<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _________
COMMISSION FILE NUMBER: 000-26541
GADZOOX NETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0308899
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
5850 HELLYER AVENUE
SAN JOSE, CA 95138
(408) 360-4950
(ADDRESS, INCLUDING ZIP CODE, OR REGISTRANT'S
PRINCIPAL EXECUTIVE OFFICES AND TELEPHONE
NUMBER, INCLUDING AREA CODE)
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 on June 30,
2000 was 27,768,230 shares.
Page 1 of 38 pages.
<PAGE> 2
GADZOOX NETWORKS, INC.
FORM 10-Q
QUARTER ENDED JUNE 30, 2000
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets as of June 30, 2000 and March 31, 2000
Condensed Statements of Operations for the Three Months Ended
June 30, 2000 and 1999
Condensed Statements of Cash Flows for the Three Months Ended
June 30, 2000 and 1999
Notes to Condensed Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risks
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
</TABLE>
Page 2 of 38 pages.
<PAGE> 3
This Form 10-Q contains forward-looking statements (as defined in the
Private Securities Litigation Reform Act of 1995), including but not limited to
statements regarding Gadzoox' expectations or intentions regarding the future.
Actual results and trends could differ materially from those discussed in the
forward-looking statements. In addition, past trends should not be perceived as
indicators of future performance. Among the factors that could cause actual
results to differ from the forward-looking statements are those detailed
elsewhere in this Report in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and in "Risk Factors", as well as in
Gadzoox' other filings with the Securities and Exchange Commission.
Page 3 of 38 pages.
<PAGE> 4
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GADZOOX NETWORKS, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
June 30, March 31,
2000 2000
--------- ---------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 28,029 $ 42,830
Short-term investments 32,125 30,619
Accounts receivable, net 12,388 14,131
Inventories 10,204 6,665
Prepaid expenses and other current assets 3,736 2,464
--------- ---------
Total current assets 86,482 96,709
Property and equipment, net 7,197 6,495
Goodwill 19,917 -
Other assets 1,459 292
--------- ---------
$ 115,055 $ 103,496
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of note payable $ 3,195 $ 3,248
Current portion of capital lease obligations 1,415 1,545
Accounts payable 7,944 7,079
Compensation related accruals 1,748 1,534
Deferred revenue and other 2,892 2,008
--------- ---------
Total current liabilities 17,194 15,414
Capital lease obligations, net of current portion 1,008 1,292
--------- ---------
Total liabilities 18,202 16,706
--------- ---------
Stockholders' equity:
Common stock 138 134
Additional paid-in capital 151,323 127,251
Deferred compensation (971) (1,140)
Accumulated deficit (53,637) (39,455)
Total stockholders' equity 96,853 86,790
--------- ---------
$ 115,055 $ 103,496
========= =========
</TABLE>
The condensed notes are an integral part to these
condensed financial statements.
Page 4 of 38 pages.
<PAGE> 5
GADZOOX NETWORKS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
----------------------
June 30, June 30,
2000 1999
-------- --------
<S> <C> <C>
Net revenues $ 9,002 $ 9,211
Cost of revenues 5,223 5,414
-------- --------
Gross margin 3,779 3,797
-------- --------
Operating expenses:
Research and development 5,519 3,917
Sales and marketing 5,727 1,888
General and administrative 1,484 764
In-process research and development costs 4,900 -
Amortization of goodwill and intangible assets 1,048 -
Amortization of deferred compensation 168 322
-------- --------
Total operating expenses 18,846 6,891
-------- --------
Loss from operations (15,067) (3,094)
Total other income (expense), net 885 (142)
-------- --------
Net Loss $(14,182) $ (3,236)
======== ========
Basic net loss per share $ (0.52) $ (0.58)
======== ========
Weighted average shares used in computing
basic net loss per share 27,125 5,626
======== ========
Pro forma basic net loss per share $ (0.52) $ (0.17)
======== ========
Weighted average shares used in computing
pro forma basic net loss per share 27,125 19,533
======== ========
</TABLE>
The condensed notes are an integral part to these
condensed financial statements.
Page 5 of 38 pages.
<PAGE> 6
GADZOOX NETWORKS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
---------------------
2000 1999
-------- --------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Loss $(14,182) $ (3,236)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 834 566
Amortization of goodwill and intangible assets 1,048 -
In-process research and development costs 4,900 -
Amortization of deferred compensation 168 322
Accrued interest 57 202
Changes in operating assets and liabilities,
net of assets acquired:
Accounts receivable 1,743 (1,295)
Inventories (3,539) 1,374
Prepaid expenses and other assets (1,421) (75)
Accounts payable and other accrued liabilities 1,074 (699)
-------- --------
Net cash used in operating activities (9,318) (2,841)
-------- --------
Cash Flows from Investing Activities:
Purchases of property and equipment (1,454) (603)
Purchases of investments (1,000) -
Net cash used in the acquisition of SmartSAN, net of cash acquired (1,167) -
Purchase of available for sale investments (1,506) -
-------- --------
Net cash used for investing activities (5,127) (603)
-------- --------
Cash Flows from Financing Activities:
Proceeds from convertible note 2,999 -
Payments on note payable (3,392) (90)
Payments on capital lease obligations (414) (28)
Proceeds from issuance of common stock to employees 451 205
Net cash (used in) provided by financing activities (356) 87
-------- --------
Net decrease in cash and cash equivalents (14,801) (3,357)
Cash and cash equivalents at beginning of period 42,830 12,202
-------- --------
Cash and cash equivalents at end of period $ 28,029 $ 8,845
======== ========
Supplemental Cash Flow Information:
Cash paid for interest $ 52 $ 57
======== ========
Property and equipment acquired under capital lease obligations $ - $ 244
======== ========
</TABLE>
The condensed notes are an integral part to these
condensed financial statements.
Page 6 of 38 pages.
<PAGE> 7
GADZOOX NETWORKS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Information for the three months ended
June 30, 2000 is unaudited)
1. BASIS OF PRESENTATION
The condensed financial statements included herein have been prepared by
Gadzoox Networks, Inc. ("Gadzoox") without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to such rules and regulations. In the
opinion of management, the disclosures are adequate to make the information not
misleading. The condensed balance sheet as of March 31, 2000, has been derived
from the audited financial statements as of that date, but does not include all
disclosures required by accounting principles generally accepted in the United
States. These financial statements and notes should be read in conjunction with
the audited financial statements and notes thereto, included in Gadzoox' Annual
Report on Form 10-K filed with the Securities and Exchange Commission on June
29, 2000 and dated March 31, 2000.
In the opinion of management, the unaudited condensed financial statements
reflect all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation Gadzoox' financial position, results of
operations and cash flows for the periods indicated. The results of operations
for the three months ended June 30, 2000, are not necessarily indicative of the
results that may be expected for future quarters or the fiscal year ending March
31, 2001.
2. ACQUISITION OF SMARTSAN SYSTEMS, INC.
On April 5, 2000, in an acquisition accounted for under the purchase method
of accounting, Gadzoox acquired all of the outstanding shares of SmartSAN
Systems, Inc., a California corporation ("SmartSAN"). Gadzoox acquired SmartSAN
by issuing 239,433 shares of its common stock in exchange for 100% of the
outstanding stock of SmartSAN and has agreed to issue 108,376 additional shares
pursuant to the exercise of SmartSAN stock options outstanding at the time of
the acquisition. Total consideration was as follows:
<TABLE>
<S> <C>
Value of stock issued and options assumed $23,625,000
Merger and other related costs paid in cash 1,169,000
-----------
Total Consideration $24,794,000
===========
</TABLE>
The allocation of the total consideration to the fair value of acquired
assets and liabilities is as follows:
<TABLE>
<S> <C>
Fair value of net assets acquired and liabilities assumed ($ 1,071,000)
Goodwill 20,965,000
In-process research and development 4,900,000
------------
$ 24,794,000
============
</TABLE>
Page 7 of 38 pages.
<PAGE> 8
At the time of the acquisition, Gadzoox expensed approximately
$4,900,000 of purchased in-process research and development costs. Other
purchased intangible assets, including goodwill, developed technology and other
intangible assets of approximately $20,965,000 are being amortized over their
estimated useful lives of five years on a straight-line basis. For the quarter
ended June 30, 2000, Gadzoox amortized approximately $1,048,000 of goodwill and
intangible assets.
The $4,900,000 expensed as in-process research and development costs
represented approximately 19% of the purchase price and was attributed and
supported by an analysis that identified revenue and costs on a
project-by-project basis. The value assigned to purchased in-process technology,
based on a discounted cash flow method, was determined by identifying research
projects in areas for which technological feasibility has not been established.
As of the acquisition date, in-process projects consisted of the Geminix router
and two other router products. The value of in-process research and development
was determined by estimating the costs to develop the purchased in-process
technology into commercially viable products, estimating the resulting net cash
flows from such projects and discounting the net cash flows back to their
present value. The discount rate includes a risk-adjusted discount rate to take
into account the uncertainty surrounding the successful development of the
purchased in-process technology and the completeness of each product at the time
of the acquisition. The discount rate used was 35%. The percentage complete
calculations for all products were estimated based on research and development
expenses incurred to date and management's estimates of remaining development
costs which do not differ materially from historical amounts. At the date of
acquisition, The Geminix router and two other products under development at the
time of the acquisition were determined to be 80%, 65% and 25% complete,
respectively.
3. NET LOSS PER SHARE
Basic and diluted net income (loss) per share are presented in conformity
with Statement of Financial Accounting Standards No. 128, "Earnings Per Share,"
("SFAS No. 128") for all periods presented. In accordance with the Securities
and Exchange Commission Staff Accounting Bulletin No. 98, common stock and
convertible preferred stock issued or granted for nominal consideration prior to
the anticipated effective date of an initial public offering must be included in
the calculation of basic and diluted net income (loss) per share as if such
stock has been outstanding for all periods presented. To date, Gadzoox has not
had any issuances or grants for nominal consideration.
In accordance with SFAS No. 128, basic net income (loss) per share has
been computed using the weighted-average number of shares of common stock
outstanding during the period, less shares subject to repurchase. Pro forma
basic net loss per share has been computed as described above and assuming the
conversion of convertible preferred stock into an equivalent number of common
shares, as if the shares had converted on the dates of their issuance.
Page 8 of 38 pages.
<PAGE> 9
The following table presents the calculation of basic and pro forma
basic net loss per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended
-------------------------
June 30, June 30,
2000 1999
-------- --------
(unaudited)
<S> <C> <C>
Net loss $(14,182) $ (3,236)
======== ========
Basic:
Weighted average shares of common
stock outstanding 27,127 5,961
Less: Weighted average shares of
common stock subject to repurchase (2) (335)
-------- --------
Weighted average shares used in
computing basic net loss per share 27,125 5,626
======== ========
Basic net loss per share $ (0.52) $ (0.58)
======== ========
Pro forma:
Net loss $(14,182) $ (3,236)
======== ========
Shares used above 27,125 5,626
Pro forma adjustment to reflect
weighted average effect of assumed
conversion of convertible preferred
stock - 13,907
-------- --------
Weighted average shares used in
computing pro forma basic net
loss per shares 27,125 19,533
======== ========
Pro forma basic net loss per share $ (0.52) $ (0.17)
======== ========
</TABLE>
4. CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
All highly liquid investment securities with original maturities of three
months or less are considered cash equivalents. Available for sale investments
not intended to be held to maturity with original maturities of more than three
months are considered short-term investments. Management determines the
appropriate classification of investments in debt and equity securities at the
time of purchase. All of Gadzoox' investments are classified as available for
sale. At June 30, 2000, Gadzoox held $60.2 million in cash and cash equivalents
and short-term investments. All investments are stated at fair market value.
5. INVENTORIES
Inventories are stated at the lower of cost or market, on a first in, first out
method. Inventories consist of the following (in thousands):
Page 9 of 38 pages.
<PAGE> 10
<TABLE>
<CAPTION>
June 30, March 31,
2000 2000
----------- ---------
(unaudited)
<S> <C> <C>
Raw materials $ 3,044 $3,582
Work-in-progress 171 58
Finished goods 6,989 3,025
------- ------
$10,204 $6,665
======= ======
</TABLE>
6. CONVERTIBLE NOTE
In September 1998, Gadzoox entered into a $15,000,000 convertible note
purchase agreement (the "Agreement") with Seagate Technology, Inc. ("Seagate").
The Agreement provides that Seagate purchase up to $15.0 million of convertible
subordinated promissory notes (the "Convertible Notes"), bearing simple interest
on the unpaid principal balance at a rate equal to 5.75% per annum with
principal and interest maturing September 2001. At the sole option of the
Company, the Company may require that any portion or all of the outstanding
balance of principal and interest on the Convertible Note converts into shares
of Series G preferred stock at a price of $7.65 per share. Accrued interest is
converted prior to any principal owing under the Convertible Note. In the event
of a default, as defined in the Agreement, Seagate may declare all outstanding
interest and principal immediately due and payable in cash. Gadzoox may, upon 30
days written notice to Seagate, prepay the Convertible Note in whole or in part.
For the period from October 1998 through June 30, 2000, a total $12.8
million of principal and accrued interest was converted into 1,668,722 shares of
common stock in three separate transactions.
At June 30, 2000, there was approximately $3.1 million of unpaid principal
and interest outstanding under the Convertible Note; if converted at June 30,
2000, the Convertible Note would have converted into 404,691 shares of common
stock. In June 2000, Gadzoox notified Seagate of its intention to repay, on July
31, 2000, the outstanding principal and interest owing under the Convertible
Note which is estimated to be approximately $3.1 million at that date. On July
31, 2000, the Company repaid, in full, the outstanding principal and accrued
interest under the loan of approximately $3.1 million in cash. As a result of
the repayment, the Company has reclassified the amount of the convertible note
at March 31, 2000, of $3,052,000 from long-term liabilities to short-term
liabilities.
7. LEGAL PROCEEDINGS
From time to time, Gadzoox may become involved in various lawsuits and legal
proceedings which arise in the ordinary course of business. In May 1999, a
former employee filed a complaint against Gadzoox. The parties have voluntarily
agreed to participate in a mediation session that we expect to occur within the
next 60 days. If mediation is unsuccessful, discovery will commence and Gadzoox
intends to defend against the charges. Management believes the resolution of
this claim will not have a material adverse effect on Gadzoox' financial
condition or results of operations. However, litigation is subject to inherent
uncertainties, and an adverse result in this or other matters could arise from
time to time that may harm Gadzoox' business and, financial condition and
results of operations.
8. COMMON STOCK
1999 EMPLOYEE STOCK PURCHASE PLAN
Page 10 of 38 pages.
<PAGE> 11
In May 1999, the Board of Directors approved the adoption of Gadzoox'
1999 Employee Stock Purchase Plan (the "Stock Purchase Plan"). The Stock
Purchase Plan was approved by the stockholders on June 19, 1999. A total of
150,000 shares of common stock were initially reserved for issuance under the
Stock Purchase Plan. The number of shares reserved for issuance under the Stock
Purchase Plan are subject to annual increases to be added on the first day of
Gadzoox' fiscal year, beginning in 2000, and equal to the lesser of (a) 250,000
shares, (b) 0.5% of the outstanding shares on such date, or (c) a lesser amount
determined by the Board of Directors. In April 2000, the Board of Directors
authorized 250,000 shares to be added to the Stock Purchase Plan. The Stock
Purchase Plan allows eligible employees to purchase shares of common stock
through payroll deductions at 85% of the fair market value of the common stock.
As of June 30, 2000, 38,879 shares had been purchased from the Stock Purchase
Plan.
1993 STOCK OPTION PLAN
In May 1999, the Board of Directors approved and adopted an Amended and
Restated 1993 Stock Option Plan (the "Amended Plan"). The Amended Plan was
approved by the stockholders on June 19, 1999 and was effective upon the closing
of Gadzoox' initial public offering on July 20, 1999. Under the Amended Plan,
the number of shares authorized for issuance increased to 8,180,000. The number
of shares reserved for issuance under the Amended Plan will be subject to annual
increases to be added on the first day of Gadzoox' fiscal year, beginning in
2000, and equal to the lesser of (a) 1,500,000 shares, (b) 1% of the outstanding
shares on such date, or (c) a lesser amount determined by the Board of
Directors. Accordingly, in April 2000, the Board of Directors authorized
1,342,092 shares to be added to the Amended Plan.
1999 DIRECTOR STOCK OPTION PLAN
In May 1999, the Board of Directors approved the adoption of the 1999
Director Stock Option Plan (the "Director Plan"). The Director Plan was approved
by the stockholders on June 19, 1999. The Director Plan provides for the
automatic grant of 5,000 shares of common stock to each non-employee director on
the later of the date of adoption of the Director Plan or the date on which such
person first becomes a director (the "Initial Grant"). After the Initial Grant,
the non-employee director will receive automatic annual grants of 2,500 shares
of common stock. All shares granted under the Director Plan are 100% vested at
the grant date and expire upon the earlier of three years or the resignation of
the director from the Board of Directors. A total of 50,000 shares of common
stock were initially reserved for issuance under the Director Plan. The number
of shares reserved for issuance under the Director Plan is subject to annual
increases, beginning with the fiscal year beginning in 2000, sufficient to bring
the number of shares available for future issuance to 50,000 shares. In April
2000, the Board of Directors authorized an additional 50,000 shares to be added
to the Director Plan. As of June 30, 2000, options to acquire 20,520 shares of
common stock were outstanding under the Director Plan.
2000 NONSTATUTORY STOCK OPTION PLAN
In June 2000, the Board of Directors approved the adoption of the 2000
Nonstatutory Stock Option Plan (the "NSO Plan"). The number of shares reserved
for issuance under this Plan was 1,600,000. The NSO Plan is designed to issue
stock option grants to only non-officer employees. Options shall vest at a rate
of 1/48th each month for existing employees, subject to the optionee's continued
employment with the Company, and for new employees 1/4th shall vest on the first
anniversary date of the grant with the remainder vesting at 1/48th per month. No
grants had been issued as of June 30, 2000, however during July 2000, 956,400
shares were granted.
9. BUSINESS SEGMENTS
Page 11 of 38 pages.
<PAGE> 12
During the year ended March 31, 2000, Gadzoox adopted Statement of Financial
Accounting Standards No. 131 "Disclosures About Segments of an Enterprise and
Related Information ("SFAS No. 131") which requires a new basis of determining
reportable business segments, i.e., the management approach. This approach
requires that business segment information used by management to assess
performance and manage company resources be the source for information
disclosure. On this basis, Gadzoox is organized and operates as one business
segment, the development, manufacture, marketing and sales of hubs, switches,
routers and managed storage systems for storage area networks.
10. FACILITY LEASE AGREEMENTS
In May 2000, Gadzoox entered into a facility lease agreement with its
current facility lessor to lease an additional 73,000 square feet in a building
to be erected next to its current headquarter facilities. The triple-net lease
expires on November 30, 2005 and provides for an initial monthly square foot
rental rate of $2.00. In addition, the Board of Directors authorized the
issuance of warrants to the lessor to purchase 50,000 shares of common stock at
$26.375 per share.
In June 2000, Gadzoox entered into an eighteen-month facility lease of
approximately 7,800 square feet in a neighboring facility. The monthly full
service lease provides for monthly square foot rental rate of $3.75.
11. EQUITY INVESTMENT IN STRATEGIC PARTNER
In May 2000, Gadzoox purchased 49,164 shares of Series C Preferred Stock of
DataCore Software Corporation, a privately held strategic partner, at $20.34 per
share for a total investment of approximately $1.0 million.
Page 12 of 38 pages.
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the
condensed interim financial statements and the notes thereto included in Item 1
of this Quarterly Report and with Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in Gadzoox' Annual
Report on Form 10-K filed with the Securities and Exchange Commission on June
29, 2000, and as amended on July 31, 2000.
FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY
This discussion contains forward-looking statements that relate to future
events or our future performance such as future product development and
deployment including development and deployment of the Geminix router, the
Axxess Network Storage Pool product, a fibre channel fabric backbone switch and
other future products, percentage of revenues derived from products, percentage
of gross margin, our investment in research and development, sales and marketing
and general and administrative activities or the evolution of SAN capabilities
and the market for SAN products. In certain cases you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"intends," "potential" or "continue" or the negative of such terms or other
comparable terminology. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of various factors,
including but not limited to market acceptance of our new products and the speed
at which customers adopt current and new products for SANs; the ability and
willingness of our distribution channel partners to sell our products; growth
rates of the market segment within which we participate; competition in our
industry and the timing of new technology and product introductions; the ability
to retain and hire skilled personnel and the risks outlined under "Risk Factors"
and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on
Form 10-K, as amended, filed with the Securities and Exchange Commission and
dated March 31, 2000. All forward-looking statements included in this document
are based on information available to us on the date hereof and we assume no
obligation to update any such forward-looking statements.
COMPANY OVERVIEW
We are a leading provider of hardware and software products for storage
area networks, or "SANs". Our SAN hub, switch, router and network storage pool
products are designed to leverage the capabilities of fibre channel technology
to enable companies to better manage the growth in mission-critical data by
overcoming the limitation of traditional captive storage architecture. We sell
our SAN products primarily through leading original equipment manufacturers
("OEMs"), including Hewlett-Packard Company, Compaq Computer Corporation and
Data General Corporation. We also sell our products through distribution channel
partners.
We were founded in April 1992 and initially developed electronic test
equipment. Since October 1995, we have focused on developing fibre channel
network products that address the needs of the SAN market. In fiscal 1997, we
sold our patent rights to the electronic test equipment. Prior to fiscal 1998,
our operating activities related primarily to increasing our research and
development capabilities, designing and developing hardware and software
products which we currently sell and staffing our administrative, marketing and
sales organizations. Since our inception, we have incurred significant losses,
and as of June 30, 2000, we had an accumulated deficit of $53.6 million and our
net loss for the quarter ended June 30, 2000 was approximately $14.2 million. We
have not achieved profitability on a quarterly or annual basis and anticipate
that we will incur net losses for the foreseeable future. We expect to continue
to incur significant sales and marketing, product development and administrative
expenses, and as a result, we need
Page 13 of 38 pages.
<PAGE> 14
to generate significant net revenues to achieve and maintain profitability. With
the exception of the three months ended June 30, 2000, our net revenues have
grown in the past. However, we may not be able to sustain these growth rates,
and we may not realize sufficient net revenues to achieve profitability.
On April 5, 2000, in an acquisition accounted for under the purchase
method of accounting, Gadzoox acquired all of the outstanding shares of SmartSAN
Systems, Inc., a California corporation ("SmartSAN"). Gadzoox acquired SmartSAN
by issuing 239,433 shares of its common stock in exchange for 100% of the
outstanding stock of SmartSAN and has agreed to issue 108,376 additional shares
pursuant to the exercise of SmartSAN stock options outstanding at the time of
the acquisition. Total consideration was as follows:
<TABLE>
<S> <C>
Value of stock issued and options assumed $23,625,000
Merger and other related costs paid in cash 1,169,000
-----------
Total Consideration $24,794,000
===========
</TABLE>
The allocation of the total consideration to the fair value of acquired assets
and liabilities is as follows:
<TABLE>
<S> <C>
Fair value of net assets acquired and liabilities assumed ($ 1,071,000)
Goodwill 20,965,000
In-process research and development 4,900,000
------------
$ 24,794,000
============
</TABLE>
At the time of the acquisition, Gadzoox expensed approximately
$4,900,000 of purchased in-process research and development costs. Other
purchased intangible assets, including goodwill, developed technology and other
intangible assets of approximately $20,965,000 are being amortized over their
estimated useful lives of five years on a straight-line basis. For the quarter
ended June 30, 2000, Gadzoox amortized approximately $1,048,000 of goodwill and
intangible assets.
We currently derive substantially all of our net revenues from sales of
a limited number of products. During fiscal 2000, substantially all of our net
revenues were derived from sales of our hub and switch products. We commenced
commercial shipment of our Capellix 3000 switch products during the quarter
ending December 31, 1999 and commenced commercial shipment of our Capellix 2000
switch products in the fiscal quarter ended March 31, 2000. During the fiscal
quarter ended June 30, 2000, we derived initial revenues from our Geminix router
product. We expect that as we continue to sell our Capellix switch products and
our router and network storage pool products, our hub revenues will decrease as
an overall percentage of our total net revenues in fiscal 2001. We may not be
successful in our efforts to diversify our product base or complete the
development of our fibre channel fabric backbone switch and other products under
development. Also, we may not be successful in the adoption of new products.
Additionally, even if our customers adopt our Capellix, Geminix and newer
products, we can not assure you that our net revenues will increase.
We depend on a few key customers. In fiscal 2000, approximately 72% of
our net revenues came from four customers with sales to Hewlett-Packard, Compaq
Computer Corporation, Bell Microproducts, Inc. and Tokyo Electron Limited, each
accounting for more than 10% of our net revenues. For the three months ended
June 30, 2000, approximately 95% of our net revenues came from two customers
with approximately 58% from Hewlett Packard Company and 37% from Compaq Computer
Corporation.
We record product net revenues upon shipment and provide an allowance
for product returns based on management's estimates. Allowances for estimated
sales returns are provided at the time of revenue recognition. Our past product
return experience may not be indicative of future product return rates.
Page 14 of 38 pages.
<PAGE> 15
Our contracts with our distribution channel partners generally contain
additional provisions for stock rotation, which provide for a right of return of
10% to 15% of the value of purchases during the prior three months, to be offset
with an immediately deliverable order in an amount equal to or greater than the
stock to be rotated. We provide reserves for stock rotations. Our past stock
rotation experience may not be indicative of future stock rotation rates.
Our gross margins are affected by fluctuations in demand for our
products, the mix of products sold, the mix of sales channels through which our
products are sold, the timing and size of customer orders and product
implementations, new product introductions both by us and by our competitors,
changes in our pricing policies and those of our competitors, component costs
and the volume manufacturing pricing we are able to obtain from our contract
manufacturer and other factors.
Although we enter into general sales contracts with our customers, none
of our customers are obligated to purchase any amount of our products pursuant
to these contracts. We rely on our customers to submit purchase orders for
specific quantities of our products. All of our sales contracts contain
provisions regarding the following:
- products and pricing;
- order dates, rescheduling and cancellations;
- warranties and repair procedures; and
- marketing and/or sales support and training obligations.
Our OEM contracts generally contain additional provisions regarding
product technical specifications, labeling and boxing instructions and other
customization instructions. Several of our OEM sales contracts contain favored
pricing provisions as well as confidentiality provisions. Two of our OEM sales
contracts provide the OEM the right to manufacture our product in the event of a
material default we are unable to cure within a specified time period.
We currently outsource substantially all of our product manufacturing to
Sanmina Corporation, a third-party manufacturer and manufacture our products in
two of their locations in the United States. Our agreement with Sanmina
Corporation provides for two months of rolling purchase orders and rolling
forecasts for nine months immediately following the purchase order period.
Purchase prices are negotiable throughout the three-year contract period. We are
liable for materials that Sanmina Corporation purchases on our behalf that we
cannot use, cannot be cancelled before receipt or are unique parts otherwise
unusable by Sanmina Corporation. The agreement restricts our ability to
reschedule orders and allows us to cancel existing orders subject to penalties
of up to the total purchase price. Sanmina Corporation provides warranties on
workmanship and pass-through warranties on component parts. Sanmina Corporation
purchases most of the key components used to manufacture our products. Gadzoox
obtains some of these key components, such as our application specific
integrated circuits, or ASICs, from sole sources and other components, such as
optical transceivers. If we inaccurately forecast demand for our products,
Sanmina Corporation may be unable to provide us with adequate manufacturing
capacity. In addition, Sanmina Corporation may not be able to obtain adequate
supplies of components to meet our customers' delivery requirements.
Alternatively, excess inventory may be accumulated by Sanmina Corporation for
our account. In order to reduce the cost of sales, during the quarter ended
September 30, 1999, we relocated substantially all of our manufacturing
operations from Sanmina Corporation's manufacturing facility in Santa Clara,
California to its manufacturing facility in Guntersville, Alabama. Additionally,
in July 2000 we entered into an agreement with another contract manufacturing
partner to manufacture our products in Thailand and, for a lower volume of
products, to manufacture in San Jose, California. The relocation of certain of
our manufacturing facilities is time consuming and expensive and there can be no
assurance that
Page 15 of 38 pages.
<PAGE> 16
these moves will not disrupt the manufacturing of our products. Such disruptions
could cause us to lose net revenues and damage our customer relationships.
Page 16 of 38 pages.
<PAGE> 17
QUARTERLY RESULTS OF OPERATIONS
The following table presents our operating results for the three-month
periods ended June 30, 2000 and 1999 as a percentage of net revenues,
represented by selected items from the unaudited Condensed Consolidated
Statements of Operations. This table should be read in conjunction with the
Condensed Consolidated Financial Statements included elsewhere herein.
<TABLE>
<CAPTION>
Three Months Ended
--------------------
June 30, June 30,
2000 1999
-------- --------
<S> <C> <C>
Net revenues 100% 100%
Cost of revenues 58 59
---- ---
Gross margin 42 41
---- ---
Operating expenses:
Research and development 61 43
Sales and marketing 64 20
General and administrative 16 8
In-process research and development costs 54 -
Amortization of intangible asset 12 -
Amortization of deferred compensation 2 3
---- ---
Total operating expenses 209 74
---- ---
Loss from operations (167) (33)
Total other income (expense), net 10 (2)
---- ---
Net Loss (157)% (35)%
==== ===
</TABLE>
Net Revenues
Net revenues for the three months ended June 30, 2000, decreased by
approximately $0.2 million or 2% to $9.0 million compared to net revenues of
$9.2 million for the same period in fiscal 1999. For the quarter ended June 30,
2000, approximately 58% of our net revenues came from sales to Hewlett-Packard
Company and approximately 37% of our net revenues came from sales to Compaq
Computer Corporation. We expect a majority of our net revenues in the
foreseeable future to be derived from a limited number of customers. For the
quarter ended June 30, 1999, approximately 29%, 31% and 15% of our net revenues
came from sales to Hewlett-Packard Company, Compaq Computer Corporation and Bell
Microproducts, Inc., respectively.
The decrease in net revenues is primarily attributable to a decrease in
orders from our distribution channel partners due to decreased sell-through to
end-user customers, which resulted in a corresponding decrease in net revenues
of approximately $6.0, or 40%, for the quarter ended June 30, 2000, compared to
net revenues for the quarter ended March 31, 2000. For the quarter ended June
30, 2000, 97% of our net revenues came from sales to OEM customers as compared
to 72% net revenues represented by sales to OEM customers during the quarter
ended June 30, 1999, respectively. Although we have taken several actions to
improve the ability of our distribution channel partners to sell our products to
end-users, we can not assure you that demand for our products through the
distribution channel will increase. If we are unable to effectively leverage
sales through our distribution channel partners, our net revenues may
Page 17 of 38 pages.
<PAGE> 18
continue to decline and our business could be harmed. International sales
represented 34% and 31% of our net revenues for the quarter ended June 30, 2000
and June 30, 1999, respectively.
Page 18 of 38 pages.
<PAGE> 19
Gross Margin
Gross margin remained relatively constant at 42% or $3.8 million for the
quarter ended June 30, 2000, compared to 41% or $3.8 million for the quarter
ended June 30, 1999.
Research and Development Expenses
Research and development expenses consist primarily of salaries and
related personnel costs, fees paid to consultants and outside service providers,
material costs for prototype and test units and other expenses related to the
design, development, testing and enhancements of our products. We expense our
research and development costs as they are incurred.
Research and development expenses increased by 41% to $5.5 million for
the quarter ended June 30, 2000, up from $3.9 million for the quarter ended June
30, 1999. These increases are primarily due to additional research and
development personnel, including the addition of our strategic research and
development team, and the cost of development of the Capellix switch product,
Axxess Network Storage Pool product, Geminix and other router technology, our
fibre channel fabric backbone switch and other future products. We believe that
a significant level of investment in product research and development is
required to remain competitive. Accordingly, we expect to continue to devote
substantial resources to product research and development such that research and
development expenses will continue to increase in absolute dollars.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of salaries, commissions
and other related expenses for personnel engaged in marketing, sales and
customer engineering support functions, as well as costs associated with trade
shows, promotional activities, travel expenses and other related expenses.
Sales and marketing expenses increased by 203% to $5.7 million during
the quarter ended June 30, 2000, up from $1.9 million for the quarter ended June
30, 1999. The increases are primarily attributable to increased staffing, the
cost of supporting OEM customers, providing sales support for distribution
customers, sales tools, training and other marketing and sales activities.
We intend to continue to invest in our sales and marketing operations
and efforts, both domestically and internationally, in order to increase market
awareness and to generate additional sales of our products. However, we cannot
be certain that any increased expenditures will result in higher net revenues.
In addition, we believe our future success depends upon establishing additional
successful relationships with a variety of selling partners. We believe that
continued investment in sales and marketing is critical to our success and
expect these expenses to continue to increase in absolute dollars in the future.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries and
related expenses for executive, finance, accounting, information technology,
facilities and human resources personnel, recruiting expenses, professional fees
and costs associated with expanding our information systems.
General and administrative expenses increased by 94% to $1.5 million for
the quarter ended June 30, 2000, up from $0.8 million for the quarter ended June
30, 1999. These increases are primarily
Page 19 of 38 pages.
<PAGE> 20
attributable to increases in personnel, additional expenses incurred related to
the growth of our business, expansion of our information infrastructure and our
operation as a public company.
We expect general and administrative expenses to continue to increase in
absolute dollars as we add personnel and incur additional costs related to the
growth of our business, expansion of our information infrastructure and our
operation as a public company.
In-process Research and Development Costs
As a result of our acquisition of SmartSAN in April 2000, we expensed
approximately $4.9 million as in-process research and development costs which
represented approximately 19% of the purchase price and was attributed and
supported by an analysis that identified revenue and costs on a
project-by-project basis.
The value assigned to purchased in-process technology, based on a
discounted cash flow method, was determined by identifying research projects in
areas for which technological feasibility has not been established. As of the
acquisition date, in-process projects consisted of the Geminix router and two
other router products. The value of in-process research and development was
determined by estimating the costs to develop the purchased in-process
technology into commercially viable products, estimating the resulting net cash
flows from such projects and discounting the net cash flows back to their
present value. The discount rate includes a risk-adjusted discount rate to take
into account the uncertainty surrounding the successful development of the
purchased in-process technology and the completeness of each product at the time
of the acquisition. The discount rate used was 35%. The percentage complete
calculations for all products were estimated based on research and development
expenses incurred to date and management's estimates of remaining development
costs which do not differ materially from historical amounts. At the date of
acquisition, all the Geminix router and two other products were determined to be
80%, 65% and 25% complete, respectively.
Amortization of Goodwill and Intangible Assets
As a result of our acquisition of SmartSAN in April 2000, purchased
intangible assets, including goodwill, developed technology and other intangible
assets of approximately $21.0 million are being amortized over their estimated
useful lives of five years on a straight-line basis. For the quarter ended June
30, 2000, Gadzoox amortized approximately $1 million of goodwill and intangible.
Amortization of Deferred Compensation
In connection with the grant of stock options to employees, we recorded
deferred compensation within stockholders' equity of approximately $3.0 million,
representing the difference between the estimated fair value of the common stock
for accounting purposes and the option exercise price of these options at the
date of grant. We recorded amortization of deferred compensation of
approximately $0.2 million and $0.3 million for the quarters ended June 30, 2000
and 1999, respectively.
The amortization expense relates to options awarded to employees in all
operating expense categories. The amount of deferred compensation expense to be
recorded in future periods could decrease if options for which accrued but
unvested compensation has been recorded are forfeited.
Other Income (Expense), net
Page 20 of 38 pages.
<PAGE> 21
Interest income, net of interest expense related to our debt and lease
obligations, includes income from our cash and cash equivalents and short-term
investments, net of expenses related to our financing obligations.
Interest income, net of interest expense, totaled $0.9 million for the
quarter ended June 30, 2000. For the quarter ended June 30, 1999, interest
expense, net of interest income, totaled $0.1 million. This increase is
primarily due to interest income earned from investment of the proceeds received
from the issuance of common stock from our initial public offering in July 1999
and by lower interest expense charged on the convertible note due to partial
conversion of the note in connection with our initial public offering. This
increase was partially offset by interest expense charged on capital lease
obligations.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through
private sales of convertible preferred stock, the issuance of a convertible
note, equipment financing and proceeds from our initial public offering.
For the three months ended June 30, 2000, we used $9.3 million in cash
from operations compared to $2.8 for the same period in 1999. This represents an
increase of 228% and is primarily due to an increase in our net loss of $14.2
million, in part due to a one-time charge of approximately $4.9 million for
in-process research and development costs and the amortization of goodwill of
approximately $1 million, both in connection with our acquisition of SmartSAN in
April 2000 and an increase in inventories.
For the three months ended June 30, 2000, Gadzoox used $1.5 million in
cash from investing activities to acquire property and equipment compared to
$0.6 million used in the same period in 1999. Additionally, we invested $1.5
million during the three months ended June 30, 2000 in short-term investments.
In May 2000, we purchased 49,164 shares of Series C Preferred Stock of DataCore
Software Corporation, a privately held strategic partner, at $20.34 per share
for a total investment of approximately $1,000,000. For the three months ended
June 30, 2000, we used approximately $1.2 million in cash for the acquisition of
SmartSAN.
In July 2000, we repaid approximately $3.1 million of principal and
accrued interest on our note payable to Seagate. Accordingly, at June 30, 2000,
and March 31, 2000, we classified our Seagate note payable as a current
obligation. For the three months ended June 30, 2000, cash used by financing
activities was $0.2 million. Cash provided by financing activities was $0.9
million for the three months ended June 1999.
For the three months ended June 30, 2000, we did not acquire any
equipment under capitalized leases. For the three months ended June 30, 1999, we
acquired $0.2 million in equipment under capitalized leases. At June 30, 2000,
we had $2.4 million in outstanding capitalized lease obligations.
Cash, cash equivalents and short-term investments totaled $60.2 at June
30, 2000, down from $73.4 million at March 31, 2000. This decrease is primarily
due to cash used in operations of $9.3 million. This decrease was partially
offset by cash raised from the exercise of employee stock options.
Our capital requirements depend on numerous factors, including market
acceptance of our products, the resources we devote to developing, marketing,
selling and supporting our products, the timing and expense associated with
expanding and educating our distribution channels, and other factors. We expect
to devote substantial capital resources to continue our research and development
efforts, to hire and expand our sales, support, marketing and product
development organizations, to expand marketing programs, to establish additional
facilities worldwide and for other general corporate activities. We believe that
our
Page 21 of 38 pages.
<PAGE> 22
existing cash balances, credit facilities and cash generated from future
operations will be sufficient to fund our operations for at least the next 12
months. However, we may require additional financing within this time frame and
there can be no assurances that this additional funding, if needed, will be
available on terms acceptable to us or at all.
Page 22 of 38 pages.
<PAGE> 23
RISK FACTORS
You should carefully consider the following risk factors and all other
information contained in this Form 10-Q. Risks and uncertainties, in addition to
those we describe below, that are not presently known to us, or that we
currently believe are immaterial may also impair our business operations. If any
of the following risks occur, our business, operating results and financial
condition could be seriously harmed. See also page 13 of this document for a
discussion of forward-looking statements. In addition, the trading price of our
common stock could decline due to the occurrence of any of these risks.
WE HAVE INCURRED SIGNIFICANT LOSSES IN EVERY FISCAL YEAR AND FISCAL QUARTER
SINCE OUR INCEPTION AND WE MAY NEVER BECOME PROFITABLE.
We have incurred significant losses since inception and expect to continue to
incur losses on both a quarterly and annual basis for the foreseeable future. As
of June 30, 2000, our accumulated deficit was $53.6 million and we expect to
incur significant product development, sales and marketing and administrative
expenses and, as a result, we will need to generate increased net revenues to
achieve profitability. Further, even if we achieve profitability, given the
competition in, and the evolving nature of the storage area networking market,
we may not be able to sustain or increase profitability on a quarterly or annual
basis.
DUE TO OUR LIMITED OPERATING HISTORY, WE MAY HAVE DIFFICULTY ACCURATELY
PREDICTING REVENUES FOR FUTURE PERIODS AND APPROPRIATELY BUDGETING FOR EXPENSES,
AND, BECAUSE MOST OF OUR EXPENSES ARE FIXED IN THE SHORT-TERM, WE MAY NOT BE
ABLE TO DECREASE OUR EXPENSES IN A TIMELY MANNER TO OFFSET ANY UNEXPECTED
SHORTFALL IN REVENUES.
We have generated net revenues for less than six years and, thus, we have
only a short history from which to predict future net revenues. This limited
operating experience, combined with the rapidly evolving nature of the SAN
market in which we sell our products, reduces our ability to accurately forecast
our quarterly and annual revenue. Further, we plan our operating expenses based
primarily on these revenue projections. Because most of our expenses are fixed
in the short-term or incurred in advance of anticipated revenue, we may not be
able to decrease our expenses in a timely manner to offset any unexpected
shortfall in revenue. For example, during the quarter ended June 30, 2000,
orders from our distribution channel partners were significantly lower than
expected due to decreased sell-through to end-user customers which resulted in a
corresponding decrease in net revenues of approximately $6.0 million, or 40%
compared to net revenues for the quarter ended March 31, 2000. Also, in July
1998, Digital Equipment Corporation cancelled orders for our Bitstrip product,
which resulted in a corresponding decrease in net revenues. If a similar
situation were to occur in the future, we may incur additional unexpected losses
which could seriously harm our business. For further financial information
relating to our business, see "Notes to Condensed Financial Statements" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
WE HAVE A HISTORY OF QUARTERLY AND ANNUAL FLUCTUATIONS IN OUR NET REVENUES AND
OPERATING RESULTS, AND EXPECT THESE FLUCTUATIONS TO CONTINUE, WHICH MAY RESULT
IN VOLATILITY IN OUR STOCK PRICE.
Our quarterly and annual net revenues and operating results have varied
significantly in the past and are likely to vary significantly in the future due
to a number of factors, many of which are outside of our control. The primary
factors that may cause our quarterly net revenues and operating results to
fluctuate include the following:
- fluctuations in demand for our products and services;
Page 23 of 38 pages.
<PAGE> 24
- the ability and willingness of our distribution channel partners to sell
our products;
- the timing of customer orders and product implementations, particularly
large orders from our customers;
- our ability to develop, introduce, ship and support new products product
enhancements;
- the rate of adoption of SANs as an alternative to existing data storage
and management systems;
- announcements and new product introductions by our competitors and
deferrals of customer orders in anticipation of new products, services or
product enhancements introduced by us or our competitors;
- decreases in the prices at which we can sell our products;
- our ability to obtain sufficient supplies of components, including sole or
limited source components, at expected prices;
- the mix of our hub and switch products sold and the mix of distribution
channels through which they are sold;
- increases in the prices of the components we purchase;
- our ability to maintain quality manufacturing standards for our products;
- competitive technology developments which may decrease the demand for
products based on the technology we utilize;
- our ability to maintain, increase or quickly decrease the contract
production of our products; and
- the mix of our hubs, switches, routers, software and other products sold
and the mix of distribution channels through which they are sold.
Accordingly, you should not rely on the results of any past periods as an
indication of our future performance. It is likely that in future periods, our
operating results may be below expectations of public market analysts or
investors. If this occurs, our stock price may drop. For example, net revenues
for the quarter ended June 30, 2000 were 40% lower than net revenues for the
quarter ended March 31, 2000, as a result of a decline in orders from our
distribution channel partners.
IF OUR DISTRIBUTION CHANNEL PARTNERS ARE UNABLE OR UNWILLING TO RESELL OUR
PRODUCTS, OUR NET REVENUES WILL DECREASE AND OUR BUSINESS WILL BE HARMED.
During fiscal 2000, 35% of our net revenues were derived from sales to
distribution channel partners. During the three months ended June 30, 2000,
approximately 2% of our net revenues were derived from sales to distribution
channel partners. Our OEM customers have demonstrated the ability to resell our
SAN products due, in part, to the length of time they have been involved in the
SAN marketplace and the strength of their internal technical, sales and
marketing structures. Our distribution channel partners have participated in the
SAN market for a shorter period of time and often do not have trained technical,
sales and marketing staff. As a result, they are not as well positioned as our
OEM customers to provide full solution sales. Additionally, distribution channel
partners may not be able to effectively compete with
Page 24 of 38 pages.
<PAGE> 25
OEMs. For example, net revenues for the quarter ended June 30, 2000 were 40%
lower than net revenues for the quarter ended March 31, 2000 as a result of a
decline in orders from our distribution channel partners due to slower than
expected sell-through to end-user customers. Although we have taken several
actions to improve our distribution channel partners' abilities to sell our
products to end-users, we can not assure you that demand for our products
through the distribution channel will increase. If we are unable to effectively
leverage sales through our distribution channel partners, our net revenues may
continue to decline, and our business could be harmed. The inability or
unwillingness of our distribution channel partners to resell SAN networking
equipment, including full SAN solutions, would significantly reduce our net
revenues which would harm our business.
BECAUSE WE DEPEND ON A FEW KEY OEM AND DISTRIBUTION CHANNEL PARTNERS, THE LOSS
OF ANY OF THESE CUSTOMERS COULD SIGNIFICANTLY REDUCE OUR NET REVENUES.
We depend on a few key OEM and distribution channel partners. In fiscal 2000,
approximately 72% of our net revenues came from four customers with sales to
Hewlett-Packard Company, Compaq Computer Corporation, Bell Microproducts, Inc.
and Tokyo Electron Limited, each accounting for 10% or more of our net revenues.
For the quarter ended June 30, 2000, approximately 58% of our net revenues came
from sales to Hewlett-Packard Company and 37% of our net revenues came from
Compaq Computer Corporation. Although we intend to expand our distribution and
original equipment manufacture customer bases, we anticipate that our operating
results will continue to depend on sales to a relatively small number of
customers. None of our current customers have any minimum purchase obligations,
and they may stop placing orders with us at any time, regardless of any forecast
they may have previously provided. The loss of any of our key customers, or a
significant reduction in sales to those customers, could significantly reduce
our net revenues. For example, net revenues for the quarter ending June 30,
2000, were 33% less than net revenues for the quarter ended March 31, 2000, as a
result of a decline in orders from our distribution channel partners due to
slower than expected sell-through to end-user customers. As another example, in
July 1998, Digital Equipment Corporation cancelled orders for our Bitstrip
product, and in December 1998, Hewlett-Packard Company unexpectedly reduced
orders for our Gibraltar 10-port product. Digital Equipment Corporation's order
cancellation resulted in a reduction of anticipated net revenues by
approximately 12% for the fiscal year ended March 31, 1999.
OUR RELIANCE ON OEM CUSTOMERS AND DISTRIBUTION CHANNEL PARTNERS AND THE LENGTHY
PROCESS REQUIRED TO ADD THESE PARTNERS MAY IMPEDE THE GROWTH OF OUR NET
REVENUES.
We rely on OEM customers and distribution channel partners to distribute and
sell our products. As a result, our success depends substantially on (1) our
ability to initiate, manage and expand our relationships with significant OEM
customers, (2) our ability to attract distribution channel partners that are
able and willing to sell our products and (3) the sales efforts of these OEM
customers and distribution channel partners. Our OEM customers typically conduct
significant evaluation, testing, implementation and acceptance procedures before
they begin to market and sell new technologies, including our products. Based on
our experience with our larger OEM customers, this evaluation process is lengthy
and has historically been as long as nine months. This process is also complex
and may require significant sales, marketing and management efforts on our part.
The complexity of this process increases if we must qualify our products with
multiple customers at the same time. In addition, once our products have been
qualified, the length of the sales cycle of each of our OEM customers may vary
depending upon whether our products are being bundled with another product or
are being sold as an option or add-on. Sales to distribution channel partners
may also require lengthy sales and marketing cycles. Additionally, as a result
of lower than expected net revenues from our distribution channel partners, we
have taken several actions to improve sell-through at the end-user level. As a
result, we may expend significant resources in developing partner relationships
before recognizing any revenue. We may not be able to manage and expand our
Page 25 of 38 pages.
<PAGE> 26
relationships with OEM customers and distribution channel partners successfully
and they may be unwilling or unable to market our products successfully.
Moreover, our agreements with OEM customers and distribution channel partners
have no minimum purchase commitments. Our failure to manage and expand our
relationships with OEM customers and distribution channel partners or their
failure or unwillingness to market our products could substantially reduce our
net revenues and seriously harm our business.
OUR BUSINESS MAY BE HARMED BY CLASS ACTION LITIGATION DUE TO STOCK PRICE
VOLATILITY.
In the past, securities class action litigation often has been brought
against a company due to volatility in the market price of its securities. The
market price of our securities has been volatile in the past and may be volatile
in the future. Therefore, we may in the future be the target of securities
litigation. Securities litigation could result in substantial costs and divert
management's attention and resources.
IF WE ARE UNABLE TO MEET OUR FUTURE CAPITAL REQUIREMENTS, WE MAY BE UNABLE TO
DEVELOP OR ENHANCE OUR PRODUCTS, TAKE ADVANTAGE OF FUTURE OPPORTUNITIES OR
RESPOND TO COMPETITIVE PRESSURES OR UNANTICIPATED REQUIREMENTS, EACH OF WHICH
WOULD MATERIALLY HARM OUR BUSINESS.
We believe that our existing cash balances, credit facilities and cash flow
expected to be generated from future operations, will be sufficient to meet our
capital requirements at least through the next 12 months. However, we may be
required, or could elect, to seek additional funding prior to that time. In the
event we are required to raise additional funds we may not be able to do so on
favorable terms, if at all. Further, if we issue new equity securities,
stockholders may experience additional dilution or the new equity securities may
have rights, preferences or privileges senior to those of existing holders of
common stock. If we cannot raise funds on acceptable terms, we may be unable to
develop or enhance our products, take advantage of future opportunities or
respond to competitive pressures or unanticipated requirements. For additional
information on our anticipated future capital requirements, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources."
THE SAN MARKET IN WHICH WE COMPETE IS NEW AND UNPREDICTABLE, AND IF THIS MARKET
DOES NOT DEVELOP AND EXPAND AS WE ANTICIPATE, OUR BUSINESS WILL SUFFER.
The market for SANs and related hub and switch products has only recently
begun to develop and is rapidly evolving. Because the SAN market is new, it is
difficult to predict its potential size or future growth rate. Our products are
used exclusively in SANs. Accordingly, widespread adoption of SANs as an
integral part of data-intensive enterprise computing environments is critical to
our future success. Potential end-user customers who have invested substantial
resources in their existing data storage and management systems may be reluctant
or slow to adopt a new approach, like SANs. The speed at which customers adopt
current and new products for SANs is highly unpredictable. Our success in
generating net revenues in this emerging market will depend on, among other
things, our ability to:
- educate potential OEM customers, distribution channel partners and end
users about the benefits of SANs, as well as hub, switch, router and
network storage pool technologies;
- maintain and enhance our relationships with our OEM customers and channel
partners;
- predict and base our products on standards which ultimately become
industry standards; and
- predict and deliver new and innovative products demanded by the storage
area marketplace.
Page 26 of 38 pages.
<PAGE> 27
In addition, SANs are often implemented in connection with deployment of new
storage systems and servers. Accordingly, our future success is also
substantially dependent on the market for new storage systems and servers.
WE HAVE LIMITED PRODUCT OFFERINGS AND OUR BUSINESS MAY SUFFER IF DEMAND FOR ANY
OF THESE PRODUCTS DECLINES OR FAILS TO DEVELOP AS WE EXPECT.
We derive a substantial portion of our net revenues from a limited number of
products. Specifically, in fiscal 2000 and for the quarter ended June 20, 2000,
the majority of our net revenues were derived from our hub and switch products.
We expect that net revenues from our hub and switch products will continue to
account for a substantial portion of our total net revenues for the foreseeable
future. There is no assurance that our Geminix and Axxess products, as well as
other products currently under development or that will be developed, will be
adopted by end-users or our OEM or distribution channel partners or that
significant net revenues would be derived if adopted. As a result, for the
foreseeable future, we will continue to be subject to the risk of a significant
decrease in net revenues if demand for our hub and switch products decline.
Therefore, continued market acceptance of our hub, switch, router and Axxess
products is critical to our future success. Factors that may affect the market
acceptance of our products, some of which are beyond our control, include the
following:
- growth and changing requirements of the SAN and hub and switch product
markets;
- availability, price, quality and performance of competing products and
technologies;
- performance, quality, price and total cost of ownership of our products;
and
- successful development of our relationships with existing and potential
OEM customers and distribution channel partners.
OUR BUSINESS WILL SUFFER IF WE FAIL TO DEVELOP AND SUCCESSFULLY INTRODUCE NEW
AND ENHANCED PRODUCTS THAT MEET THE CHANGING NEEDS OF OUR CUSTOMERS.
Our future success depends upon our ability to address the rapidly changing
SAN market including changes in relevant industry standards and the changing
needs of our customers by developing and introducing high-quality,
technologically-progressive, cost-effective products, product enhancements and
services on a timely basis. In May 1999, we announced the launch of our Capellix
switch and commenced initial shipments in September 1999. Additionally, we
commercially shipped our Geminix product and introduced our Axxess product
during the quarter ended June 30, 2000, and we expect to release our fibre
channel backbone switch and another router product later in fiscal 2001. Our
future net revenue growth will be dependent on the success of these and other
new products, and we may not be able to develop and introduce these or other new
products successfully in the time frame we expect. Further, we cannot be certain
of the demand for, and market acceptance of, these and other new products. In
addition, we must successfully manage the introduction of new or enhanced
products to minimize disruption in our customers' ordering patterns, avoid
excessive levels of older product inventories and ensure that adequate supplies
of new products can be delivered to meet our customers' demands. Our net
revenues may be reduced if we fail to develop product enhancements, if we fail
to introduce new products, if we do not successfully manage inventories of our
older products or if any new products or product enhancements that we develop
and introduce are not broadly accepted.
Page 27 of 38 pages.
<PAGE> 28
COMPETING TECHNOLOGES MAY EMERGE AND WE MAY FAIL TO ADOPT NEW TECHNOLOGIES ON A
TIMELY BASIS. FAILURE TO UTILIZE NEW TECHNOLOGIES MAY DECREASE THE DEMAND FOR
OUR PRODUCTS.
The technology being deployed today in most SAN products is FC-AL or FC-SW.
During the last fiscal year, the development of competing technologies such as
Ethernet IP has been discussed by the technical community. If we are unable to
identify new technologies in a timely manner and efficiently utilize such new
technologies in our product developments, the demand for our current products
may decrease significantly and rapidly, which would harm our business.
WE WILL BE UNABLE TO MANUFACTURE OR SELL OUR PRODUCTS IF OUR SOLE CONTRACT
MANUFACTURER IS UNABLE TO MEET OUR MANUFACTURING NEEDS.
Sanmina Corporation, a third-party manufacturer for numerous companies,
manufactures all of our products at its Guntersville, Alabama facility. Sanmina
Corporation is not obligated to supply products to us for any specific period,
or in any specific quantity, except as may be provided in a particular purchase
order which has been accepted by Sanmina Corporation. If Sanmina Corporation
experiences delays, disruptions, capacity constraints or quality control
problems in its manufacturing operations, then product shipments to our
customers could be delayed, which would negatively impact our net revenues and
our competitive position and reputation. Further, our business would be harmed
if we fail to effectively manage the manufacture of our products. We generally
place orders with Sanmina Corporation at least two months prior to scheduled
delivery of products to our customers. Accordingly, if we inaccurately forecast
demand for our products, we may be unable to obtain adequate manufacturing
capacity from Sanmina Corporation or adequate quantities of components to meet
our customers' delivery requirements or we may accumulate excess inventories. In
the future, we intend to work with additional new contract manufacturers that
can potentially manufacture our higher volume products at lower costs in foreign
locations. We could experience difficulties and disruptions in the manufacture
of our products while we transition to new facilities. Manufacturing disruptions
could prevent us from achieving timely delivery of products and could result in
lost net revenues. Additionally, we must coordinate our efforts with those of
our suppliers and Sanmina Corporation, and our other new third party
manufacturers, to rapidly achieve volume production. Although we have not
experienced supply problems with Sanmina Corporation, we have experienced delays
in product deliveries from one of our former contract manufacturers. Moreover,
we may in the future need to find additional contract manufacturers that can
manufacture our products in higher volume and at lower costs. We may not find a
contract manufacturer that meets our needs. Additionally, qualifying a new
contract manufacturer and commencing volume production is expensive and time
consuming. If we are required or choose to change contract manufacturers, we may
lose net revenues and our customer relationships may suffer.
BECAUSE WE DEPEND ON SOLE SOURCE AND LIMITED SOURCE SUPPLIERS FOR KEY
COMPONENTS, WE ARE SUSCEPTIBLE TO SUPPLY SHORTAGES THAT COULD ADVERSELY AFFECT
OUR OPERATING RESULTS.
We depend upon a single source for each type of our application-specific
integrated circuits, or ASICs, and limited sources of supply for several key
components, including, but not limited to, power supplies, chassis and optical
transceivers. We have in the past experienced and may in the future experience
shortages of, or difficulties in acquiring, these components. Because we rely on
Sanmina Corporation, and now our newer contract manufacturer, to procure
components required for the manufacture of our products, Sanmina Corporation may
suffer component shortages. If we or our contract manufacturing partners are
unable to buy these components, we will not be able to manufacture our products
on a timely basis which would harm our business
Page 28 of 38 pages.
<PAGE> 29
BECAUSE WE ORDER COMPONENTS AND MATERIALS BASED ON ROLLING FORECASTS, WE MAY
OVERESTIMATE OR UNDERESTIMATE OUR COMPONENT AND MATERIAL REQUIREMENTS, WHICH
COULD INCREASE OUR COSTS OR PREVENT US FROM MEETING CUSTOMER DEMAND.
We use rolling forecasts based on anticipated product orders to determine our
component requirements. Lead times for materials and components that we order
vary significantly and depend on factors, such as, specific supplier
requirements, contract terms and current market demand for such components. As a
result, our component requirement forecasts may not be accurate. If we
overestimate our component requirements, we may have excess inventory, which
would increase our costs. If we underestimate our component requirements, we may
have inadequate inventory, which could interrupt our manufacturing and delay
delivery of our products to our customers. Any of these occurrences would
negatively impact our business and operating results.
OUR OPERATING RESULTS MAY SUFFER BECAUSE OF COMPETITION IN THE SAN MARKET, AS
WELL AS ADDITIONAL COMPETITION FROM DATA NETWORKING COMPANIES AND ENTERPRISE
SOFTWARE DEVELOPERS.
The market for our SAN hub, switch and router products is competitive, and is
likely to become even more competitive. In the SAN market, our current
competitors include Ancor Communications, Inc., Brocade Communications Systems,
Inc., Emulex Corporation, McData Corporation, Vixel Corporation, Cornerstone,
Chaparral Network Storage, Inc., Atto and Pathlight. In addition to these
companies, we expect new SAN competitors to emerge. In the future, we may also
compete against data networking companies which may develop SAN products.
Furthermore, although we currently offer products that complement the software
products offered by Legato Systems, Inc. and Veritas Software Corporation, they
and other enterprise software developers may in the future compete with us. We
also compete with providers of data storage solutions that employ traditional
storage technologies, including small computer system interface-based technology
such as Adaptec, Inc., LSI Logic Corporation and QLogic Corporation. Increased
competition could result in pricing pressures, reduced sales, reduced margins,
reduced profits, reduced market share or the failure of our products to achieve
or maintain market acceptance. Some of our competitors and potential competitors
have longer operating histories, greater name recognition, access to larger
customer bases, more established distribution channels or substantially greater
resources than we have. As a result, they may be able to respond more quickly
than we can to new or changing opportunities, technologies, standards or
customer requirements. Moreover, we have only recently begun to offer SAN
switch, router and Axxess products. Therefore, we may not be able to compete
successfully in the SAN switch product market.
IF WE CANNOT INCREASE OUR SALES VOLUMES, REDUCE OUR COSTS OR INTRODUCE HIGHER
MARGIN PRODUCTS TO OFFSET REDUCTIONS IN THE AVERAGE UNIT PRICE OF OUR PRODUCTS,
OUR OPERATING RESULTS MAY SUFFER.
We anticipate that as products in the storage area market become more
commoditized, the average unit price of our products will continue to decline in
the future in response to changes in product mix, competitive pricing pressures,
new product introductions by us or our competitors or other factors. If we are
unable to offset the anticipated decrease in our average selling prices by
increasing our sales volumes, our net revenues will decline. In addition, to
maintain our gross margins, we must continue to reduce the manufacturing cost of
our products. Further, as average unit prices of our current products decline,
we must develop and introduce new products and product enhancements with higher
margins. If we cannot maintain our gross margins, our business could be
seriously harmed, particularly if the average selling price of our products
decreases significantly.
Page 29 of 38 pages.
<PAGE> 30
OUR PRODUCTS ARE COMPLEX AND MAY CONTAIN UNDETECTED SOFTWARE OR HARDWARE ERRORS,
WHICH COULD LEAD TO AN INCREASE IN OUR COSTS OR A REDUCTION IN OUR NET REVENUES.
Networking products frequently contain undetected software or hardware errors
when first introduced or as new versions are released. Our products are complex
and we have from time to time found errors in existing products, and we may from
time to time find errors in our existing, new or enhanced products. In addition,
our products are combined with products from other vendors. As a result, should
problems occur, it may be difficult to identify the source of the problem. The
occurrence of hardware and software errors, whether caused by our or other
vendors' SAN products, could adversely affect sales of our products, cause us to
incur significant warranty and repair costs, divert the attention of our
engineering personnel from our product development efforts and cause significant
customer relationship problems.
IF WE DO NOT HIRE, RETAIN AND INTEGRATE HIGHLY SKILLED MANAGERIAL, ENGINEERING,
SALES, MARKETING, FINANCE AND OPERATIONS PERSONNEL, OUR BUSINESS MAY SUFFER.
Our success depends to a significant degree upon the continued contributions
of our key personnel in engineering, sales, marketing, finance and operations,
many of whom would be difficult to replace. We do not maintain key person life
insurance on most of our key personnel and do not have employment contracts with
any of our key personnel. The loss of the services of any of our key personnel
could have a negative impact on our business. We also believe that our success
depends to a significant extent on the ability of our key personnel to operate
effectively, both individually and as a group. Many of our employees have only
recently joined us. If we are unable to integrate new employees in a timely and
cost-effective manner, our operating results may suffer. We believe our future
success will also depend in large part upon our ability to attract and retain
highly skilled managerial, engineering, sales, marketing, finance and operations
personnel. Competition for these people is intense, especially in the San
Francisco Bay area where our operations are headquartered. In particular, we
have experienced difficulty in hiring qualified ASIC, software, system, test and
customer support engineers and we may not be successful in attracting and
retaining individuals to fill these positions. If we are unable to attract or
retain qualified personnel in the future, or if we experience delays in hiring
required personnel, particularly qualified engineers and sales personnel, our
ability to develop, introduce and sell our products could be harmed. In
addition, companies in our industry whose employees accept positions with
competitors frequently claim that their competitors have engaged in unfair
hiring practices. We may be subject to such claims in the future as we seek to
hire qualified personnel. Any claim of this nature could result in material
litigation. We could incur substantial costs in defending ourselves against
these claims, regardless of their merits.
WE HAVE EXPERIENCED A PERIOD OF RAPID GROWTH, AND IF WE ARE NOT ABLE TO
SUCCESSFULLY MANAGE THIS AND FUTURE GROWTH, OUR BUSINESS MAY SUFFER.
We have recently experienced a period of rapid growth. At March 31, 1997, we
had a total of 38 employees, and at June 30, 2000, we had a total of 213
employees. We plan to continue to hire new employees to expand our operations
significantly to pursue existing and potential market opportunities. This growth
will place a significant demand on our management and our operational resources.
In order to manage growth effectively, we must implement and improve our
operational systems, procedures and controls on a timely basis. Our key
personnel have limited experience managing this type of growth. If we cannot
manage growth effectively, our business could suffer.
BECAUSE OUR INTELLECTUAL PROPERTY IS CRITICAL TO THE SUCCESS OF OUR BUSINESS,
OUR OPERATING RESULTS WOULD SUFFER IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR
INTELLECTUAL PROPERTY.
Page 30 of 38 pages.
<PAGE> 31
Because our products rely on proprietary technology and will likely continue
to rely on technological advancements for market acceptance, we believe that the
protection of our intellectual property rights will be critical to the success
of our business. To protect our intellectual property rights, we rely on a
combination of patent, copyright, trademark and trade secret laws and
restrictions on disclosure. We also enter into confidentiality or license
agreements with our employees, consultants and corporate partners, and control
access to and distribution of our software, documentation and other proprietary
information. Despite our efforts to protect our proprietary rights, unauthorized
parties may copy or otherwise obtain and use our products or technology.
Monitoring unauthorized use of our products is difficult and the steps we have
taken may not prevent unauthorized use of our technology, particularly in
foreign countries where the laws may not protect our proprietary rights as fully
as in the United States. If we are unable to protect our intellectual property
from infringement, other companies may be able to use our intellectual property
to offer competitive products at lower prices. We may not be able to effectively
compete against these companies.
WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY, AND EFFORTS TO PROTECT IT MAY
CAUSE US TO BECOME INVOLVED IN COSTLY AND LENGTHY LITIGATION WHICH COULD
SERIOUSLY HARM OUR BUSINESS.
Although we are not currently involved in any intellectual property
litigation, we may be a party to litigation in the future either to protect our
intellectual property or as a result of an alleged infringement of others'
intellectual property. These claims and any resulting litigation could subject
us to significant liability for damages and could cause our proprietary rights
to be invalidated. Litigation, regardless of the merits of the claim or outcome,
would likely be time-consuming and expensive to resolve and would divert
management time and attention. Any potential intellectual property litigation
could also force us to do one or more of the following:
- stop using the challenged intellectual property or selling our products or
services that incorporate it;
- obtain a license to use the challenged intellectual property or to sell
products or services that incorporate it, which license may not be
available on reasonable terms, or at all; or
- redesign those products or services that are based on or incorporate the
challenged intellectual property.
If we are forced to take any of the foregoing actions, we may be unable to
manufacture and sell our products, and our net revenues would be substantially
reduced.
INDUSTRY STANDARDS AND GOVERNMENT REGULATIONS AFFECTING OUR BUSINESS EVOLVE
RAPIDLY, AND IF WE CANNOT DEVELOP PRODUCTS THAT ARE COMPATIBLE WITH THESE
EVOLVING STANDARDS, OUR BUSINESS WILL SUFFER.
Our products must comply with industry standards. For example, in the United
States, our products must comply with various regulations and standards defined
by the Federal Communications Commission. Internationally, our products are also
required to comply with standards established by authorities in various
countries. Any new products and product enhancements that we introduce in the
future must also meet industry standards at the time they are introduced.
Failure to comply with existing or evolving industry standards or to obtain
timely domestic or foreign regulatory approvals or certificates could materially
harm our business. Our products comprise only a part of the entire SAN. All
components of the SAN must comply with the same standards in order to operate
efficiently together. We depend on companies that provide other components of
the SAN to support the industry standards as they evolve. Many of these
companies are significantly larger and more influential in effecting industry
standards than we are. Some industry standards may not be widely adopted or they
may not be implemented uniformly,
Page 31 of 38 pages.
<PAGE> 32
and competing standards may emerge that may be preferred by OEM customers or end
users. If other companies do not support the same industry standards that we do,
or if competing standards emerge, market acceptance of our products could
suffer.
WE PLAN TO INCREASE OUR INTERNATIONAL SALES ACTIVITIES WHICH WILL SUBJECT US TO
ADDITIONAL BUSINESS RISKS.
For the fiscal year ended March 31, 2000, approximately 30% of our net
revenues were from international sales activities, and for the quarter ended
June 30, 2000, approximately 34% of our net revenues were from international
sales activities. We plan to continue to increase our international sales
activities. Our international sales will be limited if we cannot establish
relationships with international distributors, establish additional foreign
operations, expand international sales channel management, hire additional
personnel and develop relationships with international service providers. Even
if we are able to successfully continue international operations, we may not be
able to maintain or increase international market demand for our products. Our
international operations are subject to a number of risks, including:
- multiple protectionist, adverse and changing governmental laws and
regulations;
- reduced or limited protections of intellectual property rights;
- potentially adverse tax consequences resulting from changes in tax laws;
and
- political and economic instability.
To date, none of our international net revenues and costs have been
denominated in foreign currencies. As a result, an increase in the value of the
U.S. dollar relative to foreign currencies could make our products more
expensive and thus less competitive in foreign markets. A portion of our
international net revenues may be denominated in foreign currencies in the
future, which would subject us to risks associated with fluctuations in those
foreign currencies.
WE MAY BECOME INVOLVED IN COSTLY AND TIME-CONSUMING LITIGATION THAT MAY
SUBSTANTIALLY INCREASE OUR COSTS AND THEREBY HARM OUR BUSINESS.
We may from time to time become involved in various lawsuits and legal
proceedings which arise in the ordinary course of our business. For example, in
May 1999, a former employee filed a complaint against us. The parties have
voluntarily agreed to participate in a mediation session that we expect to occur
within the next 60 days. If mediation is unsuccessful, discovery will commence
and Gadzoox intends to defend against the charges. However, litigation is
subject to inherent uncertainties, and an adverse result in this or other
matters could arise from time to time that may harm Gadzoox' business and,
financial condition and results of operations.
WE MAY ENGAGE IN FUTURE ACQUISITIONS THAT DILUTE OUR STOCKHOLDERS' EQUITY AND
CAUSE US TO INCUR DEBT OR ASSUME CONTINGENT LIABILITIES.
As part of our strategy, we expect to review opportunities to buy other
businesses or technologies that would complement our current products, expand
the breadth of our market or enhance our technical capabilities, or that may
otherwise offer growth opportunities. For example, in April 2000, we completed
our acquisition of SmartSAN Systems, Inc. While we have no additional current
agreements or negotiations underway, we may buy businesses, products or
technologies in the future. In the event of any future purchases, we could:
- issue stock that would dilute our current stockholders' percentage
ownership;
Page 32 of 38 pages.
<PAGE> 33
- incur debt; and
- assume liabilities.
These purchases could also involve numerous risks, including:
- problems integrating the purchased operations, technologies or products;
- unanticipated costs;
- diversion of management's attention from our core business;
- adverse effects on existing business relationships with suppliers and
customers;
- risks associated with entering markets in which we have no or limited
prior experience; and
- potential loss of key employees of purchased organizations.
We may not be able to successfully integrate any businesses, products,
technologies or personnel that we might purchase in the future.
OUR PRINCIPAL STOCKHOLDERS HAVE SIGNIFICANT VOTING POWER AND MAY TAKE ACTIONS
THAT MAY NOT BE IN THE BEST INTERESTS OF OUR OTHER STOCKHOLDERS.
As of June 30, 2000, our executive officers and directors and their
affiliates beneficially owned, in the aggregate, approximately 37% of our
outstanding common stock. As a result, these stockholders may be able to
exercise significant control over all matters requiring stockholder approval,
including the election of directors and approval of significant corporate
transactions, which could delay or prevent an outside party from acquiring or
merging with us.
FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET MAY DEPRESS OUR STOCK
PRICE.
As of June 30, 2000, our executive officers, directors and their affiliates
beneficially owned, in the aggregate, approximately 37% of our outstanding
common stock, which they are able to sell in the public market. Sales of a
substantial number of shares of our common stock could cause our stock price to
fall. In addition, the sale of these shares could impair our ability to raise
capital through the sale of additional stock.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD PREVENT OR DELAY A
CHANGE IN CONTROL OF OUR COMPANY AND MAY REDUCE THE MARKET PRICE OF OUR COMMON
STOCK.
Provisions of our certificate of incorporation and bylaws may discourage, delay
or prevent a merger or acquisition that a stockholder may consider favorable.
These provisions include:
- authorizing our board of directors to issue preferred stock without
stockholder approval;
- providing for a classified board of directors with staggered, three-year
terms;
Page 33 of 38 pages.
<PAGE> 34
- prohibiting cumulative voting in the election of directors;
- requiring super-majority voting to effect significant amendments to our
certificate of incorporation and bylaws;
- limiting the ability of stockholders to call special meetings;
- prohibiting stockholder actions by written consent; and
- establishing advance notice requirements for nominations for election to
the board of directors or for proposing matters that can be acted on by
stockholders at stockholder meetings.
Certain provisions of Delaware law also may discourage, delay or prevent
someone from acquiring or merging with us, which may cause the market price of
our common stock to decline.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS.
The primary objective of our investment activities is to preserve
principal while at the same time maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities that
we may invest in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the principal amount of our investment will probably decline. To minimize
this risk in the future, we intend to maintain our portfolio of cash equivalents
and short-term investments in a variety of securities, including commercial
paper, money market funds, government and non-government debt securities. In
general, money market funds are not subject to market risk because the interest
paid on such funds fluctuates with the prevailing interest rate. As of June 30,
2000, all of our investments were in cash equivalents and short-term
investments. See Note 3 of the Notes to the Condensed Financial Statements.
We have operated primarily in the United States and all sales to date
have been made in U.S. dollars. Accordingly, we have not had any material
exposure to foreign currency rate fluctuations.
Page 34 of 38 pages.
<PAGE> 35
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, Gadzoox may become involved in various lawsuits and
legal proceedings which arise in the ordinary course of business. For example,
in May 1999, a former employee filed a complaint against Gadzoox. The parties
have voluntarily agreed to participate in a mediation session that we expect to
occur within the next 60 days. If mediation is unsuccessful, discovery will
commence and Gadzoox intends to defend against the charges. However, litigation
is subject to inherent uncertainties, and an adverse result in this or other
matters could arise from time to time that may harm Gadzoox' business and,
financial condition and results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In connection with its initial public offering in July of 1999, Gadzoox
filed a Registration Statements on Form S-1, SEC File No. 333-78029 (the
"Registration Statement"), which was declared effective by the Securities and
Exchange Commission on July 19, 1999. Pursuant to the Registration Statement,
Gadzoox registered 4,025,000 shares of its common stock, par value of $0.005 per
share, including 525,000 shares sold to the underwriters upon the exercise of
their over-allotment option. The aggregate offering price of the shares
registered was $84.5 million, $5.9 million of which was applied toward the
underwriters discounts and commissions. Other expenses related to the offering
were approximately $1.1 million. Gadzoox received net proceeds of approximately
$77.5 million from the sale of common stock in the initial public offering.
Managing underwriters of the offering were Credit Suisse First Boston, Hambrecht
& Quist, and Morgan Keegan & Company, Inc.
Gadzoox invested the proceeds from the offering in short-term investment
grade, interest bearing securities and intends to use the proceeds for working
capital and general corporate purposes, including expenditures for research and
development of new products, sales channel development and other corporate
purposes. In addition, we may use a portion of the net proceeds to acquire
businesses, products or technologies that are complementary to our current or
future business and product lines. The use of proceeds from the offering does
not represent a material change in the use of proceeds described in the
prospectus.
Page 35 of 38 pages.
<PAGE> 36
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
We filed an Amended Current Report for Form 8-K dated May 16,
2000 amending a previously filed report concerning the acquisition of
SmartSAN Systems, Inc.
We filed a Current Report on Form 8-K dated June 19, 2000 to
report the issuance of a press release concerning expected results for
the quarter ending June 30, 2000.
We filed a Current Report on Form 8-K dated July 13, 2000 to
report the issuance of a press release announcing earnings for the
quarter ended June 30, 2000.
We filed a Current Report on Form 8-K dated August 7, 2000 to
report the amendment of our previously announced financial results for
the quarter ended June 30, 2000 relating to the acquisition of SmartSAN
Systems, Inc. initially reported using the pooling of interests method
of accounting and amended to report the acquisition using the purchase
accounting method.
Page 36 of 38 pages.
<PAGE> 37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on behalf by the undersigned
thereunto duly authorized.
Dated: August 14, 2000 GADZOOX NETWORKS, INC.
---------------- (Registrant)
/s/ Michael Parides
---------------------------
MICHAEL PARIDES
President and Chief Executive Officer
/s/ Christine E. Munson
----------------------------
CHRISTINE E. MUNSON
Chief Financial Officer and
Vice President of Administration
Page 37 of 38 pages.
<PAGE> 38
EXHIBIT INDEX
<TABLE>
EXHIBIT
NO. DESCRIPTION
------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
