<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 September 30, 2000
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number
CLARENT CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0433687
(I.R.S. Employer
(State or other jurisdiction of Identification No.)
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 38,916,847 at September 30, 2000.
This report consists of 29 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 September 30, 2000 and
December 31, 1999................................................... 3
Condensed Consolidated Statements of Operations for the Three and
Nine Month Periods Ended September 30, 2000 and 1999................ 4
Condensed Consolidated Statements of Cash Flows for the Nine Month
Periods ended September 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................................................. 12
Item 3: Quantitative and Qualitative Disclosures About Market Risk..... 18
Part II: Other Information
Item 2: Changes in Securities and Use of Proceeds...................... 28
Item 6: Exhibits and Reports on Form 8-K............................... 28
Signatures............................................................. 29
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $206,975 $238,724
Short-term investments............................. 79,660 42,581
Accounts receivable, net........................... 46,617 24,218
Inventories........................................ 12,960 8,404
Prepaid expenses and other current assets.......... 4,100 2,826
-------- --------
Total current assets............................. 350,312 316,753
Property and equipment, net.......................... 28,871 12,696
Investments.......................................... 16,750 2,988
Goodwill, net........................................ 100,863 2,931
Other intangible assets, net......................... 40,701 --
Deferred tax assets.................................. 15,911 --
Other assets......................................... 1,964 --
-------- --------
$555,372 $335,368
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $ 10,611 $ 8,552
Deferred revenue................................... 13,125 10,117
Accrued liabilities................................ 26,220 7,857
-------- --------
Total current liabilities........................ 49,956 26,526
Deferred tax liabilities............................. 15,910 --
Stockholders' equity:
Common stock....................................... 580,584 353,894
Deferred compensation.............................. (11,868) (5,990)
Accumulated other comprehensive loss............... (269) (112)
Accumulated deficit................................ (78,941) (38,950)
-------- --------
Total stockholders' equity....................... 489,506 308,842
-------- --------
$555,372 $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 September Nine Months Ended
30, September 30,
----------------- ------------------
2000 1999 2000 1999
-------- ------- -------- --------
<S> <C> <C> <C> <C>
Net revenue:
Product and software................. $ 41,131 $12,363 $ 88,464 $ 26,978
Service.............................. 4,392 864 9,955 2,267
-------- ------- -------- --------
Total revenue...................... 45,523 13,227 98,419 29,245
Cost of revenue:
Product and software................. 18,090 4,488 35,421 10,698
Service.............................. 2,176 947 5,894 2,164
-------- ------- -------- --------
Total cost of revenue.............. 20,266 5,435 41,315 12,862
-------- ------- -------- --------
Gross profit........................... 25,257 7,792 57,104 16,383
-------- ------- -------- --------
Operating expenses:
Research and development............. 8,414 2,466 18,320 6,023
Sales and marketing.................. 15,255 6,518 38,129 16,166
General and administrative........... 5,009 1,773 10,033 4,402
Amortization of compensation......... 1,763 1,901 4,073 17,543
Amortization of goodwill & other
intangibles......................... 6,023 -- 6,474 --
Purchased in-process research &
development......................... 31,496 -- 31,496 --
Merger related costs................. 1,386 -- 1,386 --
-------- ------- -------- --------
Total operating expenses........... 69,346 12,658 109,911 44,134
-------- ------- -------- --------
Loss from operations................... (44,089) (4,866) (52,807) (27,751)
Other income, net...................... 5,088 716 13,602 569
-------- ------- -------- --------
Loss before provision for income
taxes................................. (39,001) (4,150) (39,205) (27,182)
Provision for income taxes............. (502) (72) (786) (83)
-------- ------- -------- --------
Net loss............................... $(39,503) $(4,222) $(39,991) $(27,265)
======== ======= ======== ========
Basic and diluted net loss per share... $ (1.08) $ (0.17) $ (1.18) $ (2.17)
======== ======= ======== ========
Shares used in computing basic and
diluted net loss per share............ 36,482 25,526 33,763 12,543
======== ======= ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------
2000 1999
--------- --------
<S> <C> <C>
Operating activities:
Net loss................................................ $ (39,991) $(27,265)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation.......................................... 6,081 1,609
Amortization of compensation.......................... 4,073 17,543
Purchased in-process research and development......... 31,496 --
Amortization of goodwill & other intangibles.......... 6,860 --
Changes in operating assets and liabilities, net of
effect of acquired businesses :
Accounts receivable................................. (16,031) (8,251)
Inventories......................................... (61) (1,848)
Prepaid expenses and other current assets........... (84) (1,186)
Other assets........................................ (1,339) (425)
Accounts payable and accrued liabilities............ 2,086 5,430
Deferred revenue.................................... 2,602 4,997
--------- --------
Net cash used in operating activities................. (4,308) (9,396)
--------- --------
Investing activities:
Purchases of short-term investments..................... (120,519) (23,728)
Purchases of long-term investments...................... (15,250) (3,000)
Sales and maturities of investments..................... 88,450 --
Purchases of property and equipment..................... (18,718) (6,902)
Business combinations, net of cash acquired............. 33,316 --
--------- --------
Net cash used in investing activities..................... (32,721) (33,630)
--------- --------
Financing activities:
Proceeds from line of credit............................ -- 1,628
Proceeds from long term debt............................ -- 182
Proceeds from issuance of preferred stock............... -- 332
Proceeds from issuance of common stock.................. 5,369 62,784
--------- --------
Net cash provided by financing activities................. 5,369 64,926
--------- --------
Effect of exchange rate changes on cash and cash
equivalents.............................................. (89) 67
--------- --------
Net (decrease) increase in cash and cash equivalents...... (31,749) 21,967
Cash and cash equivalents at beginning of period.......... 238,724 11,903
--------- --------
Cash and cash equivalents at end of period................ $ 206,975 $ 33,870
========= ========
Supplemental disclosure of non-cash investing activities:
Common stock received in exchange for settlement of
accounts receivable...................................... $ 1,500 --
Issuance of common stock in connection with acquisition... $ 194,412 --
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
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 September 30, 2000 and for the three
and nine month periods ended September 30, 2000 and September 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. Inventories
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Raw materials..................................... $ 9,577 $7,347
Work-in-process................................... 304 --
Finished goods.................................... 3,079 1,057
------- ------
$12,960 $8,404
======= ======
</TABLE>
3. Investments
The Company invests in equity instruments of privately-held companies for
the promotion of business and strategic objectives. The Company has also
invested in a venture capital management fund. Except for the $1.5 million
investment noted below, all of the Company's investments are valued at the
cash paid for the stock received. These investments are included as long-term
investments in the balance sheet and are accounted for under the cost method
when ownership is less than 20% and there are no indicators of control. For
these non-quoted investments, the Company regularly reviews operating
performance, financing status, liquidity prospects and cash flow forecasts in
assessing carrying values. Impairment losses are recorded when events and
circumstances indicate that such assets might be impaired and the decline in
value is other than temporary. To date, no such losses have been recorded.
During the nine months ended September 30, 2000, the Company has invested
$8.5 million in various privately-held companies and $6.75 million in a
venture capital management fund. The Company is committed to invest an
additional $8.25 million in the venture capital management fund over the next
two quarters.
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.
During the nine months ended September 30, 2000, the Company recorded
revenues from certain customers in which the Company had an investment.
Revenues from these customers have been recorded at the value of the products
and services sold.
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>
Three Months
Ended September Nine Months Ended
30, September 30,
----------------- ------------------
2000 1999 2000 1999
-------- ------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss)................... $(39,503) $(4,222) $(39,991) $(27,265)
Other comprehensive income (loss):
Translation adjustments........... (116) 24 (137) (48)
Unrealized income (loss) on
investments...................... 9 (27) (20) (27)
-------- ------- -------- --------
Comprehensive income (loss)..... $(39,610) $(4,225) $(40,148) $(27,244)
======== ======= ======== ========
</TABLE>
5. Income Taxes
The provisions for income taxes of $502,000 and $786,000 for the three and
nine month periods ending September 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.
On July 24, 2000 the Company issued 528,739 shares of common stock to
acquire Peak Software Solutions, Inc. On August 10, 2000 the Company issued
4,444,832 shares of common stock to acquire ACT Networks Inc. and assumed all
outstanding stock option agreements. At September 30, 2000 the aggregate
number of shares authorized for issuance under the ACT Networks stock option
plans and agreements was 1,235,795 shares of Clarent common stock.
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>
Three Months Nine Months
Ended September Ended September
30, 30,
--------------- ---------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Product and software revenue
United States............................. $10,542 $ 6,175 $25,430 $13,039
Other Americas............................ 4,028 21 6,667 123
Europe, Middle East & Africa.............. 6,460 2,989 15,966 3,754
Asia Pacific.............................. 20,101 3,178 40,401 10,062
------- ------- ------- -------
Total................................... $41,131 $12,363 $88,464 $26,978
======= ======= ======= =======
Service revenue
United States............................. $ 2,107 $ 327 $ 4,822 $ 1,122
Other Americas............................ 287 18 477 49
Europe, Middle East & Africa.............. 859 85 2,096 195
Asia Pacific.............................. 1,139 434 2,560 901
------- ------- ------- -------
Total................................... $ 4,392 $ 864 $ 9,955 $ 2,267
======= ======= ======= =======
</TABLE>
8. Net Loss Per Share
Basic 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.
The following table sets forth the computation of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
Three Months
Ended September Nine Months Ended
30, September 30,
----------------- ------------------
2000 1999 2000 1999
-------- ------- -------- --------
(in thousands, except per share
amounts)
<S> <C> <C> <C> <C>
Numerator:
Net loss............................... $(39,503) $(4,222) $(39,991) $(27,265)
======== ======= ======== ========
Denominator:
Weighted average shares outstanding.... 36,482 26,651 33,826 14,005
Less shares subject to repurchase...... -- (1,125) (63) (1,462)
-------- ------- -------- --------
Denominator for basic and diluted net
loss per share...................... 36,482 25,526 33,763 12,543
Net loss per share--basic and diluted.... $ (1.08) $ (0.17) $ (1.18) $ (2.17)
======== ======= ======== ========
</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
8
<PAGE>
CLARENT CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
calculations of diluted net loss per share were 5,121,000 and 10,012,000 for
the three months ended September 30, 2000 and 1999, respectively, and
5,921,000 and 19,511,000 for the nine months ended September 30, 2000 and
1999, respectively.
9. Acquisitions
On July 24, 2000 the Company completed 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 0.8636 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
$44.5 million in stock and paid $16.7 million in cash. This acquisition was
accounted for using the purchase method and was not included in the
calculation of proforma results as it is not considered to be material to the
operating results of the Company. The operating results of PEAK have been
included in the condensed consolidated statements of operations from the date
of acquisition.
On August 10, 2000 the Company acquired ACT Networks, Inc., 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 $150
million of stock for the outstanding shares of ACT Networks and assumed stock
options to purchase approximately 1.1 million shares of Clarent's common stock
with an aggregate fair value of $27 million. The ACT Networks acquisition has
been accounted for as a purchase and accordingly, results of operations and
the estimated fair value of the assets acquired and liabilities assumed are
included in Clarent's condensed consolidated financial statements from the
date of acquisition.
The ACT Networks acquisition cost, allocation of excess purchased cost over
the fair value of net assets acquired to goodwill and other intangible assets
acquired and the related life of the intangible assets (in thousands, except
for asset life):
<TABLE>
<CAPTION>
Acquisition
Cost Asset Life
----------- ----------
(in years)
<S> <C> <C>
Value of common stock and stock options issued...... $176,789
Transaction costs................................... 7,008
Merger related restructuring costs.................. 8,885
--------
192,682
Less net tangible assets acquired................... 68,950
--------
Excess purchase cost over the fair value of net
tangible assets acquired........................... $123,732
========
Excess purchase cost was allocated to the following:
Assembled workforce................................. $ 6,642 3
Customer base....................................... 19,276 5
Developed technology................................ 13,860 5
In-process research and development................. 31,496
Goodwill............................................ 42,506 5
Deferred compensation............................... 9,952 4
-------- ---
$123,732
========
</TABLE>
9
<PAGE>
CLARENT CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The fair value assigned to purchased in-process research and development in
the allocation of purchase cost included research and development projects for
which technological feasibility had not been achieved and no future
alternative uses had been established. The Company computed its valuations of
in-process research and development using a discounted cash flow analysis on
the anticipated income stream to be generated by the purchased technology.
This allocation of fair value is charged to operations at the date of
acquisition and totaled $31.5 million for the nine months ended September 30,
2000.
In valuing in-process research and development, the Company considered,
among other factors, the stage of completion of the development efforts and
the estimated net present value of cash flows expected to result from the
successful deployment of the new products. The stage of completion was
determined by estimating the costs and time incurred to date relative to the
costs and time to be incurred to develop the in-process technology into
commercially viable products. The estimated net present value of cash flows
was based on incremental future cash flows from revenues expected to be
generated by the products being developed, taking into account the
characteristics and applications of the technology, the size and growth rate
of existing and future markets and an evaluation of past and anticipated
product life cycles. Estimated future cash flows were discounted to arrive at
a net present valued and were allocated to in-process research and development
based on the percentage of completion at the date of acquisition.
In valuing the developed technology of $13.9 million the expected future
cash flows of the existing developed technologies were discounted taking into
account the characteristics and applications of the products, the size of
existing markets, growth rates of existing and future markets, as well as an
evaluation of past and anticipated product-life cycles.
To determine the value of the assembled work force of $6.6 million the
Company evaluated the work force in place at the acquisition date and utilized
the cost approach to estimate the value of replacing the work force. Costs
considered in replacing the work force included costs of identifying,
recruiting and interviewing candidates, as well as the cost of training new
employees. These costs were then summed up and tax-effected to estimate the
value of the assembled workforce.
To determine the value of the customer base of $19.2 million the Company
utilized the avoided cost approach. Under this approach, the fair value of the
acquired customer relationships is equal to the costs which the acquirer will
avoid spending in recreating similar functional customer relationships. Costs
considered in recreating the customer base included the amount of costs and
time that sales, marketing, development and corporate personnel would have to
spend in order to acquire the customer base.
The following summary prepared on an unaudited pro forma basis reflects the
condensed consolidated results of operations of the Company, excluding the
charge for acquired in-process research and development, as if the acquisition
of ACT Networks had occurred at the beginning of 1999 and does not purport to
be indicative of what would have occurred had the acquisition been made as of
the beginning of 1999 or of results which may occur in the future.
10
<PAGE>
CLARENT CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The pro forma results of operations combine the consolidated results of
operations of the Company, excluding the charge for acquired in-process
research and development, and the historical results for ACT Networks for the
nine months ended September 30, 2000 and for the nine months ended September
30, 1999 (in thousands, except per share data):
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------
2000 1999
--------- ---------
<S> <C> <C>
Net revenue............................................. $ 127,029 $ 69,955
========= =========
Net loss................................................ $(26,708) $(32,981)
========= =========
Net loss per share--basic and diluted................... $ (0.71) $ (1.94)
========= =========
Denominator for basic and diluted net loss per share.... 37,381 16,988
</TABLE>
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 a material 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 "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
applicable transactions entered into beginning January 1, 2000. The adoption
of SOP 98-9 did not have a material impact on the company's 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. In October 2000, the SEC issued
additional written guidance to further supplement SAB 101. The Company will be
required to adopt SAB 101 in the fourth quarter of 2000. The Company is
currently evaluating the impact of SAB 101 on its consolidated results of
operations, financial position, and cash flows.
11
<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.
12
<PAGE>
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 Nine Months Ended
September 30, September 30,
--------------------- -------------------
2000 1999 2000 1999
--------- --------- -------- --------
<S> <C> <C> <C> <C>
As a Percentage of Net Revenue:
Product and software........... 90.4% 93.5% 89.9% 92.2%
Service........................ 9.6 6.5 10.1 7.8
--------- --------- -------- --------
Total revenue................ 100.0 100.0 100.0 100.0
Product and software........... 39.8 33.9 36.0 36.6
Service........................ 4.8 7.2 6.0 7.4
--------- --------- -------- --------
Total cost of revenue........ 44.6 41.1 42.0 44.0
--------- --------- -------- --------
Gross margin..................... 55.4 58.9 58.0 56.0
--------- --------- -------- --------
Operating expenses:
Research and development....... 18.5 18.6 18.6 20.6
Sales and marketing............ 33.5 49.3 38.7 55.3
General and administrative..... 11.0 13.4 10.2 15.0
Amortization of compensation... 3.9 14.4 4.1 60.0
Amortization of goodwill &
other intangibles............. 13.2 0.0 6.6 0.0
Purchased in-process research &
development................... 69.2 0.0 32.0 0.0
Merger related costs........... 3.0 0.0 1.4 0.0
--------- --------- -------- --------
Total operating expenses..... 152.3 95.7 111.6 150.9
--------- --------- -------- --------
Loss from operations............. (96.9) (36.8) (53.6) (94.9)
Other income..................... 11.2 5.4 13.8 2.0
--------- --------- -------- --------
Loss before provision for income
taxes........................... (85.7) (31.4) (39.8) (92.9)
Provision for income taxes....... (1.1) (0.5) (0.8) (0.3)
--------- --------- -------- --------
Net loss......................... (86.8)% (31.9)% (40.6)% (93.2)%
========= ========= ======== ========
</TABLE>
Net revenue
Net revenue increased 244% to $45.5 million in the three months ended
September 30, 2000 from $13.2 million in the three months ended September 30,
1999. Net revenue for the nine months ended September 30, 2000 increased to
$98.4 million as compared to $29.2 million for the same period in 1999. The
increase in revenues was primarily attributable to an increase in product and
software sales of 233% to $41.1 million in the three months ended September
30, 2000 from $12.4 million in the same three month period of 1999 and of 228%
to $88.5 million in the nine months ended September 30, 2000 from $27.0
million in the same nine month period of 1999. The increased demand for
Clarent's IP based communication solution was from both existing and new
customers on a worldwide basis. During the third quarter of 2000, revenue
resulted from customers in more than 20 additional countries as compared to
the same quarter of 1999. Service revenue from maintenance and support
increased by 408% to $4.4 million in the three months ended September 30, 2000
from $0.9 million for the same three month period of 1999 and by 339% to
$10.0 million in the nine months ended September 30, 2000 from $2.3 million in
the same nine 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 273% to $20.3 million in the three months ended
September 30, 2000 from $5.4 million in the three months ended September 30,
1999. Cost of revenue for the nine months ended September 30, 2000 increased
to $41.3 million as compared to $12.9 million for the same period in 1999.
These increases were primarily attributable to increases in product and
software costs of 303% to $18.1 million in the three
13
<PAGE>
months ended September 30, 2000 from $4.5 million in the same period of 1999
and of 231% to $35.4 million in the nine months ended September 30, 2000 from
$10.7 million in the same nine month period of 1999. Maintenance and support
costs also increased by 130% to $2.2 million in the three months ended
September 30, 2000 from $0.9 million in the same period of 1999 and by 172% to
$5.9 million in the nine months ended September 30, 2000 from $2.2 million in
the same nine month period of 1999 due to the increases in technical support
personnel to service our increased customer base. Gross margin was 55% for the
third quarter 2000, compared to 59% for the corresponding period in 1999 and
61% for the second quarter, 2000. Gross margin increased to 58% for the nine
months ended September 30, 2000 as compared to 56% for the same nine 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 but this has been offset by the acquisition of ACT Networks
during the third quarter of 2000 and the addition of their hardware revenue to
the sales mix. 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 the price erosion to continue to be offset by increases in gross margin
from software revenue.
Research and Development Expenses
Research and development expenses increased 241% to $8.4 million in the
three months ended September 30, 2000 from $2.5 million in the three months
ended September 30, 1999 and by 204% to $18.3 million in the nine months ended
September 30, 2000 from $6.0 million in the same nine 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 were constant as a
percentage of revenue at 19% for the three month periods ended September 30,
2000 and 1999, respectively, and decreased to 19% from 21% for the nine month
periods ended September 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 increases in
the number of research and development personnel as a result of acquisitions
during the third quarter of 2000.
Sales and Marketing Expenses
Sales and marketing expenses increased 134% to $15.3 million in the three
months ended September 30, 2000 from $6.5 million in the three months ended
September 30, 1999 and by 136% to $38.1 million in the nine months ended
September 30, 2000 from $16.2 million in the same nine 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 34% from 49% for the three month
periods ended September 30, 2000 and 1999, respectively and to 39% from 55%
for the nine month periods ended September 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 183% to $5.0 million in the
three months ended September 30, 2000 from $1.8 million in the three months
ended September 30, 1999 and by 128% to $10.0 million in the nine months ended
September 30, 2000 from $4.4 million in the same nine 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. General and administrative expenses as a percentage of revenue
decreased to 11% from 13% for the three month periods ended September 30, 2000
and 1999, respectively and to 10% from 15% for the nine month periods ended
September 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.
14
<PAGE>
Amortization of Compensation
For the three months ended September 30, 2000, amortization of compensation
was $1.8 million as compared to $1.9 million in the three months ended
September 30, 1999 and $4.1 million as compared to $17.5 million for the nine
month periods ended September 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 $12.3 million were recognized in
the nine month period ended September 30, 1999. There were no warrant
compensation expenses recognized in 2000.
Amortization of Goodwill and Other Intangibles
For the three and nine months ended September 30, 2000 we recorded
amortization of goodwill and other intangibles resulting from a purchase
business combination completed in the fourth quarter of 1999 and from the two
purchase business combinations that were completed in the third quarter of
2000. The value of the other intangibles was determined using independent
valuations for both the Peak Software and ACT Networks acquisitions.
Purchased In-Process Research and Development
Purchased in-process research and development of $31.5 million represents
the write-off of in-process technology associated with our acquisition of ACT
Networks.
The cost of in-process research and development is based on a fair value
allocation of the purchase price we paid to acquire ACT Networks. The fair
value allocation to in-process research and development was determined by
identifying projects underway at the time of the ACT merger that required
additional efforts to establish technological feasibility after consummation
of the ACT merger. These projects have identifiable technological risk factors
which indicate that even though successful completion is expected, it is not
assured. If an identified project is not successfully completed, there is no
alternative future use for the project and the expected future income will not
be realized.
In valuing in-process research and development, the Company considered,
among other factors, the stage of completion of the development efforts and
the estimated net present value of cash flows expected to result from the
successful deployment of the new products. The stage of completion was
determined by estimating the costs and time incurred to date relative to the
costs and time to be incurred to develop the in-process technology into
commercially viable products. The estimated net present value of cash flows
was based on incremental future cash flows from revenues expected to be
generated by the products being developed, taking into account the
characteristics and applications of the technology, the size and growth rate
of existing and future markets and an evaluation of past and anticipated
product life cycles. Estimated future cash flows were discounted to arrive at
a net present valued and were allocated to in-process research and development
based on the percentage of completion at the date of acquisition.
If we do not successfully deploy commercially accepted technology or
products based on the purchased in-process research and development, our
operating results could be adversely affected in future periods.
15
<PAGE>
Merger Related Costs
Merger related costs are costs of integration of $1.4 million from the
acquisition of ACT Networks that were immediately charged to operations.
Other Income
Other income was $5.1 million in the three months ended September 30, 2000
as compared to $716,000 in the three months ended September 30, 1999 and $13.6
million in the nine months ended September 30, 2000 as compared to $569,000 in
the same 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 and
acquisitions.
Provision for Income Taxes
For the three and nine months ended September 30, 2000 we recorded
provisions for income taxes of $502,000 and $786,000, respectively, related to
current foreign income tax provided on the profits attributable to our foreign
operations and for U.S. state taxes. For the three and nine months ended
September 30, 1999 the tax provisions of $72,000 and $83,000 were 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 used in operating activities was $4.3 million in the nine months
ended September 30, 2000 compared to $9.4 million used in operating activities
in the same period of 1999. The net cash used in operating activities in 2000
was principally the result of the net loss of $40.0 million, the increase in
accounts receivable of $16.0 million and an increase in prepaid and other
assets of $1.4 million offset by adjustments for amortization of compensation,
goodwill and intangibles of $7.8 million, depreciation of $6.1 million and a
charge for purchased in-process research and development of $31.5 million,
increases in accounts payable and accrued liabilities of $2.1 million and in
deferred revenue of $2.6 million. Amortization of deferred compensation,
goodwill and intangibles has increased significantly as a result of the two
acquisitions completed during the third quarter of 2000. The increase in
accounts receivable is the result of increased sales both through growth and
acquisition and the result of the timing of sales in the quarter. We now have
customers in 78 countries throughout the world. We have also decreased
dependency on key customers with only 2 customers individually contributing
greater than 10%. The increase in deferred revenue for 2000 is a result of
increased service revenue deferred for support and maintenance contracts as a
result of the overall increase in sales.
Net cash used in operating activities for the first nine months of 1999 was
attributable primarily to a net loss of $27.3 million and increases in trade
accounts receivable of $8.3 million, inventory of $1.8 million and prepaid and
other assets of $1.6 million, partially offset by depreciation of $1.6
million, amortization of compensation of $17.5 million, increases in accounts
payable and accrued liabilities of $5.4 million and increases in deferred
revenue of $5.0 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 September 30, 1999 as well
as increased sales of maintenance and support contracts.
16
<PAGE>
Net cash used in investing activities was approximately $32.7 million in the
first nine months of 2000 as compared to $33.6 million for the same period in
1999. For 2000, a net $32.1 million of cash used in investing activities was
for the purchase of investment securities net of sales and maturities as
compared to $26.7 million invested during the same period in 1999. Included in
the net cash used in investing activities during 2000 was $15.3 million
invested in long term investments represented by interests in various
privately held companies and a venture capital management fund. During the
nine months ended September 30, 2000 the Company acquired net cash of
$33.3 million from business combinations. The remaining cash used in investing
activities for each year was for purchases of property and equipment totalling
$18.7 million for the nine months ended September 30, 2000 and $6.9 million
for the same period of 1999.
Net cash provided by financing activities was $5.4 million in the three
months ended September 30, 2000 as opposed to $64.9 million for the same
period in 1999. During 2000, cash provided by financing activities was
primarily 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 the public offerings in July and November 1999 and a bank line
of credit.
We believe that our current cash, cash equivalents and short-term
investments balances of $286.6 million at September 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 our current cash, cash
equivalents and short-term investments balances are 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 terms 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.
17
<PAGE>
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
September 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 $226.4 million at September 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 0.2%) in the fair
market value of our available-for-sale securities.
We invest in equity securities of privately-held companies for the promotion
of business and strategic objectives. These investments are generally in
companies in the telecommunications industry. We also have invested in a
venture capital management fund. These investments are included in long-term
investments and are accounted for using the cost method. For investments in
which no public market exists, our policy is to regularly review the operating
performance, recent financing transactions and cash flow forecasts for such
companies in assessing the net realizable values of the securities of these
companies. Impairment losses on equity investments are recorded when events
and circumstances indicate that such assets are impaired and the decline in
value is other than temporary. To date, we have not recorded any impairment
losses.
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 September 30, 2000, we had an accumulated deficit of $78.9 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.
18
<PAGE>
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>
$(52,807,000) Nine months ended September 30, 2000
(33,163,000) Year Ended December 31, 1999
(5,824,000) Year ended December 31, 1998
</TABLE>
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
19
<PAGE>
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. 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. our products interoperate with competing IP telephony products
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 September 30, 1999 to September 30, 2000,
the number of our employees increased from approximately 230 to 760. We expect
our anticipated growth and expansion to continue to place strain on our
management, operational and financial
20
<PAGE>
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.
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.
21
<PAGE>
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 be
sure 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. 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. For the nine months ended September 30, 2000, two customers,
Triumph Technologies and Bright Oceans Corporation (distributor for China
Mobile) accounted for 13% and 10%, respectively, of our net revenues and for
the three months ended September 30, 2000, the same two customers accounted
for 13% and 22% 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. Technologies and
Bright Oceans Corporation (distributor for China Mobile) accounted for 13% and
10%, respectively, of our net revenues and for the three months ended
September 30, 2000, the same two customers accounted for 13% and 22% 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 41% of revenue for the nine months ended September 30, 2000
and 17% of revenue for the same period 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.
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International sales represented approximately 66% of total revenue for the
nine months ended September 30, 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.
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
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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 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
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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 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 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
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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.
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 $30.75 to a high of $169.75 during the nine month period from January
1, 2000 to September 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.
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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.
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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PART II: OTHER INFORMATION
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) On July 24, 2000, Clarent acquired PEAK Software Solutions, Inc. Under
the terms of the merger agreement, Clarent issued 528,739 shares of its common
stock to the PEAK shareholders and $16.7 million in cash in exchange for all
of the outstanding shares of capital stock of PEAK. The shares of Clarent
common stock were issued in reliance upon Rule 506 promulgated under Section
4(2) of the Securities Act of 1933, as amended. Based on representations made
by the PEAK shareholders, the Company believed that fewer than 35 of the PEAK
shareholders were not accredited investors. Each of the non-accredited
investors appointed a purchaser representative and represented that he or she,
either alone or with the purchaser representative, had the knowledge and
experience in financial and business matters that he or she was capable of
evaluating the merits and risks of the prospective investment. All investors
were provided with the information required by Rule 502(b)(2).
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as part of this Form 10-Q:
(1) 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.(i)
(2) Exhibit 2.2 Amendment No. 1, dated as of June 30, 2000, to the
Agreement and Plan of Merger and Reorganization.(i)
(3) Exhibit 27.1 Financial Data Schedule.
(4) Exhibit 99.1 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.(ii)
(5) Exhibit 99.2 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.(ii)
--------
(i) Incorporated by reference to the Exhibits filed with the registrant's
Registration Statement on Form S-4 (No. 333-38216).
(ii) Incorporated by reference to the Exhibits filed with the registrant's
Quarterly Report on Form 10-Q filed with the SEC on August 14, 2000.
(b) Reports on Form 8-K. On August 10, 2000, the Company filed a Current
Report on Form 8-K announcing completion of its acquisition of ACT
Networks, Inc. on August 10, 2000. The required financial statements
and pro forma financial information were subsequently filed by
amendment on Form 8-K/A filed with the SEC on October 24, 2000.
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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: November 14, 2000
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