim periods shown. The results of operations
for such periods are not necessarily indicative of the results expected for the
full fiscal year or for any future period. These financial statements should be
read in conjunction with the consolidated financial statements and related notes
included in the Company's Registration Statement on Form S-1, filed with the
Securities and Exchange Commission effective on June 30, 1999. Certain prior
period balances have been reclassified to conform to current period
presentation.
2. Inventories
Inventories consist of the following (in thousands):
June 30, December 31,
1999 1998
---------- ------------
Raw materials................ $ 3,929 $ 2,529
Finished goods............... 1,649 1,091
---------- --------
$ 5,578 $ 3,620
========== =========
3. Comprehensive Income (Loss)
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS 130). FAS
130 establishes new rules for the reporting and display of comprehensive income
and its components, requiring foreign currency translation adjustments, which
currently are reported in stockholders' equity, to be included in other
comprehensive income/loss. Prior year financial statements have been
reclassified to conform to the requirements of FAS 130. At June 30, 1999, the
Company's accumulated other comprehensive loss consisted entirely of cumulative
translation adjustments. The Company's total comprehensive income (loss) is as
follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---------- ---------- --------- ---------
<S> <C> <C> <C> <C>
Net loss............................... $ (17,564) $ (1,302) $ (23,043) $ (1,626)
Other comprehensive income (loss)...... (2) (12) 24 (16)
----------- ----------- --------- ---------
Comprehensive loss..................... $ (17,566) $ (1,314) $ (23,019) $ (1,642)
=========== =========== ========== ==========
</TABLE>
4. Income Taxes
The provision for income taxes of approximately $11,000 for the three month
and six month periods ending June 30, 1999 consists entirely of foreign income
tax provided on the profits attributable to the Company's foreign operations.
6
<PAGE>
CLARENT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5. Short Term Borrowings
In May 1998, the Company established a $5,000,000 line of credit with a
financial institution. The interest rate on this credit facility was variable
and was equal to one-half of one percentage point above the prime rate. Under
the terms of this arrangement, the Company is to pay an additional, pro-rated
fee of 0.4% of all advances drawn in excess of $3,000,000. In addition,
borrowings under this arrangement are limited to the Company's eligible
receivable base. The terms of the line of credit establish certain affirmative
and negative covenants, under which the Company must maintain certain financial
ratios and corporate reporting practices, respectively. In February 1999, the
financial institution increased the line of credit to $7,000,000 and revised the
ratios. In June 1999, the financial institution revised the line of credit to
include eligible inventory, further revise the ratios, and increase the interest
rate to prime plus 4%. Borrowings under the line of credit are secured by
substantially all of the assets of the Company. At June 30, 1999, $5,300,000 was
outstanding under this line of credit. The line of credit agreement expires
February 16, 2000.
6. Long Term Debt
In February 1999, the Company entered into a $3,000,000 equipment term loan
facility. The loan bears interest at the bank's prime rate plus .75%. Under the
terms of the agreement, the Company granted a security interest in certain
assets of the Company and must maintain financial covenants. Borrowings and
interest are repayable in installments over 24 to 27 months. As of June 30,
1999, there was approximately $1,202,000 outstanding against the term loan
facility.
7. Stock Split
In April 1999, the Company's board of directors approved a two-for-one
split of the Company's common stock. The stock split became effective on June
28, 1999. In addition, each share of the Company's convertible preferred stock
converted into two shares of common stock upon the closing of the initial public
offering on July 7, 1999. All share and per share amounts in the accompanying
condensed consolidated financial statements have been adjusted retroactively.
On April 8, 1999, the Company's board of directors authorized the
reincorporation of the Company in Delaware. The par value of the preferred and
common stock is $0.001 per share. On the closing of the Company's initial public
offering, the Amended and Restated Certificate of Incorporation was amended to
authorize 5,000,000 shares of preferred stock and 50,000,000 shares of common
stock. The board of directors has the authority to fix or alter the
designations, powers, preferences, and rights of the preferred stock without the
approval of the Company's stockholders.
8. Segments of an Enterprise and Related Information
The Company operates in one industry segment. The Company designs, develops
and sells Internet protocol telephony, or IP telephony systems. Net revenue for
non-U.S. locations are substantially the result of export sales from the U.S.
Net revenue by geographic region based on customer location were as follows (in
thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Net revenue
United States.............................. $ 3,338 $ 1,576 $ 7,658 $ 2,967
Other Americas............................. 59 3 133 3
Europe..................................... 657 65 875 71
Asia....................................... 5,250 1,439 7,352 2,438
---------- ---------- --------- ----------
Total............................................ $ 9,304 $ 3,083 $ 16,018 $ 5,479
========== ========== ========= ==========
</TABLE>
7
<PAGE>
CLARENT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
9. Net Loss Per Share
The Company follows the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share." Basic and diluted net loss per share is
computed by dividing net loss by the weighted average number of common shares
outstanding during the period less outstanding shares subject to a right of
repurchase by the Company. Outstanding shares subject to repurchase are not
included in the computations of basic and diluted net loss per share until the
time-based vesting restrictions have lapsed. Common equivalent shares from stock
options and warrants (using the treasury stock method) are excluded from the
computation of net loss per share as their effect is anti-dilutive.
10. Related Party Transactions
In June 1997, the Company entered into an agreement for advisory services
with WK Technology Fund, a Taiwanese corporation, one of whose principals is a
member of the Company's board of directors. The advisory services primarily
related to business strategy for the Company and were to be performed over a
four-year term. As consideration for the advisory services, the Company granted
to WK Technology Fund a warrant to purchase up to 1,400,000 shares of the
Company's common stock at an exercise price of $0.05 per share. On the six-month
anniversary of the warrant effective date, 175,000 of the warrants vested with
the remaining warrants vesting ratably over the subsequent 42 months or
immediately 30 days prior to the closing of the Company's initial public
offering. The warrant has a life of five years. The Board of Directors
terminated the advisory services arrangement in June 1999 and elected to have
the unvested portion of the warrants become fully vested. In connection with
this termination, the Company recorded a compensation charge totaling
approximately $11.6 million during the three-month period ending June 30, 1999
and $12.3 million for the six months ended June 30, 1999 that is included in
amortization of compensation in the condensed consolidated statements of
operations and cash flows. The Company has recorded compensation charges
totaling $81,000 and $83,000 for the three and six months periods ended June 30,
1998. WK Technology Fund purchased 408,328 shares of the Company's common stock
under this warrant in August 1998 and the remaining 991,672 shares in July 1999.
11. Subsequent Event
In July 1999, the Company completed an initial public offering of 4.6
million shares, including 600,000 over-allotment shares at $15.00 per share. Net
proceeds from the offering were approximately $62 million. Upon the closing of
the initial public offering 13,847,014 shares of the Company's convertible
preferred stock were automatically converted into common stock.
12. Recent Accounting Pronouncements
In December 1998, the AICPA issued Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions" ("SOP 98-9"). SOP 98-9 requires use of the "residual method" for
recognition of revenue when vendor-specific objective evidence (VSOE) exists for
undelivered elements but does not exist for delivered elements of a software
arrangement. The Company will be required to comply with the provisions of SOP
98-9 for transactions entered into beginning January 1, 2000.
8
<PAGE>
CLARENT CORPORATION
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion in conjunction with CLARENT
CORPORATION's unaudited condensed consolidated financial statements and notes
thereto. Certain statements contained in this Quarterly Report on Form 10-Q,
including, without limitation, statements containing the words "believes",
"anticipates", "estimates", "expects", and words of similar import, constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. You should not place undue reliance on these
forward-looking statements. Our actual results could differ materially from
those anticipated in these forward-looking statements for many reasons,
including the risks faced by us described below and elsewhere in this Quarterly
Report, and in other documents we file with the SEC.
Overview
We are a leading provider of scalable IP telephony products to carriers and
Internet service providers around the world. Our intelligent architecture and
the Clarent Command Center enable our products to route, manage, inter-connect
and terminate high volumes of calls for service provider customers including the
world's largest long distance telecommunication companies.
We were incorporated in July 1996 and commenced sales of our products in
March 1997. Prior to March 1997, our operations consisted primarily of various
start-up activities, such as research and development, recruiting personnel and
raising capital. Since March 1997 we have expanded our research and development,
sales and marketing and customer support activities. These activities include
developing new products and technologies and enhancing existing products, hiring
sales and marketing personnel, expanding our customer base, developing customer
relationships, marketing the Clarent IP telephony solution, expansion of our
domestic and international distribution channels and hiring customer support
personnel.
Results of Operations
The following table presents certain consolidated statement of operations
data for the periods indicated as a percentage of total net revenue:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
------ ------ ------- -------
<S> <C> <C> <C> <C>
As a Percentage of Net Revenue:
Net revenue..................................... 100.0% 100.0% 100.0% 100.0%
Cost of revenue................................. 44.6 45.3 46.4 39.7
------ ------ ------- -------
Gross margin.................................... 55.4 54.7 53.6 60.3
------ ------ ------- -------
Operating expenses:
Research and development....................... 21.4 22.6 22.2 22.6
Sales and marketing............................ 60.4 50.4 60.2 49.9
General and administrative..................... 13.7 18.0 16.4 13.3
Amortization of compensation .................. 146.8 2.7 97.7 1.6
------ ------ ------- -------
Total operating expenses....................... 242.3 93.7 196.5 87.4
------ ------ ------- -------
Loss from operations............................ (186.9) (39.0) (142.9) (27.1)
Interest expense, net........................... (1.8) (3.3) (0.9) (2.6)
------ ------ ------- -------
Loss before provision for income taxes.......... (188.7) (42.3) (143.8) (29.7)
Provision for income taxes...................... - - - -
------ ------ ------- -------
Net loss........................................ (188.7)% (42.3)% (143.8)% (29.7)%
====== ====== ======= =======
</TABLE>
9
<PAGE>
CLARENT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net Revenue
Net revenue increased 202% to $9.3 million in the three months ended June
30, 1999 from $3.1 million in the three months ended June 30, 1998. Net revenue
for the six months ended June 30, 1999 increased to $16.0 million as compared to
$5.5 for the same period in 1998. The increase in net revenue is primarily
attributed to increased sales of Clarent Command Center and Clarent Fax software
as well as an increase in port volume of our Clarent Gateway products sold,
partially offset by a decrease in our average per port selling prices for those
products.
Cost of Revenue
Cost of revenue increased 197% to $4.1 million in the three months ended
June 30, 1999 from $1.4 million in the three months ended June 30, 1998. Cost of
revenue for the six months ended June 30, 1999 increased to $7.4 million
compared to $2.2 million for the same period in 1998. Gross margin was 55% for
the quarter and 54% for the six-month period in 1999, compared to 55% and 60%
for the corresponding periods in 1998. The decline in gross margin for the six
months ended June 30, 1999 is primarily attributable to a decline in the average
selling prices of our products. Increased sales of our software products both in
absolute dollars and as a percentage of net revenue positively impacted our
gross margin in the three months ended June 30, 1999.
Research and Development Expenses
Research and development expenses increased 185% to $2.0 million in the
three months ended June 30, 1999 from $698,000 in the three months ended June
30, 1998. Research and development expenses for the six months ended June 30,
1999 increased to $3.6 million as compared to $1.2 million for the same period
in 1998. The absolute dollar increases in research and development expenses from
period to period were attributable to increases in the number of research and
development personnel. Research and development expenses decreased as a
percentage of net revenue from 23% for the three and six month periods ended
June 30, 1998 to 21% and 22% for the three and six month periods ended June 30,
1999, respectively.
Sales and Marketing Expenses
Sales and marketing expenses increased 262% to $5.6 million in the three
months ended June 30, 1999 from $1.6 million in the three months ended June 30,
1998. Sales and marketing expenses for the six months ended June 30, 1999
increased to $9.6 million as compared to $2.7 million for the same period in
1998. The absolute dollar increase in sales and marketing expenses was primarily
attributable to an increase in personnel and related expenses required to
implement our sales and marketing strategy and, to a lesser extent, increased
public relations and other promotional expenses. Sales and marketing expenses
increased as a percentage of net revenue from 50% for the three and six month
periods ended June 30, 1998 to 60% for the three and six month periods ended
June 30, 1999. The growth rate of sales and marketing expenses exceeded the
growth rate of net revenue for the period because we were adding sales and
marketing personnel and spending on promotional activities in anticipation of
increased future sales.
General and Administrative Expenses
General and administrative expenses increased 130% to $1.3 million in the
three months ended June 30, 1999 from $554,000 in the three months ended June
30, 1998. General and administrative expenses for the six months ended June 30,
1999 increased to $2.6 million as compared to $730,000 for the same period in
1998. The absolute dollar increase in general and administrative expenses from
period to period was primarily attributable to an increase in personnel and
related expenses required to build the infrastructure to support a larger
organization.
10
<PAGE>
CLARENT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Amortization of Compensation
We incurred $13.7 million in the three months ended June 30, 1999 in
amortization of compensation associated with the granting of stock options and
warrants to purchase common stock as compared to $84,000 in the three months
ended June 30, 1998. Amortization of compensation expense includes the
amortization of stock compensation charges resulting from the granting of stock
options at prices below the deemed fair value of our common stock. These amounts
are being amortized using the graded method over the vesting period of the stock
options. Amortization of stock compensation was approximately $2.1 million for
the three months ended June 30, 1999 and $3.3 million for the six months ended
June 30, 1999 as compared to $3,000 and $3,000 for the three and six month
periods ended June 30, 1998.
Amortization of compensation also includes compensation charges associated
with the granting of a warrant for advisory services to an investor, WK
Technology Fund. Amortization of compensation totaled $11.6 million in the
quarter ending June 30, 1999 and $12.3 million for the six months ended June 30,
1999 as compared to $81,000 and $83,000 for the three and six month periods
ended June 30, 1998. We terminated the advisory services arrangement with WK
Technology Fund in June 1999 which caused the unvested portion of the warrant to
become fully vested and all unamortized compensation charges relative to the
associated warrant have been recognized in the period ended June 30, 1999.
Interest Expense, net
Interest expense, net increased 61% to $163,000 in the three months ended
June 30, 1999 from $101,000 in the three months ended June 30, 1998. Interest
expense, net for the six months ended June 30, 1999 increased to $147,000 as
compared to $141,000 for the same period in 1998. The increase was attributable
to the increased debt required to finance Clarent's growth.
Provision for Income Taxes
For the three and six months ended June 30, 1999 we recorded a provision
for income taxes of $11,000 related to current foreign income tax provided on
the profits attributable to our foreign operations.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through private
sales of convertible preferred stock, which totaled $18.8 million in aggregate
net proceeds through June 30, 1999. We have also financed our operations through
lines of credit, of which $5.3 million had been borrowed and was outstanding as
of June 30, 1999. In July 1999, Clarent completed an initial public offering
from which net proceeds approximated $62 million.
Net cash used in operating activities was $8.3 million for the six months
ended June 30, 1999 as compared to $2.5 million for the six months ended June
30, 1998.
Net cash used in operating activities for the six months ended June 30,
1999 was attributable primarily to our net loss of approximately $23.0 million,
increases in trade accounts receivable of $6.3 million and inventories of $2.0
million partially offset by amortization of compensation of $15.6 million,
increases in deferred revenue of $3.2 million and increases in accounts payable
and accrued liabilities of $3.9 million. The increase in inventory was primarily
in anticipation of expected growth in product revenue as well as a greater need
for evaluation units. The increase in accounts receivable was primarily the
result of increased sales of which a significant portion occurred during the
last month of the period. Deferred revenue increased due to increased sales of
maintenance and support contracts as well as to account for product shipments
with contingencies that have yet to be satisfied.
11
<PAGE>
CLARENT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For 1998, cash used in operating activities was attributable primarily to a
net loss of approximately $1.6 million, and increases in trade accounts
receivable of $3.1 million and inventories of $853,000. The cash used in
operating activities was offset in part by increases in accounts payable and
accrued liabilities of approximately $837,000 and an increase in deferred
revenue of approximately $2.3 million. All of these increases were primarily the
result of higher sales as compared to 1997. The increase in inventory was in
anticipation of continued growth in product revenue.
Net cash used in investing activities was $3.7 million for the six months
ended June 30, 1999 and $390,000 for the six months ended June 30, 1998. For
each of these periods, cash used in investing activities was attributable to
purchases of property and equipment.
Net cash provided by financing activities was $4.4 million for the six
months ended June 30, 1999 and $9.1 million for the six months ended June 30,
1998. For 1999, cash provided by financing activities was attributable primarily
to $2.8 million from our line of credit, $1.2 million from our equipment term
loan facility and $377,000 from the issuance of our stock. In 1998, cash
provided by financing activities included $7.1 million in proceeds from the
issuance of preferred stock and $2.6 million received from the issuance of
bridge notes convertible into Series C preferred stock partially offset by
$550,000 in repayment of those bridge notes.
As of June 30, 1999, our principal commitments consisted of obligations
outstanding under operating leases. Although we have no material commitments for
capital expenditures, we anticipate a substantial increase in capital
expenditures and lease commitments consistent with our anticipated growth in
operations, infrastructure and personnel. We also may establish additional
operations as we expand globally.
At June 30, 1999 we had a line of credit for $7.0 million with a financial
institution and an additional $3.0 million equipment term loan facility.
Borrowings under this agreement are limited to our eligible receivable base and
eligible inventory. The terms of the line of credit agreement establish
affirmative and negative covenants, under which we must maintain certain
financial ratios and reporting practices. As of June 30, 1999, $5.3 million was
outstanding under this line of credit and $1.2 million was outstanding under the
equipment term loan facility. At June 30, 1999, we had no additional
availability under our line of credit and $1.8 million unused under our
equipment term loan facility.
We believe that the net proceeds from the initial public offering, together
with our current cash, cash equivalents and borrowing capacity will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 12 months. Thereafter, if cash generated from
operations is insufficient to satisfy our liquidity requirements, we may seek to
sell additional equity or debt securities or increase the available borrowings
under our line of credit. If additional funds are raised through the issuance of
debt securities, these securities could have rights, preferences and privileges
senior to holders of common stock, and the term of this debt could impose
restrictions on our operations. The sale of additional equity or convertible
debt securities could result in additional dilution to our stockholders, and we
cannot be certain that additional financing will be available in amounts or on
terms acceptable to us, if at all.
Year 2000 Compliance
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. As a result, software
that records only the last two digits of the calendar year may not be able to
distinguish between 20th and 21st century dates. This may result in software
failures or the creation of erroneous results.
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CLARENT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
We have conducted the first phases of a Year 2000 readiness review for the
prior and current versions of our products. The review includes assessment,
implementation, including remediation, modifications, where necessary, of
current product versions, validation testing and contingency planning. We
continue to respond to customer questions about prior versions of our products
on a case-by-case basis.
We have largely completed all phases of this plan, except for contingency
planning, for the prior and current versions of our products. As a result, all
current versions of our products are "Year 2000 compliant," as defined below,
when configured and used in accordance with the related documentation, and
provided that the underlying operating system of the computer on which our
products run and any other software used with or in the computer on which our
products run are also Year 2000 compliant. We are also are supplying our
customers who use prior versions of our products with software updates for the
third party supplied software components of our products to make those versions
Year 2000 compliant. We have not tested our products on all platforms or all
versions of operating systems that we currently support.
We define "Year 2000 compliant" as the ability to:
. correctly handle date information needed for the December 31, 1999 to
January 1, 2000 date change;
. function according to the product documentation provided for this date
change, without changes in operation resulting from the advent of a
new century, assuming correct configuration;
. where appropriate, respond to two-digit date input in a way that
resolves the ambiguity as to century in a disclosed, defined and
predetermined manner;
. if the date elements in interfaces and data storage specify the
century, store and provide output of date information in ways that are
unambiguous as to century; and
. recognize the year 2000 as a leap year.
We have tested software obtained from third parties that is incorporated
into our products, and we are seeking assurances from our vendors that licensed
software is Year 2000 compliant. Despite testing by us and by current and
potential clients, and assurances from developers of products incorporated into
our products, our products may contain undetected errors or defects associated
with Year 2000 date functions. Known or unknown errors or defects in our
products could result in delay or loss of revenue, diversion of development
resources, damage to our reputation, or increased service and warranty costs,
any of which could materially adversely affect our business, operating results
or financial condition. Some industry analysts have predicted significant
litigation regarding Year 2000 compliance issues, and we are aware of such
lawsuits against other software vendors. Because of the unprecedented nature of
such litigation, it is uncertain whether or to what extent we may be affected by
it.
Our internal systems include both our information technology, or IT, and
non-IT systems. We have initiated an assessment of our material internal IT
systems, including both our own software products and third-party software and
hardware technology, but we have not initiated an assessment of our non-IT
systems. We expect to complete testing of our IT systems in the third quarter of
1999. If our IT systems are not Year 2000 compliant, we may not have allowed
sufficient time for remediation of any deficiencies. To the extent that we are
not able to test the technology provided by third-party vendors, we are seeking
assurances from vendors that their systems are Year 2000 compliant. We have
completed our initial inventory/assessments of our non-IT systems and the
inventory/assessment of licensed software included in our products and have
confirmed that the licensed software that we incorporate in our products is Year
2000 compliant. This confirmation has been achieved through a combination of
internal testing, vendor Year
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
2000 Readiness Disclosures, and an ongoing certification program addressing all
of our suppliers and vendors.
We are not currently aware of any material operational issues or costs
associated with preparing our internal IT and non-IT systems for the Year 2000.
Our costs incurred through June 30,1999 have totaled less than $100,000. We
expect to incur less than $200,000 in costs to complete our Year 2000 compliance
efforts. However, we may experience material unanticipated problems and costs
caused by undetected errors or defects in the technology used in our internal IT
and non-IT systems.
We do not currently have any information concerning the Year 2000
compliance status of our customers. If our current or future customers fail to
achieve Year 2000 compliance or if they divert technology expenditures to
address Year 2000 compliance problems, our business could suffer.
We have funded our Year 2000 plan from available cash and have not
separately accounted for these costs in the past. To date, these costs have not
been material. We expect to incur additional costs related to the Year 2000 plan
for administrative personnel to manage the project, outside contractor
assistance, technical support for our products, product engineering and customer
satisfaction. In addition, we may experience material problems and costs with
Year 2000 compliance that could adversely affect our business, results of
operations, and financial condition.
We have not yet developed a contingency plan to address situations that may
result if we are unable to achieve Year 2000 readiness of our critical
operations. However, we have appointed a cross-functional group to develop our
plan by the end of third quarter 1999. The overall cost of developing and
implementing our plan may be material. Finally, we are also subject to external
forces that might generally affect industry and commerce, such as utility or
transportation company Year 2000 compliance failures and related service
interruptions.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Financial Market Risk
Our financial market risk includes risks associated with international
operations and related foreign currencies. We anticipate that international
sales will continue to account for a significant portion of our consolidated
revenue. Our international sales are currently denominated in U.S. dollars and
therefore are not subject to foreign currency exchange risk. Expenses of our
international operations are denominated in each country's local currency and
therefore are subject to foreign currency exchange risk; however, through June
30, 1999, we have not experienced any significant negative impact on our
operations as a result of fluctuations in foreign currency exchange rates.
We also have financial market risk on the interest rate associated with our
short term debt. At June 30, 1999, we believe that our financial market risk
related to this debt was immaterial.
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CLARENT CORPORATION
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
RISK FACTORS WHICH MAY IMPACT FUTURE OPERATING RESULTS
Factors that have affected our results of operations in the past, and are
likely to affect our results of operations in the future, include the following:
We have a limited operating history, which makes it difficult to evaluate our
prospects.
We are an early-stage company in the emerging IP telephony market. We were
founded in July 1996 and have not generated significant revenue to date. Because
of our limited operating history, we have limited insight into trends that may
emerge in our market and affect our business. The revenue and income potential
of the IP telephony market, and our business in particular, are unproven. As a
result of our limited operating history, we have limited financial data that you
can use to evaluate our business. You must consider our prospects in light of
the risks, expenses and challenges we might encounter because we are at an early
stage of development in a new and rapidly evolving market.
Unless we generate significant revenue growth, our increasing expenses and
negative cash flow will significantly harm our financial position.
As of June 30, 1999, we had an accumulated deficit of $31.2 million. We
expect to incur operating losses for the foreseeable future, and these losses
may be substantial. Further, we expect to incur negative operating cash flow in
the future. We expect to continue to increase capital expenditures and our
research and development, sales and marketing and general and administrative
expenses. We will need to generate significant revenue growth to achieve
profitability and positive operating cash flow. Even if we do achieve
profitability and positive operating cash flow, we may not be able to sustain or
increase profitability or positive operating cash flow on a quarterly or annual
basis.
We have experienced operating losses in each quarterly and annual period
since inception. The following table shows our operating losses for the periods
indicated:
Period Operating Loss
------ --------------
July 2, 1996 (inception) to December 31, 1996................ $ (276,000)
Year ended December 31, 1997................................. (2,129,000)
Year ended December 31, 1998................................. (5,824,000)
Six months ended June 30, 1999............................... (22,885,000)
Our operating results are volatile, and an unanticipated decline in revenue may
disproportionately affect our net income or loss in a quarter.
Our quarterly and annual operating results have varied significantly in
the past and will likely vary significantly in the future. As a result, our
future operating results are difficult to predict. Further, we incur expenses in
significant part on our expectations of our future revenue. As a result, we
expect our expense levels to be relatively fixed in the short run. Therefore, an
unanticipated decline in revenue for a particular quarter may disproportionately
affect our net income (loss) in that quarter.
Any of the above factors could harm our business, financial condition and
results of operations. We believe that period-to-period comparisons of our
results of operations are not meaningful, and you should not rely upon them as
indicators of our future performance.
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QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
If we do not reduce costs, introduce new products or increase sales volume, our
gross margin may decline.
We have experienced significant erosion in the average selling prices of
our products due to a number of factors, including competitive pricing
pressures, rapid technological change and sales discounts. We anticipate that
the average selling prices of our products will decrease and fluctuate in the
future in response to the same factors. Therefore, to maintain or increase our
gross margin, we must develop and introduce new products and product
enhancements on a timely basis. We must also continually reduce our costs of
production. As our average selling prices decline, we must increase our unit
sales volume to maintain or increase our revenue. To date, the erosion in the
average selling prices has not had a material affect on our business. However,
we cannot be certain that the erosion in the average selling prices will not
affect our business in the future. If our average selling prices decline more
rapidly than our costs of production, our gross margin will decline, which could
seriously harm our business, financial condition and results of operations.
Our markets are highly competitive, and we cannot assure you that we will be
able to compete effectively.
We compete in a new, rapidly evolving and highly competitive and fragmented
market. We expect competition to intensify in the future. We cannot assure you
that we will be able to compete effectively. We believe that the main
competitive factors in our market are product quality, features, cost and
customer relationships. Our current principal competitors include 3Com
Corporation, Cisco Systems, Inc., Lucent Technologies Inc., Nortel Networks
Corporation and VocalTec Communications, Ltd. We also expect that other
companies may enter our market with better products and technologies.
We expect our competitors to continue to improve the performance of their
current products and introduce new products or new technologies. To be
competitive, we must continue to invest significant resources in research and
development, sales, marketing and customer support. We cannot be sure that we
will have sufficient resources to make these investments or that we will be able
to make the technological advances necessary to be competitive. Increased
competition is likely to result in price reductions, reduced gross margin and
loss of market share. Our failure to compete successfully against current or
future competitors could seriously harm our business, financial condition and
results of operations.
Our future ability to generate sales depends on the interoperability of our
products with those of other vendors.
While our products currently connect to the traditional system using
standard interfaces, an increasing number of our customers have requested that
our products interoperate with competing IP telephony products from other
vendors. The interoperability standards for IP telephony equipment are evolving.
If we are unable to provide our customers interoperable solutions, they may seek
vendors who provide product interoperability. This could seriously harm our
business, financial condition and results of operations.
If we lose key personnel, we may not be able to successfully operate our
business.
Our future success depends, in large part, on our ability to attract and
retain highly skilled personnel. The loss of the services of any of our key
personnel, the inability to attract or retain qualified personnel in the future
or delays in hiring required personnel, particularly engineers, sales personnel
and marketing personnel, may seriously harm our business, financial condition
and results of operations. We will need to expand our sales operations and
marketing operations in order to increase market awareness of our products and
generate increased revenue. New sales personnel and marketing personnel will
require training and take time to achieve full productivity. In addition, the
design and installation of IP telephony solutions can be complex. Accordingly,
we need highly trained professional services and customer support personnel. We
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QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
currently have a small professional services and customer support organization
and will need to increase our staff to support new customers and the expanding
needs of existing customers. Competition for personnel is intense, especially in
the San Francisco Bay Area where we maintain our headquarters. We cannot be
certain that we will successfully attract and retain additional qualified
personnel. In addition, our key person life insurance policy, covering some of
our key employees, may be insufficient to cover the costs associated with the
loss of one of these employees.
Our failure to manage our rapid growth effectively could negatively affect our
results of operations.
Since we began commercial shipment of our products in March 1997, we have
experienced a period of rapid growth and expansion that is significantly
straining all of our resources. From September 30, 1998 to June 30, 1999, the
number of our employees increased from approximately 70 to 200. We expect our
anticipated growth and expansion to continue to place strain on our management,
operational and financial resources. Our inability to manage growth effectively
could seriously harm our business, financial condition and results of
operations. We may not be able to install adequate control systems in an
efficient and timely manner, and our current or planned operational systems,
procedures and controls may not be adequate to support our future operations.
Delays in the implementation of new systems or operational disruptions when we
transition to new systems would impair our ability to accurately forecast sales
demand, manage our product inventory and record and report financial and
management information on a timely and accurate basis.
The IP telephony alternative may not achieve widespread acceptance, which could
cause our business to fail.
The IP telephony market is relatively new and evolving rapidly. Less than
1% of all voice calls worldwide are currently transmitted over IP-based data
networks. Our ability to increase revenue in the future depends on some of both
existing and future circuit-switched telephone network calls moving to IP-based
data networks. The use of IP telephony for voice calls might be hindered by the:
. reluctance of service providers that have invested substantial
resources in the existing telephone network infrastructure to replace
or expand their current networks with this new technology; and
. lack of partnerships between service providers, keeping them from
having global IP telephony network coverage.
Accordingly, in order to achieve commercial acceptance, we will have to
educate prospective customers, including large, established telecommunications
companies, about the benefits and uses of IP telephony solutions in general, our
products in particular, and the need to partner with other IP telephony service
providers to extend the coverage of their networks. If these efforts fail or if
IP telephony does not achieve commercial acceptance, our business, financial
condition and results of operations could be seriously harmed.
Our inability to introduce new products and product enhancements could prevent
us from increasing revenue.
We expect that the IP telephony market will be characterized by rapid
technological change. We also expect that the increased use of IP telephony will
require us to rapidly evolve and adapt our products to remain competitive. The
successful operation of our business depends on our ability to develop and
introduce new products and product enhancements that respond to technological
changes or evolving industry standards on a timely and cost-effective basis. We
cannot be certain that we will successfully develop and market these types of
products and product enhancements. Our failure to produce technologically
competitive products in a cost-effective manner and on a timely basis will
seriously harm our business, financial condition and results of operations.
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CLARENT CORPORATION
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
Future regulation or legislation could restrict our business or increase our
cost of doing business.
At present there are few laws or regulations that specifically address
access to or commerce on the Internet, including IP telephony. We are unable to
predict the impact, if any, that future legislation, legal decisions or
regulations concerning the Internet may have on our business, financial
condition and results of operations. Regulation may be targeted towards, among
other things, assessing access or settlement charges, imposing tariffs or
imposing regulations based on encryption concerns or the characteristics and
quality of products and services, which could restrict our business or increase
our cost of doing business. The increasing growth of the IP telephony market and
popularity of IP telephony products and services heighten the risk that
governments will seek to regulate IP telephony and the Internet. In addition,
large, established telecommunications companies may devote substantial lobbying
efforts to influence the regulation of the IP telephony market, which may be
contrary to our interests.
We depend on new entrants in the service provider market to generate a portion
of our revenue and our operating results may be harmed if these new entrants are
not commercially viable.
We expect to generate a portion of our revenue from new entrants in the
telecommunications service provider market. Failure to generate revenue from
these new entrants could have a negative impact on our business. Examples of
these service providers include traditional, local, international and wholesale
long distance companies, competitive local exchange carriers and Internet
telephony service providers. Many of these new entrants are still building their
infrastructures and rolling out their services. We cannot guarantee that any of
these companies will achieve commercial viability. Given that these new entrants
may be start-up operations with uncertain financial resources, we cannot be sure
that these new entrants will be able to pay their obligations to us for purchase
of our products on a timely basis, or at all. Some of our new entrant customers
have been late in making payments to us. To date, late payments from our
customers have not significantly impacted our operations. However, we cannot be
certain that late payments from our customers will not impact our operations in
the future. The failure of these companies to achieve commercial viability or
pay their obligations to us would, in turn, seriously harm our business,
financial condition and results of operations.
A loss of one or more of our key customers could cause a significant decrease in
our net revenue.
We have historically derived the majority of our revenue from a small
number of customers, particularly various entities within AT&T. In 1998 entities
affiliated with AT&T Corporation accounted for 36% and Technet International
accounted for 12% of our net revenue. In the first half of 1999, entities
affiliated with AT&T Corporation accounted for 20%, Technet International
accounted for 15%, and JiTong and affiliates accounted for 23% of our net
revenue. None of our customers is obligated to purchase additional products or
services. Accordingly, we cannot be certain that present or future customers
will not terminate their purchasing arrangements with us or significantly reduce
or delay their orders. Any termination, change, reduction or delay in orders
could seriously harm our business, financial condition and results of
operations.
We may not be able to expand our direct sales and distribution channels, which
would harm our ability to generate revenue.
We believe that our future success is dependent upon our ability to expand
our direct sales force and establish successful relationships with a variety of
international distribution partners. To date, we have entered into agreements
with only a small number of distribution partners that accounted for
approximately 18% of net revenue for 1998 and 11% of net revenue for the first
half of 1999. These distribution agreements typically may be terminated without
cause upon 90 days notice. 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 these
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DISCLOSURES ABOUT MARKET RISK
distribution partners will devote adequate resources to marketing, selling and
supporting our products. We must successfully manage our distributor
relationships. We cannot guarantee that we will successfully manage our
distributor relationships in the future. Our inability to generate revenue from
distribution partners may harm our business, financial condition and results of
operations.
Sales to customers based outside the United States have historically accounted
for a significant portion of our revenue, which exposes us to risks inherent in
international operations.
International sales represented approximately 94% of net revenue in 1997,
48% in 1998 and 52% in the first half of 1999. Our international operations are
subject to a variety of risks associated with conducting business
internationally any of which could seriously harm our business, financial
condition and results of operations. These risks include:
. greater difficulty in accounts receivable collections;
. import or export licensing and product certification requirements;
. tariffs, duties, price controls or other restrictions on foreign
currencies or trade barriers imposed by foreign countries;
. potential adverse tax consequences, including restrictions on
repatriation of earnings;
. fluctuations in currency exchange rates;
. seasonal reductions in business activity in some parts of the world;
. unexpected changes in regulatory requirements;
. burdens of complying with a wide variety of foreign laws, particularly
with respect to intellectual property and license requirements;
. difficulties and costs of staffing and managing foreign operations;
. political instability;
. the impact of recessions in economies outside of the United States;
and
. limited ability to enforce agreements, intellectual property and other
rights in some foreign countries.
We may not be able to expand our international operations, which would reduce
our ability to increase revenue.
We currently have offices in Belgium, Germany, Japan, the People's Republic
of China, South Korea, Spain, Taiwan and the United Kingdom. We intend to expand
the scope of our international operations, which will require us to enhance our
communications infrastructure and may include the establishment of overseas
assembly operations. If we are unable to expand our international operations
effectively and quickly, we may be unable to successfully market, sell, deliver
and support our products internationally.
Our sales cycle is typically long and unpredictable, causing us to incur
expenditures prior to the receipt of orders.
We incur research and development, and sales and marketing, including
customer support, expenditures prior to receiving orders for our products from
any given customer. The length of the sales cycle with a particular customer is
influenced by a number of factors, including:
. a customer's experience with sophisticated telecommunications
equipment, such as our product;
. the particular telecommunications market that the customer serves; and
. the cost of purchasing our product, including the cost of converting
from installed equipment, which may be significant.
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CLARENT CORPORATION
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
Before we receive orders, our customers typically test and evaluate our products
for a period of months or, in some cases, over a year.
We cannot be certain that the sales cycle for our products will not
lengthen in the future. In addition, the emerging and evolving nature of the IP
telephony market may cause prospective customers to delay their purchase
decisions as they evaluate new technologies and develop and implement new
systems. As the average order size for our products grows, the process for
approving purchases is likely to become more complex, leading to potential
delays in receipt of these orders. As a result, our long and unpredictable sales
cycle contributes to the uncertainty of our future operating results.
Delays in customer orders could have a negative impact on our results of
operations for any given quarter.
We have historically received a significant portion of our product orders
near the end of a quarter. Accordingly, a delay in an anticipated receipt or
delivery of a given order past the end of a particular quarter may negatively
impact our results of operations for that quarter. These delays may become more
likely given that we expect that the average size of our customer orders may
increase. As a result, a delay in the recognition of revenue, even from just one
customer, may have a significant negative impact on our results of operations
for a given period. Any delay in sales of our products could result in a
significant decrease in cash flow, which, in turn, could severely affect our
ability to make payments as they come due and could cause our operating results
to vary significantly from quarter to quarter.
We may not be able to raise capital as needed to maintain our operations.
We believe that the net proceeds from our initial public offering, together
with our current cash, cash equivalents and borrowing capacity will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 12 months. After that, we may need to raise
additional funds, and additional financing may not be available on favorable
terms, if at all. We may also require additional capital to acquire or invest in
complementary businesses or products or obtain the right to use complementary
technologies. If we cannot raise needed funds on acceptable terms, we may not be
able to develop or enhance our products, take advantage of future opportunities
or respond to competitive pressures or unanticipated requirements, which could
seriously harm our business, financial condition and results of operations. If
we issue additional equity securities to raise funds, the ownership percentage
of our existing stockholders would be reduced. New investors may demand rights,
preferences or privileges senior to those of existing holders of our common
stock.
Our dependence on independent manufacturers may result in product delivery
delays.
We license technology that is incorporated into our products from
independent manufacturers, including AudioCodes, Ltd. and Natural Microsystems.
If these vendors fail to supply us with their components on a timely basis, we
could experience significant delays in shipping our products. Although we
believe there are other sources for this licensed technology, any significant
interruption in the supply or support of any licensed technology could seriously
harm our sales, unless and until we can replace the functionality provided by
this licensed technology. Also, because our products incorporate software
developed and maintained by third parties, we depend on these third parties to
deliver reliable products, support these products, enhance their current
products, develop new products on a timely and cost-effective basis, and respond
to emerging industry standards and other technological changes. The failure of
these third parties to meet these criteria could seriously harm our business,
financial condition and results of operations.
Our business could be harmed if we are unable to forecast our inventory needs
accurately.
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QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
Lead times for materials and components used in the assembly of our
products vary significantly. If orders do not match forecasts, we may have
excess or inadequate inventory of some materials and components.
Our strategy to outsource assembly and test functions in the future could delay
our ability to deliver our products on a timely basis.
We assemble and test our products at our facility in Redwood City,
California. Based on volume or customer requirements, we may begin outsourcing
some of our assembly and test functions. This outsourcing strategy involves
risks, including the potential absence of adequate capacity and reduced control
over delivery schedules, manufacturing yields, quality and costs. In the event
that any significant subcontractor were to become unable or unwilling to
continue to manufacture and/or test our products in the required volumes, we
would have to identify and qualify acceptable replacements. This process could
be lengthy, and we cannot be sure that additional sources would be available to
us on a timely basis. Any delay or increase in costs in the assembly and testing
of products by third-party subcontractors, could seriously harm our business,
financial condition and results of operations.
Our facilities are vulnerable to damage from earthquakes and other natural
disasters.
Our assembly facilities are located on or near known earthquake fault zones
and are vulnerable to damage from fire, floods, earthquakes, power loss,
telecommunications failures and similar events. If such a disaster occurs while
we still assemble our products in-house, our ability to assemble, test and ship
our products would be seriously, if not completely, impaired, which would
seriously harm our business, financial condition and results of operations. We
cannot be sure that the insurance we maintain against fires, floods, earthquakes
and general business interruptions will be adequate to cover our losses in any
particular case.
Fluctuations in the values of foreign currencies could have a negative impact on
our profitability.
Due to our international operations, we incur expenses in a number of
currencies. We do not currently engage in currency hedging activities to limit
the risks of exchange rate fluctuations. Therefore, fluctuations in the value of
foreign currencies could have a negative impact on the profitability of our
global operations, which would seriously harm our business, financial condition
and results of operations. All of our sales, including international sales are
currently denominated in U.S. dollars. However, we do not expect that future
international sales will continue to be denominated in U.S. dollars.
Fluctuations in the value of the U.S. dollar and foreign currencies may make our
products more expensive than local product offerings.
Defects in our products may seriously harm our credibility and harm our
business.
We have detected and may continue to detect errors and product defects in
connection with new product releases and product upgrades. These problems may
affect network uptime and cause us to incur significant warranty and repair
costs and cause significant customer relations problems. Service providers
require a strict level of quality and reliability from telecommunications
equipment suppliers. Traditional telecommunications equipment is expected to
provide a 99.999% level of reliability. IP telephony products are inherently
complex and frequently contain undetected software or hardware errors when first
introduced or as new versions are released. In addition, the detection of errors
in software products requires an unknown level of effort to correct and may
delay the release of new products or upgrades or revisions to existing products,
which could materially affect the market acceptance and sales of our products.
If we deliver products or upgrades with undetected material software errors or
product defects, our credibility and market acceptance and sales of our products
may be harmed. In some of our contracts, we have agreed to indemnify our
customers against certain liabilities arising from defects in our products.
While we carry insurance policies covering this type of liability, these
policies may not provide sufficient protection should
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a claim be asserted. To date, product defects have not had a material negative
affect on our results of operations. However, we cannot be certain that product
defects will not have a material negative affect on our results of operations in
the future. A material product liability claim may have significant consequences
on our ability to compete effectively and generate positive cash flow and may
seriously harm our business, financial condition and results of operations.
We may have difficulty identifying the source of the problem when there is a
problem in a network.
Our products must successfully integrate with products from other vendors,
such as traditional telephone systems. As a result, when problems occur in a
network, it may be difficult to identify the source of the problem. The
occurrence of hardware and software errors, whether caused by our products or
another vendor's products, may result in the delay or loss of market acceptance
of our products and any necessary revisions may force us to incur significant
expenses. The occurrence of some of these types of problems may seriously harm
our business, financial condition and results of operations.
We may not have adequate protection for our intellectual property, which may
make it easier for others to sell competing products.
We rely on a combination of copyright, trademark and trade secret laws and
restrictions on disclosure to protect our intellectual property rights. Despite
our efforts to protect our proprietary rights, unauthorized parties may attempt
to copy or otherwise obtain and use our products or technology. Monitoring
unauthorized use of our products is difficult, and we cannot be certain that the
steps we have taken will prevent misappropriation of our technology. The laws of
some foreign countries do not protect our proprietary rights to as great an
extent as the laws of the United States, and many United States companies have
encountered substantial infringement problems in these countries, some of which
are countries in which we have sold and continue to sell products. If we fail to
adequately protect our intellectual property rights, it would be easier for our
competitors to sell competing products.
Our products may infringe on the intellectual property rights of third parties,
which may result in lawsuits and prohibit us from selling our products.
We believe there is a risk that third parties have filed, or will file
applications for, or have received or will receive, patents or obtain additional
intellectual property rights relating to materials or processes that we use or
propose to use. As a result, from time to time, third parties may assert
exclusive patent, copyright, trademark and other intellectual property rights to
technologies that are important to us. In addition, third parties may assert
claims or initiate litigation against us or our manufacturers, suppliers or
customers with respect to existing or future products, trademarks or other
proprietary rights. Any claims against us or customers that we indemnify against
intellectual property claims, with or without merit, may be time- consuming,
result in costly litigation and diversion of technical and management personnel
or require us to develop non-infringing technology. If a claim is successful, we
may be required to obtain a license or royalty agreement under the intellectual
property rights of those parties claiming the infringement. If we are unable to
obtain the license, we may be unable to market our products. Limitations on our
ability to market our products and delays and costs associated with monetary
damages and redesigns in compliance with an adverse judgment or settlement could
harm our business, financial condition and results of operations.
Our failure and the failure of our key suppliers and customers to be Year 2000
compliant may negatively impact our business and results of operations.
The Year 2000 computer issue creates a significant risk for us in at least
four areas:
. potential warranty or other claims arising from our products for
failure to be Year 2000 compliant;
22
<PAGE>
CLARENT CORPORATION
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
. systems we use to run our business may fail or produce inaccurate
results;
. systems used by our suppliers may fail or produce inaccurate results,
causing operational difficulties for us; and
. potential customers may reduce spending on IP telephony products as a
result of significant information systems spending on Year 2000
remediation or to limit additional changes to their networks during
the current year.
If any of these risks materialize, it may seriously harm our business,
financial condition and results of operations.
We may in the future be the target of securities class action litigation, which
could be costly and time consuming to defend.
In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. We may in the future be the target of similar litigation. Securities
litigation may result in substantial costs and divert management's attention and
resources, which may seriously harm our business, financial condition and
results of operations.
Our certificate of incorporation and bylaws and Delaware law contain provisions
that could delay or prevent a change of control of Clarent.
Certain provisions of our certificate of incorporation and bylaws and
Delaware law may discourage, delay or prevent a merger or acquisition that a
stockholder may consider favorable. These provisions include:
. authorizing the board of directors to issue additional preferred
stock;
. prohibiting cumulative voting in the election of directors;
. limiting the persons who may call special meetings of stockholders;
. prohibiting stockholder action by written consent; and
. establishing advance notice requirements for nominations for election
of the board of directors or for proposing matters that can be acted
on by stockholders at stockholder meetings.
We are also subject to certain provisions of Delaware law which could
delay, deter or prevent us from entering into an acquisition, including Section
203 of the Delaware General Corporation Law, which prohibits a Delaware
corporation from engaging in a business combination with an interested
stockholder unless specific conditions are met.
23
<PAGE>
CLARENT CORPORATION
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
Our Registration Statement on Form S-1 (Registration No. 333-76051) under
the Securities Act of 1933, as amended, for the initial public offering became
effective on June 30, 1999. In the offering, we sold an aggregate of 4,600,000
shares of our common stock for an initial price of $15.00 per share, including
600,000 shares pursuant to the exercise of the underwriters' over-allotment
option. The net proceeds from the offering were approximately $62 million. We
intend to use the proceeds of the offering primarily for additional working
capital and other general corporate purposes, including increased research and
development expenditures, sales and marketing expenditures, and general and
administrative expenditures.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
By written consent dated as of June 22, 1999 the Company's stockholders
approved the following proposals:
. A proposal to approve the Company's reincorporation in the State of
Delaware;
. A proposal to approve amendment of the Company's Certificate of
Incorporation to effect a two-for-one stock split of the Company's
common stock immediately prior to the initial public offering and to
amend the authorized capital of the Company to consist of 50,000,000
shares of common stock and 5,000,000 of preferred stock at the closing
of the initial public offering;
. A proposal to approve amendment and restatement of the Company's 1996
Stock Option Plan as the 1999 Amended and Restated Equity Incentive
Plan;
. A proposal to approve the adoption of the 1999 Non-Employee Directors'
Stock Option Plan and the 1999 Employee Stock Purchase Plan;
. A proposal to approve the increase in the authorized number of
directors from four to five; and
. A proposal to approve the form of Indemnity Agreement for use as an
agreement between the Company and each of its executive officers and
directors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The following exhibits are filed as part of this Form 10-Q:
(a) Exhibit 27.1 Financial Data Schedule
(d) Reports on Form 8-K - None
24
<PAGE>
CLARENT CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CLARENT CORPORATION
By /s/ Jerry Shaw-Yau Chang
-----------------------------
Jerry Shaw-Yau Chang
Chief Executive Officer,
President and Director
By /s/ Richard J. Heaps
-----------------------------
Richard J. Heaps
Chief Operating Officer and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: August 16, 1999
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CLARENT
CORPORATION CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED) FOR JUNE 30, 1999
AND CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) FOR THE SIX MONTHS
ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 4,273
<SECURITIES> 0
<RECEIVABLES> 14,671
<ALLOWANCES> 1,444
<INVENTORY> 5,578
<CURRENT-ASSETS> 23,807
<PP&E> 6,580
<DEPRECIATION> 1,476
<TOTAL-ASSETS> 29,307
<CURRENT-LIABILITIES> 21,968
<BONDS> 0
0
21,356
<COMMON> 26,381
<OTHER-SE> (40,973)
<TOTAL-LIABILITY-AND-EQUITY> 29,307
<SALES> 16,018
<TOTAL-REVENUES> 16,018
<CGS> 7,427
<TOTAL-COSTS> 7,427
<OTHER-EXPENSES> 31,476
<LOSS-PROVISION> 638
<INTEREST-EXPENSE> 147
<INCOME-PRETAX> (23,032)
<INCOME-TAX> 11
<INCOME-CONTINUING> (23,043)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (23,043)
<EPS-BASIC> 3.87
<EPS-DILUTED> 3.87
</TABLE>
