<PAGE>
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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, 2000
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 000-26441
Clarent Corporation
(Exact name of registrant as specified in its charter)
Delaware 77-0433687
(I.R.S. Employer Identification No.)
(State or other jurisdiction of
incorporation or organization)
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 33,332,922 at June 30, 2000.
This report consists of 26 pages of which this page is number 1.
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<PAGE>
CLARENT CORPORATION
FORM 10-Q INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Part I: Financial Information
Item 1: Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of June 30, 2000 and
December 31, 1999.................................................. 3
Condensed Consolidated Statements of Operations for the Three and
Six Month Periods Ended June 30, 2000 and 1999..................... 4
Condensed Consolidated Statement of Cash Flows for the Six Month
Periods ended June 30, 2000 and 1999............................... 5
Notes to Unaudited Condensed Consolidated Financial Statements...... 6
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ 11
Item 3: Quantitative and Qualitative Disclosures About Market Risk.... 15
Part II: Other Information
Item 4: Submission of Matters to a Vote of Securities Holders......... 26
Item 5: Other Information............................................. 26
Item 6: Exhibits and Reports on Form 8-K.............................. 27
Signatures............................................................ 28
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
----------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................ $199,157 $238,724
Short-term investments............................... 77,017 42,581
Accounts receivable, net............................. 29,102 24,218
Inventories.......................................... 14,604 8,404
Prepaid expenses and other current assets............ 2,888 2,826
-------- --------
Total current assets............................... 322,768 316,753
Property and equipment, net............................ 17,591 12,696
Other assets........................................... 9,367 5,919
-------- --------
$349,726 $335,368
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................................... $ 15,402 $ 8,552
Deferred revenue..................................... 11,032 10,117
Other accrued liabilities............................ 9,806 7,857
-------- --------
Total current liabilities.......................... 36,240 26,526
Stockholders' equity:
Common stock......................................... 356,766 353,894
Deferred compensation................................ (3,680) (5,990)
Accumulated other comprehensive loss................. (162) (112)
Accumulated deficit.................................. (39,438) (38,950)
-------- --------
Total stockholders' equity......................... 313,486 308,842
-------- --------
$349,726 $335,368
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended Six Months Ended
June 30, June 30,
----------------- -----------------
2000 1999 2000 1999
------- -------- ------- --------
<S> <C> <C> <C> <C>
Revenue:
Product and software.................. $25,255 $ 8,486 $47,333 $ 14,614
Service............................... 3,058 818 5,563 1,404
------- -------- ------- --------
Total revenue....................... 28,313 9,304 52,896 16,018
Cost of revenue:
Product and software.................. 9,020 3,424 17,331 6,210
Service............................... 2,080 722 3,718 1,217
------- -------- ------- --------
Total cost of revenue............... 11,100 4,146 21,049 7,427
Gross profit............................ 17,213 5,158 31,847 8,591
------- -------- ------- --------
Operating expenses:
Research and development.............. 5,566 1,991 9,906 3,557
Sales and marketing................... 11,819 5,623 22,874 9,648
General and administrative............ 2,583 1,272 5,024 2,629
Amortization of compensation.......... 932 13,662 2,310 15,642
Amortization of goodwill.............. 225 -- 451 --
------- -------- ------- --------
Total operating expenses............ 21,125 22,548 40,565 31,476
------- -------- ------- --------
Loss from operations.................... (3,912) (17,390) (8,718) (22,885)
Other income (expense).................. 4,399 (163) 8,514 (147)
------- -------- ------- --------
Income (loss) before provision for
income taxes........................... 487 (17,553) (204) (23,032)
Provision for income taxes.............. (259) (11) (284) (11)
------- -------- ------- --------
Net income (loss)....................... $ 228 $(17,564) $ (488) $(23,043)
------- -------- ------- --------
Basic and diluted net income (loss) per
share.................................. $ 0.01 $ (2.73) $ (0.02) $ (3.87)
======= ======== ======= ========
Shares used in computing basic net
income (loss) per share................ 32,934 6,429 32,174 5,951
======= ======== ======= ========
Shares used in computing diluted net
income (loss) per share................ 38,166 6,429 32,174 5,951
======= ======== ======= ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
------------------
2000 1999
-------- --------
<S> <C> <C>
Operating activities:
Net loss................................................. $ (488) $(23,043)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation........................................... 3,481 869
Amortization of compensation........................... 2,310 15,642
Amortization of goodwill............................... 451 --
Changes in operating assets and liabilities:
Accounts receivable.................................. (6,384) (6,284)
Inventories.......................................... (6,200) (1,958)
Prepaid expenses and other current assets............ (62) (251)
Other assets......................................... (1,645) (396)
Accounts payable and accrued liabilities............. 8,799 3,905
Deferred revenue..................................... 915 3,223
-------- --------
Net cash provided by (used in) operating activities.... 1,177 (8,293)
-------- --------
Investing activities:
Purchases of investment securities....................... (80,836) --
Sales and maturities of investment securities............ 45,609 --
Purchases of property and equipment...................... (8,443) (3,740)
-------- --------
Net cash used in investing activities...................... (43,670) (3,740)
-------- --------
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
Proceeds from issuance of common stock................... 2,872 45
-------- --------
Net cash provided by financing activities.................. 2,872 4,379
-------- --------
Effect of exchange rate changes on cash and cash
equivalents............................................... 54 24
-------- --------
Net decrease in cash and cash equivalents.................. (39,567) (7,630)
Cash and cash equivalents at beginning of period........... 238,724 11,903
-------- --------
Cash and cash equivalents at end of period................. $199,157 $ 4,273
======== ========
Supplemental disclosure of non-cash investing activities:
Common stock received in exchange for settlement of
accounts receivable....................................... 1,500 --
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
CLARENT CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Clarent Corporation (the Company) as of June 30, 2000 and for the three and
six month periods ended June 30, 2000 and June 30, 1999 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 Annual Report
on Form 10-K, filed with the Securities and Exchange Commission on March 28,
2000. Certain prior period balances have been reclassified to conform to
current period presentation.
2. Financial Instruments
Estimated fair values of financial instruments are based on quoted market
prices. The following is a summary of available-for-sale securities (in
thousands) at June 30, 2000:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Money Market Fund.................. $ 7,461 $-- $ (2) $ 7,459
Commercial Paper................... 155,178 -- (25) 155,153
Government Securities.............. 66,669 15 (36) 66,648
Market Auction Preferred........... 37,450 -- -- 37,450
-------- ---- ---- --------
$266,758 $ 15 $(63) $266,710
======== ==== ==== ========
Classified as:
Cash Equivalents................. $189,720 $-- $(27) $189,693
Short-Term Investments........... 77,038 15 (36) 77,017
-------- ---- ---- --------
$266,758 $ 15 $(63) $266,710
======== ==== ==== ========
</TABLE>
Expected maturities may differ from contractual maturities because the
issuers of the securities may have the right to prepay or call obligations
without prepayment penalties. Realized gains and losses on sales of available-
for-sale securities were immaterial for the six months ended June 30, 2000.
3. Inventories
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
June
30, December 31,
2000 1999
------- ------------
<S> <C> <C>
Raw materials........................................... $12,676 $7,347
Finished goods.......................................... 1,928 1,057
------- ------
$14,604 $8,404
======= ======
</TABLE>
6
<PAGE>
CLARENT CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Comprehensive Income (Loss)
The Company's total comprehensive income (loss) is as follows (in
thousands):
<TABLE>
<CAPTION>
Six Months
Three Months Ended Ended
June 30, June 30,
------------------- ---------------
2000 1999 2000 1999
------------------- ----- --------
<S> <C> <C> <C> <C>
Net income (loss).................... $ 228 $ (17,564) $(488) $(23,043)
Other comprehensive income (loss):
Translation adjustments............ (114) (2) (21) 24
Unrealized income (loss) on
investments....................... 16 -- (29) --
------- ---------- ----- --------
Comprehensive income (loss)...... $ 130 $ (17,566) $(538) $(23,019)
======= ========== ===== ========
</TABLE>
5. Income Taxes
The provision for income taxes of $259,000 and $284,000 for the three and
six month periods ending June 30, 2000 consist of foreign income tax provided
on the profits attributable to the Company's foreign operations and U.S. state
taxes.
6. Stockholders' Equity
On February 15, 2000, the Company's stockholders authorized an amendment to
the restated certificate of incorporation to increase the authorized number of
shares of common stock to 200,000,000 from 50,000,000 shares.
On January 31, 2000, the Company increased the aggregate number of shares of
common stock authorized for issuance under the 1999 Amended and Restated
Equity Incentive Plan (the 1999 plan) by 792,465, or 2.5% of the Company's
outstanding shares, measured as of that date. This increase was in accordance
with the provisions of the 1999 plan. At a special meeting of the Company's
stockholders on February 15, 2000, the Company's stockholders approved an
amendment to the 1999 plan to increase the aggregate number of shares of
common stock authorized for issuance under such plan by 2,641,830 shares. On
June 7, 2000 at the annual meeting of the Company's stockholders, the
Company's stockholders approved a further amendment to the 1999 plan to
increase the shares of common stock authorized for issuance by 2,000,000 to a
total of 16,792,465.
Also at the annual meeting of stockholders on June 7, 2000, the Company's
stockholders approved an amendment to the 1999 Non-Employee Directors' Stock
Option Plan (the directors' plan) to increase the aggregate number of shares
of common stock authorized for issuance under the directors' plan by 200,000
shares to 500,000 and authorized a change in the number of shares granted
under and the vesting provisions of grants available under the directors'
plan.
7
<PAGE>
CLARENT CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. 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>
Six Months
Three Months Ended Ended
June 30, June 30,
----------------------------------
2000 1999 2000 1999
--------- ---------------- -------
<S> <C> <C> <C> <C>
Product and software revenue
United States.......................... $ 7,388 $ 2,878 $14,888 $ 6,864
Other Americas......................... 1,191 42 2,639 101
Europe, Middle East & Africa........... 4,046 579 9,505 764
Asia Pacific........................... 12,630 4,987 20,301 6,885
--------- -------- ------- -------
Total................................ $ 25,255 $ 8,486 $47,333 $14,614
========= ======== ======= =======
Service revenue
United States.......................... $ 1,247 $ 460 $ 2,718 $ 803
Other Americas......................... 133 17 186 24
Europe, Middle East & Africa........... 878 78 1,239 110
Asia Pacific........................... 800 263 1,420 467
--------- -------- ------- -------
Total................................ $ 3,058 $ 818 $ 5,563 $ 1,404
========= ======== ======= =======
</TABLE>
8. Other Assets
During March 2000, the Company reduced its accounts receivable by accepting
common stock with a value of $1.5 million in one of its privately held
customers as an alternative to cash payment. At June 30, 2000 the Company's
investment is recorded at cost. Revenues from this customer totaled $4.8
million in the six months ended June 30, 2000 and were recorded at the value
of the products and services sold. During June 2000 the Company invested $3.75
million in a venture capital management fund and has committed to invest an
additional $11.25 million in this venture capital management fund over the
next three quarters. At June 30, 2000 this investment is recorded at cost as
the Company has virtually no influence over the operating and financial
policies of the fund.
8
<PAGE>
CLARENT CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income (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 net income (loss) and diluted net loss per share until the time-based
vesting restrictions have lapsed. Diluted net income per share is computed by
dividing net income by the weighted average number of common and dilutive
common equivalent shares outstanding during the period. Dilutive common
equivalent shares consist of stock options, warrants and shares subject to
repurchase.
The following table sets forth the computation of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ------------------
2000 1999 2000 1999
--------- ---------- -------- ---------
(in thousands, except per share
amounts)
<S> <C> <C> <C> <C>
Numerator:
Net income (loss).................. $ 228 $ (17,564) $ (488) $(23,043)
======== ========== ======= =========
Denominator:
Weighted average shares
outstanding....................... 33,075 7,892 32,483 7,582
Less shares subject to repurchase.. (141) (1,463) (309) (1,631)
-------- ---------- ------- ---------
Denominator for basic net income
(loss) and diluted net loss per
share........................... 32,934 6,429 32,174 5,951
Effect of dilutive securities:
Employee stock options............. 5,090
Warrants........................... 1
Shares subject to repurchase....... 141
--------
Denominator for diluted net
income per share................ 38,166
========
Net income (loss) per share--basic... $ 0.01 $ (2.73) $ (0.02) $ (3.87)
======== ========== ======= =========
Net income (loss) per share--
diluted............................. $ 0.01 $ (2.73) $ (0.02) $ (3.87)
======== ========== ======= =========
</TABLE>
The Company has excluded all convertible preferred stock, warrants for
convertible preferred stock and common stock, outstanding stock options and
shares subject to repurchase from the calculation of diluted loss per common
share because all such securities are anti-dilutive. The total number of
shares excluded from the calculations of diluted net loss per share were
21,261,000 for the three months ended June 30, 1999 and 6,157,000 and
21,525,000 for the six months ended June 30, 2000 and 1999, respectively.
10. Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Financial
Instruments and for Hedging Activities" ("SFAS 133") which provides a
comprehensive and consistent standard for the recognition and measurement of
derivatives and hedging activities. SFAS 133 is effective for fiscal years
beginning after June 15, 2000 and is not anticipated to have an impact on the
Company's results of operations or financial condition when adopted as the
Company holds no derivative financial instruments and does not currently
engage in hedging activities.
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
9
<PAGE>
CLARENT CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
"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 adopted the
provisions of SOP 98-9 for transactions entered into beginning January 1,
2000. The adoption of SOP 98-9 did not have a material impact on our
consolidated financial statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements."
("SAB 101") SAB 101 provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements. The Company will be required to
adopt SAB 101 in the fourth quarter of 2000. The SEC has indicated that they
intend to issue additional written guidance to further supplement SAB 101. The
Company is currently evaluating the impact of SAB 101 on its consolidated
results of operations, financial position, and cash flows.
12. Subsequent events--Acquisitions
On July 25, 2000 the Company announced the acquisition of PEAK Software
Solutions, Inc., a leading software development firm specializing in building
IP-based, carrier class data and telecommunications infrastructure software.
Under the terms of the agreement, each outstanding share of PEAK stock was
exchanged for 0.86 of a share of Clarent common stock and cash of
approximately $25 per share, and the Company paid PEAK approximately $1.5
million to retire certain PEAK obligations. The Company issued approximately
$33.9 million in stock and paid $16.7 million in cash.
On August 10, 2000 the Company acquired ACT Networks, Inc. (Nasdaq:ANET).
ACT Networks is a leading provider of multi-service access and voice/data
integration products that enable the convergence of voice, video and data onto
one managed network. Under the terms of the agreement, each outstanding share
of ACT Networks was exchanged for 0.4198 of a share of Clarent common stock.
The exchange ratio was based upon an ACT Networks stock value of $14 per share
divided by Clarent's five trading day average closing price ending on and
including August 9, 2000 of $33.35 per share. The Company issued approximately
$142 million of stock for the outstanding shares of ACT Networks and assumed
an estimated $26 million in ACT Networks' outstanding stock options.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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
Clarent is a leading provider of Internet Protocol (IP) telephony systems.
Our focus is on expanding our research and development, sales and marketing
and customer support activities thereby reinforcing our worldwide leadership
position in providing the technology and intelligent product foundation for
new generation IP-based communications networks. These activities include
developing new products and technologies and enhancing existing products,
hiring research and development engineers, hiring sales and marketing
personnel, expanding our customer base, developing customer relationships,
marketing the Clarent IP telephony solution, expanding our domestic and
international distribution channels and hiring customer support personnel.
We generate revenue from sales of our integrated hardware and software
products and from maintenance and support of those products. We sell our
products primarily through our direct sales force and, to a lesser extent,
through distribution channels. We have sales and support personnel based in
Australia, Belgium, Brazil, Canada, France, Germany, Greece, Hong Kong, Italy,
Japan, Mexico, New Zealand, the People's Republic of China, Singapore, South
Korea, Spain, Sweden, Taiwan, the United Kingdom and the United States.
11
<PAGE>
Results of Operations
The following table presents certain consolidated statements of operations
data for the periods indicated as a percentage of total net revenue:
<TABLE>
<CAPTION>
Six Months
Three Months Ended Ended
June 30, June 30,
------------------- --------------
2000 1999 2000 1999
--------- --------- ----- ------
<S> <C> <C> <C> <C>
As a Percentage of Net Revenue:
Product and software................. 89.2% 91.2% 89.5% 91.2%
Service.............................. 10.8 8.8 10.5 8.8
-------- --------- ----- ------
Total revenue...................... 100.0 100.0 100.0 100.0
Product and software................. 31.9 36.8 32.8 38.8
Service.............................. 7.3 7.8 7.0 7.6
-------- --------- ----- ------
Total cost of revenue.............. 39.2 44.6 39.8 46.4
-------- --------- ----- ------
Gross margin........................... 60.8 55.4 60.2 53.6
-------- --------- ----- ------
Operating expenses:
Research and development............. 19.7 21.4 18.7 22.2
Sales and marketing.................. 41.7 60.4 43.2 60.2
General and administrative........... 9.1 13.7 9.5 16.4
Amortization of compensation......... 3.3 146.8 4.4 97.7
Amortization of goodwill............. 0.8 0.0 0.9 0.0
-------- --------- ----- ------
Total operating expenses........... 74.6 242.3 76.7 196.5
-------- --------- ----- ------
Loss from operations................... (13.8) (186.9) (16.5) (142.9)
Other income (expense)................. 15.5 (1.8) 16.1 (0.9)
-------- --------- ----- ------
Income (loss) before provision for
income taxes.......................... 1.7 (188.7) (0.4) (143.8)
Provision for income taxes............. (0.9) (0.1) (0.5) (0.1)
-------- --------- ----- ------
Net income (loss)...................... 0.8% (188.8)% (0.9)% (143.9)%
======== ========= ===== ======
</TABLE>
Revenue
Revenue increased 204% to $28.3 million in the three months ended June 30,
2000 from $9.3 million in the three months ended June 30, 1999. Net revenue
for the six months ended June 30, 2000 increased to $52.9 million as compared
to $16.0 million for the same period in 1999. The increase in revenues was
primarily attributable to an increase in product and software sales of 198% to
$25.3 million in the three months ended June 30, 2000 from $8.5 million in the
same three month period of 1999 and of 224% to $47.3 million in the six months
ended June 30, 2000 from $14.6 million in the same six month period of 1999.
Service revenue from maintenance and support increased by 274% to $3.1 million
in the three months ended June 30, 2000 from $0.8 million for the same three
month period of 1999 and by 296% to $5.6 million in the six months ended June
30, 2000 from $1.4 million in the same six month period of 1999. The increase
in maintenance and support revenue is attributable to the increase in product
sales and a larger customer base.
Cost of Revenue
Cost of revenue increased 168% to $11.1 million in the three months ended
June 30, 2000 from $4.1 million in the three months ended June 30, 1999. Cost
of revenue for the six months ended June 30, 2000 increased by 184% to $21.0
million as compared to $7.4 million for the same period in 1999. These
increases were primarily attributable to increases in product and software
costs of 163% to $9.0 million in the three months ended June 30, 2000 from
$3.4 million in the same period of 1999 and of 179% to $17.3 million in the
six months ended June 30, 2000 from $6.2 million in the same six month period
of 1999. Maintenance and support costs also
12
<PAGE>
increased by 188% to $2.1 million in the three months ended June 30, 2000 from
$0.7 million in the same period of 1999 and by 206% to $3.7 million in the six
months ended June 30, 2000 from $1.2 million in the same six month period of
1999 due to the increases in technical support personnel to service our
increased customer base. Gross margin was 61% for the second quarter 2000,
compared to 55% for the corresponding period in 1999 and 60% for the first
quarter, 2000. Gross margin increased to 60% for the six months ended June 30,
2000 as compared to 54% for the same six month period in 1999. Increased sales
of our software products both in absolute dollars and as a percentage of
revenue, has positively impacted our gross margin in 2000. 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 but we expect these to continue to be
offset by increases in gross margin from software revenue.
Research and Development Expenses
Research and development expenses increased 180% to $5.6 million in the
three months ended June 30, 2000 from $2.0 million in the three months ended
June 30, 1999 and by 178% to $9.9 million in the six months ended June 30,
2000 from $3.6 million in the same six month period of 1999. 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
revenue to 20% from 21% for the three month periods ended June 30, 2000 and
1999, respectively, and to 19% from 22% for the six month periods ended June
30, 2000 and 1999, respectively. The decrease in research and development
costs as a percentage of revenue is attributable to the significant increase
in revenue. Management expects research and development expenses to increase
as a percentage of revenue with anticipated increases in the number of
research and development personnel as a result of acquisitions.
Sales and Marketing Expenses
Sales and marketing expenses increased 110% to $11.8 million in the three
months ended June 30, 2000 from $5.6 million in the three months ended June
30, 1999 and by 137% to $22.9 million in the six months ended June 30, 2000
from $9.6 million in the same six month period of 1999. 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 as a percentage of
revenue decreased to 42% from 60% for the three month periods ended June 30,
2000 and 1999, respectively and to 43% from 60% for the six month periods
ended June 30, 2000 and 1999, respectively. The decrease in sales and
marketing costs as a percentage of revenue is attributable to the significant
increase in revenue.
General and Administrative Expenses
General and administrative expenses increased 103% to $2.6 million in the
three months ended June 30, 2000 from $1.3 million in the three months ended
June 30, 1999 and by 91% to $5.0 million in the six months ended June 30, 2000
from $2.6 million in the same six month period of 1999. 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 public company
organization. General and administrative expenses as a percentage of revenue
decreased to 9% from 14% for the three month periods ended June 30, 2000 and
1999, respectively and to 10% from 16% for the six month periods ended June
30, 2000 and 1999, respectively. The decrease in general and administrative
costs as a percentage of revenue is attributable to the significant increase
in revenue.
Amortization of Compensation
For the three months ended June 30, 2000, amortization of compensation was
$932,000 as compared to $13.7 million in the three months ended June 30, 1999
and $2.3 million as compared to $15.6 million for the six
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month periods ended June 30, 2000 and 1999, respectively. Amortization of
compensation resulted from the granting of stock options and warrants to
purchase common stock at prices below the deemed fair value of our common
stock. The compensation is being amortized using the graded method over the
vesting period of the stock options. Compensation charges relative to a
warrant provided for consulting services of $11.6 million and $12.3 million
were recognized in the three and six months periods ended June 30, 1999. There
were no warrant compensation expenses recognized in 2000.
Amortization of Goodwill
For the three and six months ended June 30, 2000 we recorded amortization of
goodwill resulting from a purchase business combination completed in the
fourth quarter of 1999.
Other Income (expense)
Other income (expense) was $4.4 million in the three months ended June 30,
2000 as compared to a net expense of $163,000 in the three months ended June
30, 1999 and $8.5 million in the six months ended June 30, 2000 as compared to
a net expense of $147,000 in the same six month period of 1999. The other
income was attributable to the interest income earned on our cash, cash
equivalents and investments primarily as a result of the funds raised in our
initial and secondary public offerings.
Provision for Income Taxes
For the three and six months ended June 30, 2000 we recorded provisions for
income taxes of $259,000 and 284,000, respectively, related to current foreign
income tax provided on the profits attributable to our foreign operations and
for U.S. state franchise taxes. For the three months ended June 30, 1999 the
tax provision of $11,000 was entirely related to current foreign income taxes
on foreign operations.
Liquidity and Capital Resources
From inception through June 1999, we financed our operations primarily
through private sales of convertible preferred stock, which totaled $18.9
million in aggregate net proceeds. In July 1999 we completed an initial public
offering of our common stock and in November 1999 we completed a secondary
public offering which together resulted in aggregate net proceeds of
approximately $303 million.
Net cash provided by operating activities was $1.2 million in the six months
ended June 30, 2000 compared to $8.3 million used in operating activities in
the same period of 1999. Net cash provided by operating activities for the six
months ended June 30, 2000 was attributable to a nominal net loss of $488,000
which was more than fully offset by amortization of compensation and goodwill
of $2.7 million, depreciation of $3.5 million, an increase in accounts payable
and accrued liabilities of $8.8 million and in deferred revenue of $915,000.
Cash used in operating activities included cash used for an increase in
accounts receivable of $6.4 million, an increase in inventory of $6.2 million
and an increase in prepaid and other assets of $1.7 million. The increase in
inventory during 2000 was primarily in anticipation of expected growth in
product revenue and to offset limited supply issues. The increase in accounts
receivable is directly attributable to a significant portion of our increased
revenue occurring during the last month of the period.
The increase in deferred revenue for the second quarter of 2000 is a result
of increased service revenue deferred for support and maintenance contracts as
a result of the overall increase in sales. In the second quarter of 2000 we
added more of the world's leading telecommunications companies to our customer
list and continued to grow the business with existing customers. We now have
customers in 68 countries throughout the world. We have also decreased
dependency on key customers with only 2 customers individually contributing
greater than 10% but each less than 15% of second quarter 2000 revenue.
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Net cash used in operating activities for the first six months of 1999 was
attributable primarily to a net loss of $23 million and increases in trade
accounts receivable of $6.3 million and inventory of $2.0 million, partially
offset by depreciation of $869,000, amortization of compensation of $15.6
million, increases in accounts payable and accrued liabilities of $3.9 million
and increases in deferred revenue of $3.2 million. The increase in inventory
for 1999 was primarily in anticipation of expected growth in product revenue.
The increase in accounts receivable was due to a significant portion of our
increased revenue occurring during the last month of the period. Deferred
revenue increased due to sales which had contingencies which were not
satisfied at June 30, 1999 as well as increased sales of maintenance and
support contracts.
Net cash used in investing activities was approximately $43.7 million in the
first six months of 2000 as compared to $3.7 million for the same period in
1999. For 2000, a net $35.2 million of cash used in investing activities was
for the purchase of investment securities net of sales and maturities.
Included in the net cash used in investing activities was a $3.75 million
investment in a venture capital management fund made in June 2000. The
remaining cash used in investing activities for each year was for purchases of
property and equipment.
Net cash provided by financing activities was $2.9 million in the first
quarter of 2000, as opposed to $4.4 million for the same period in 1999. For
the period ended June 30, 2000, cash provided by financing activities was
primarily the net proceeds from common stock issued upon exercise of employee
incentive stock options and purchases under the employee stock purchase plan.
For 1999, the cash provided by financing activities was predominantly the
proceeds from a bank line of credit and long term debt.
On July 25, 2000 we announced the acquisition of PEAK Software Solutions,
Inc., a leading software development firm specializing in building IP-based,
carrier class data and telecommunications infrastructure software. Under the
terms of the agreement, each outstanding share of PEAK stock was exchanged for
0.86 of a share of Clarent common stock and cash of approximately $25 per
share, and the Company paid PEAK approximately $1.5 million to retire certain
PEAK obligations. The Company issued approximately $33.9 million in stock and
paid $16.7 million in cash.
On August 10, 2000 we acquired ACT Networks, Inc. (Nasdaq:ANET), a leading
provider of multi-service access and voice/data integration products that
enable the convergence of voice, video and data onto one managed network.
Under the terms of the agreement, each outstanding share of ACT Networks was
exchanged for 0.4198 of a share of Clarent common stock. The exchange ratio
was based upon an ACT Networks stock value of $14 per share divided by
Clarent's five trading day average closing price ending on and including
August 9, 2000 of $33.35 per share. The Company issued approximately $142
million of stock for the outstanding shares of ACT Networks and assumed an
estimated $26 million in ACT Networks' outstanding stock options.
We believe that our current cash, cash equivalents and short-term
investments balances of $276.2 million at June 30, 2000 will be sufficient to
meet our anticipated cash needs for working capital and capital expenditures
for at least the next 12 months. If cash generated from operations is
insufficient to satisfy our liquidity requirements, we may seek to sell
additional equity or debt securities or obtain borrowings through a 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. If we are unable to obtain this
additional financing, we may be required to reduce the scope of our planned
product development and marketing efforts, which could harm our business,
financial condition and operating results.
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
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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, 2000 we have not experienced any significant
negative impact on our operations as a result of fluctuations in foreign
currency exchange rates. We do not currently engage in any hedging activities
or use derivative financial instruments.
We have an investment portfolio of fixed income securities, including those
classified as cash equivalents, of $267 million at June 30, 2000. These
securities are subject to interest rate fluctuations and will decrease in
market value if interest rates increase.
The primary objective of our investment activities is to preserve principal
while at the same time maximizing yields without significantly increasing
risk. We invest primarily in high-quality, short-term debt instruments such as
U.S. government securities and instruments issued by high quality financial
institutions and companies including money market instruments and debt issued
by corporations. A hypothetical 100 basis point increase in interest rates
would result in less than a $0.2 million decrease (less than .1%) in the fair
market value of our available-for-sale securities.
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. 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 will
significantly harm our financial position.
As of June 30, 2000, we had an accumulated deficit of $39.4 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 maintain a positive operating cash flow. Even if we do
achieve profitability and continue to maintain a 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:
<TABLE>
<CAPTION>
Operating Loss Period
-------------- ------
<S> <C>
(8,718,000) Six months ended June 30, 2000
(33,163,000) Year Ended December 31, 1999
(5,824,000) Year ended December 31, 1998
</TABLE>
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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 of
this and as a result of integration of acquired operations, we expect our
expense levels to increase 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.
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 Cisco
Systems, Inc., Lucent Technologies Inc., Nortel Networks Corporation and
Ericsson. Many of our large competitors have significantly larger market
shares (as measured by ports shipped) and stronger relationships with service
providers than we do. In addition, they may be able to compete more
effectively because they will be able to add IP telephony features to their
existing equipment or bundle these features as part of a broader solution. 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
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from other vendors. The interoperability standards for IP telephony equipment
are evolving. We have initial interoperable solutions. If we are unable to
provide or maintain our customers' interoperable solutions with other vendors'
products, they may seek vendors who provide greater 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 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 integrate successfully our acquired companies could prevent us
from operating efficiently.
We have been involved in, and may in the future be involved in, a number of
merger and acquisition transactions. These transactions have been motivated by
many factors, including our desire to acquire skilled personnel, our desire to
obtain new technologies and our desire to expand and enhance our product and
services lines. Growth through acquisition has several identifiable risks,
including difficulties associated with successfully integrating the previously
distinct businesses into a single unit, the substantial management time
devoted to integrating the companies, the possibility that we might not be
successful in retaining the employees of the acquired companies, undisclosed
liabilities, the failure to realize anticipated benefits (such as cost savings
and synergies) and issues related to product transition (such as distribution,
engineering and customer support). Realization of any of these risks in
connection with our acquisitions could have a material adverse effect on our
business, operating results, and financial condition.
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 June 30, 1999 to June 30, 2000, the
number of our employees increased from approximately 200 to 440. 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
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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.
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
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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. For the six months ended June 30, 2000, one customer, Triumph
Technologies, accounted for 13% of our net revenues and for the three months
ended June 30, 2000, two customers Triumph and Great MinCom Products Corp.
accounted for 13% and 12% of our net revenue, respectively. 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 35% of revenue for the first half of 2000 and 11% of 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 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 67% of total revenue for the
first half of 2000 and 54% for the year ended December 31, 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.
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We may not be able to expand our international operations, which would reduce
our ability to increase revenue.
We currently have employees based in Australia, Belgium, Brazil, Canada,
France, Germany, Greece, Hong Kong, Italy, Japan, Mexico, New Zealand, the
People's Republic of China, Singapore, South Korea, Spain, Sweden, Taiwan, the
United Kingdom and the United States. 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.
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.
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
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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.
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
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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 a claim
be asserted. To date, product defects have not had a material negative effect
on our results of operations. However, we cannot be certain that product
defects will not have a material negative effect 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.
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We may not be able to raise capital as needed to maintain our operations.
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 stock price is highly volatile.
The trading price of our common stock has fluctuated significantly since our
initial public offering in July 1999. In addition, the trading price of our
common stock could be subject to wide fluctuations in response to quarterly
variations in operating results, announcements of technological innovations or
new products by us or our competitors, developments with respect to patents or
proprietary rights, announcements of strategic partnerships or new customers
by us or our competitors, changes in financial estimates by securities
analysts and other events or factors. In addition, the stock market has
experienced volatility that has particularly affected the market prices of
equity securities of many high technology companies and that often has been
unrelated or disproportionate to the operating performance of these companies.
These broad market fluctuations may adversely affect the market price of our
common stock, as evidenced by a fluctuation in per share closing price from a
low of $34.75 to a high of $169.75 during the six month period from January 1,
2000 to June 30, 2000.
We may in the future be the target of securities class action or other
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. Our
acquisition activity may involve us in disputes from time to time. Litigation
that may arise from these disputes may lead to volatility in our stock price
and/or may result in our being the target of securities class action
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 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.
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<PAGE>
Substantial future sales of our shares in the public market may cause our
stock price to fall.
If our stockholders sell substantial amounts of our common stock, including
shares issued upon exercise of outstanding options and warrants, in the public
market during a short period of time, our stock price may decline
significantly. These sales also might make it more difficult for us to sell
equity or equity related securities in the future at a time and price that we
deem appropriate.
We do not intend to pay dividends.
We have never declared or paid any cash dividends on our capital stock. We
currently intend to retain any future earnings for funding growth. In
addition, pursuant to our bank credit facility, we cannot pay dividends
without our bank's consent, with limited exceptions. Therefore, we do not
expect to pay any dividends in the foreseeable future.
Year 2000 Compliance
We are currently not aware of any Year 2000 problems in any of our products,
critical systems or services.
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<PAGE>
CLARENT CORPORATION
PART II: OTHER INFORMATION
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
We held our annual meeting of stockholders on June 7, 2000. At the Meeting,
the stockholders voted to approve four proposals. The first proposal related
to the election of one director, Ms. Syaru Shirley Lin, to hold office until
the 2003 annual meeting of stockholders. The votes cast and withheld for such
nominees were as follows:
<TABLE>
<CAPTION>
Name For Against Abstain
---- ---------- ------- -------
<S> <C> <C> <C>
Syrau Shirley Lin.............................. 27,968,514 0 8,459
</TABLE>
The second proposal related to the approval of an amendment to our 1999 Non-
Employee Directors' Stock Option Plan to increase the aggregate number of
shares of common stock authorized for issuance under the plan by 200,000
shares, from 300,000 shares to 500,000 shares, and to provide for a change in
the number of shares granted under and the vesting provision of grants under
the plan. The third proposal related to the approval of an amendment to our
1999 Amended and Restated Equity Incentive Plan to increase the aggregate
number of shares of common stock authorized for issuance under such plan by
2,000,000 shares, from 14,792,465 shares to 16,792,4645 shares. The fourth
proposal related to the ratification of the appointment of Ernst & Young LLP
as our independent auditors for our fiscal year ending December 31, 2000. At
the annual meeting, our stockholders approved each proposal. The following
table contains the tabulation of the votes cast for or against each proposal,
as well as the abstentions and broker non-votes with respect to each proposal.
<TABLE>
<CAPTION>
Broker
Proposal Votes For Votes Against Abstained Non-Votes
-------- ---------- ------------- --------- ---------
<S> <C> <C> <C> <C>
Proposal 2..................... 16,886,571 8,517,003 6,863 2,586,536
Proposal 3..................... 16,836,817 8,568,023 5,597 2,586,536
Proposal 4..................... 27,595,596 375,326 6,051 0
</TABLE>
ITEM 5: OTHER INFORMATION
On July 24, 2000, we executed a definitive Agreement and Plan of Merger and
Reorganization with Cadmium Acquisition Corp., a Delaware corporation and
wholly owned subsidiary of Clarent ("Merger Sub"), PEAK Software Solutions,
Inc., a Colorado corporation ("PEAK"), certain of PEAK's shareholders (the
"Designated Shareholders") and an agent for the Designated Shareholders (the
"Merger Agreement") under which PEAK merged with and into Merger Sub (the
"Merger"), and the shareholders of PEAK received shares of our common stock
and cash in exchange for all of the outstanding shares of PEAK capital stock.
Upon consummation of the Merger, PEAK ceased to exist, and Merger Sub remained
a wholly owned subsidiary of Clarent.
Pursuant to the Merger Agreement, each share of PEAK common stock converted
into the right to receive a fraction of a share of Registrant common stock
valued at $57.37, based upon the average closing price of a share of
Registrant common stock on the Nasdaq National Market for the ten day trading
period ending on and including June 26, 2000, and $24.71 in cash. In addition,
we paid PEAK $1,537,079 to be used to retire certain obligations of PEAK. A
total of 528,739 shares of our common stock were issued pursuant to the Merger
Agreement, of which 163,838 shares will be held in escrow to secure certain
indemnification obligations of the PEAK shareholders.
The Merger Agreement creates certain obligations for the Designated
Shareholders to indemnify Clarent and certain of our affiliates for breaches
of PEAK's or the Designated Shareholders' representations, warranties and
covenants under the Merger Agreement and certain related agreements.
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<PAGE>
In connection with the execution of the Merger Agreement, Clarent, Merger
Sub, the Designated Shareholders, each of the other shareholders of PEAK (the
"Non-Designated Shareholders" and together with the Designated Shareholders,
the "Shareholders"), an agent for the Non-Designated Shareholders and a
purchaser representative entered into a Shareholders' Agreement dated as of
July 24, 2000 (the "Shareholders' Agreement"). The Shareholders' Agreement
affords the Shareholders certain registration rights and creates certain
obligations for the Non-Designated Shareholders to indemnify Registrant and
certain of our affiliates for breaches of PEAK's or the Non-Designated
Shareholders' representations, warranties and covenants under the Merger
Agreement, the Shareholders' Agreement and certain related agreements.
A copy of the press release of Clarent with respect to the Merger is
included herein as Exhibit 99.1, and is incorporated by reference into this
Item 5. The summaries of the Merger Agreement and the Shareholder's Agreement
in this report are qualified in their entirety by reference to the Merger
Agreement and Shareholders' Agreement, attached hereto as Exhibit 99.2 and
99.3, respectively.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
The following exhibits are filed as part of this Form 10-Q:
(a) Exhibit 2.1 Agreement and Plan of Merger and Reorganization, dated as
of May 1, 2000, among Clarent Corporation, Copper Merger Sub, Inc.
and ACT Networks, Inc.(1)
(b) Exhibit 2.2 Amendment No. 1, dated as of June 30, 2000, to the
Agreement and Plan of Merger and Reorganization.(1)
(c) Exhibit 27.1 Financial Data Schedule.
(c) Exhibit 99.1 Press Release, dated July 25, 2000.
(d) Exhibit 99.2 Agreement and Plan of Merger and Reorganization dated as
of July 24, 2000, by and among Clarent, Cadmium Acquisition Corp.,
PEAK Software Solutions, Inc., certain shareholders of PEAK Software
Solutions, Inc. and Larry Schwartz as Shareholders' Agent.
(e) Exhibit 99.3 Shareholders' Agreement dated as of July 24, 2000, by
and among Clarent, Cadmium Acquisition Corp., certain shareholders of
PEAK Software Solutions, Inc. and Larry Schwartz as Shareholders'
Agent and Purchaser Representative.
(f) Reports on Form 8-K. There were no reports on Form 8-K filed by the
Registrant during the second quarter ended June 30, 2000.
--------
(1) Incorporated by reference to the Exhibits filed with the registrant's
Registration Statement on Form S-4 (No. 333-38216).
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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
/s/ Jerry Shaw-Yau Chang
By: _________________________________
Jerry Shaw-Yau Chang
Chief Executive Officer, President
and Director
/s/ Richard J. Heaps
By: _________________________________
Richard J. Heaps
Chief Operating Officer and Chief
Financial Officer (Principal
Financial and Accounting Officer)
Date: August 14, 2000
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