<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 March 31, 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 0-26473
EFFICIENT NETWORKS, Inc.
(Exact name of registrant as specified in its charter)
Delaware 75-2486865
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification Number)
4849 Alpha Road
Dallas, Texas 75244
(Address of principal executive office and zip code)
(972) 852-1000
(Registrant's 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 filing requirements
for the past 90 days.
YES [X] NO [ ]
As of May 9, 2000, 55,198,343 shares of the Registrant's common stock were
outstanding.
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Efficient Networks, Inc.
FORM 10-Q
March 31, 2000
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I Financial Information................................................................................ 3
Item 1. Financial Statements.............................................................................. 3
Condensed Consolidated Balance Sheets at March 31, 2000 (unaudited) and June 30, 1999............... 3
Condensed Consolidated Statements of Operations (unaudited) for the Three Months Ended
March 31, 2000, and 1999....................................................................... 4
Condensed Consolidated Statements of Operations (unaudited) for the Nine Months Ended
March 31, 2000, and 1999....................................................................... 4
Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended
March 31, 2000, and 1999....................................................................... 5
Notes to Unaudited Condensed Consolidated Financial Statements....................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................................... 11
Item 3. Qualitative and Quantitative Disclosure About Market Risk......................................... 18
Risk Factors......................................................................................... 18
Part II Other Information................................................................................... 27
Item 1. Legal Proceedings................................................................................. 27
Item 2. Changes In Securities and Use of Proceeds......................................................... 27
Item 4. Submission of Matters to a Vote of Security Holders............................................... 28
Item 6. Exhibits and Reports on Form 8-K.................................................................. 28
Signatures.................................................................................................. 29
</TABLE>
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<PAGE>
PART I Financial Information
Item 1. Financial Statements
EFFICIENT NETWORKS, INC.
Condensed Consolidated Balance Sheets
(In thousands, except share data)
<TABLE>
<CAPTION>
Assets March 31, 2000 June 30, 1999
-------------- -------------
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 351,486 $ 3,604
Short-term investments 223,248 -
Accounts receivable, net of allowance for doubtful
accounts of $880 and $120 at March 31, 2000 67,856
and June 30, 1999, respectively 10,316
Inventories 38,369 5,472
Other assets 1,867 241
---------- --------
Total current assets 682,826 19,633
Furniture and equipment, net 14,772 2,285
Other assets, net 12,705 29
Intangible assets, net of accumulated amortization of $53,715 at 871,380 -
March 31, 2000 ---------- --------
$1,581,683 $ 21,947
========== ========
Liabilities, Redeemable Convertible
Preferred Stock and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable $ 35,088 $ 4,104
Accrued liabilities 22,219 2,208
Current portion of capital lease obligations 513 -
Deferred revenue 11,996 736
---------- --------
Total current liabilities 69,816 7,048
Convertible subordinated notes 400,000 -
Capital lease obligations, net of current portion 1,643 -
Long-term debt, net of discount - 13,396
Other liabilities 19 22
---------- --------
Total liabilities 471,478 20,466
---------- --------
Redeemable convertible preferred stock 431,550 40,495
Commitments and contingencies
Stockholders' equity (deficit):
Common stock, par value $.001 per share, 200,000,000 48 4
shares authorized; 48,545,355 and 4,362,221
shares issued and outstanding at March 31, 2000 and
June 30, 1999, respectively
Additional paid-in capital 824,866 29,777
Deferred stock option compensation (11,269) (14,606)
Accumulated deficit (134,990) (54,189)
---------- --------
Total stockholders' equity (deficit) 678,655 (39,014)
---------- --------
$1,581,683 $ 21,947
========== ========
See accompanying notes to unaudited condensed consolidated financial statements.
</TABLE>
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<PAGE>
EFFICIENT NETWORKS, INC.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
------------------------ ----------------------
2000 1999 2000 1999
-------- ------- -------- --------
<S> <C> <C> <C> <C>
Net revenues $ 61,749 $ 4,115 $100,344 $ 7,139
Cost of revenues 49,093 4,189 82,017 6,699
-------- ------- -------- --------
Gross profit (loss) 12,656 (74) 18,327 440
-------- ------- -------- --------
Operating expenses:
Sales and marketing 9,776 1,385 17,278 3,856
Research and development 8,693 1,930 16,064 5,546
General and administrative 2,993 484 5,324 1,234
Stock option compensation 1,159 991 3,767 1,899
Amortization of intangibles 46,358 - 53,715 -
In process research and development charge - - 4,970 -
-------- ------- -------- --------
Total operating expenses 68,979 4,790 101,118 12,535
-------- ------- -------- --------
Loss from operations (56,323) (4,864) (82,791) (12,095)
Interest income 2,934 36 4,196 154
Interest expense and other, net (1,531) (2,126) (2,206) (2,134)
-------- ------- -------- --------
$(54,920) $(6,954) $(80,801) $(14,075)
======== ======= ======== ========
Net loss
Basic and diluted net loss per share of common stock $ (1.17) $ (1.82) $ (2.09) $ (3.77)
======== ======= ======== ========
Weighted-average shares of common stock outstanding 47,000 3,870 38,683 3,807
======== ======= ======== ========
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
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<PAGE>
EFFICIENT NETWORKS, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended March 31,
--------------------------------
2000 1999
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss....................................................... $ (80,801) $(14,075)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,167 588
Amortization of deferred stock option 3,767 1,899
compensation
Accretion of discount on subordinated promissory 604 1,982
notes
Amortization of intangible assets 53,715 -
In process research and development charge 4,970 -
Changes in operating assets and liabilities, net of assets
and liabilities acquired in business combination:
Accounts receivable (48,263) (6,038)
Inventories (31,754) (3,019)
Other assets and liabilities (14,148) 230
Accounts payable and accrued liabilities 23,782 3,672
Deferred revenue 11,260 625
--------- --------
Net cash used in operating activities (75,701) (14,136)
--------- --------
Cash flows from investing activities:
Purchase of fixed assets (11,017) (1,314)
Purchase of investments (223,248) -
Net cash received in connection with purchase of
FlowPoint Corporation 10,916 -
--------- --------
Net cash used in investing activities (223,349) (1,314)
--------- --------
Cash flows from financing activities:
Principal payments on capital lease obligations (53) (11)
Proceeds from issuance of convertible subordinated notes 400,000 -
Proceeds from issuance of promissory notes and warrants - 7,000
Proceeds from issuance of common stock, net 246,985 48
Proceeds from issuance of preferred stock - 5,402
--------- --------
Net cash provided by financing activities 646,932 12,439
--------- --------
Increase (decrease) in cash and cash equivalents 347,882 (3,011)
Cash and cash equivalents at beginning of period 3,604 7,607
--------- --------
Cash and cash equivalents at end of period $ 351,486 $ 4,596
========= ========
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
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<PAGE>
Efficient Networks, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2000
(1) Basis of Presentation
The accompanying unaudited financial data as of and for the three months
and nine months ended March 31, 2000 and 1999 have been prepared by the
Company, 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 generally
accepted accounting principles have been condensed or omitted pursuant to
such rules and regulations. These unaudited condensed consolidated
financial statements should be read in conjunction with the audited
financial statements and the notes thereto included in the Company's Annual
Report on Form 10-K for the fiscal year ended June 30, 1999.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position,
results of operations, and cash flows as of and for the three months and
nine months ended March 31, 2000 have been made. The results of operations
for the three months and nine months ended March 31, 2000 are not
necessarily indicative of the operating results for the full year.
(2) Completion of Initial and Follow-on Public Offerings
On July 15, 1999, the Company completed its initial public offering. The
Company issued 4.6 million shares of common stock in exchange for net
proceeds of approximately $63.1 million. Upon the completion of the
initial public offering, certain outstanding subordinated promissory notes
converted into an aggregate of 3.6 million shares of redeemable convertible
preferred stock, and all then outstanding redeemable convertible preferred
stock converted into an aggregate of 28.3 million shares of common stock.
On February 8, 2000 the Company completed a follow-on public offering of
5.75 million shares of common stock of which the Company issued and sold
2.75 million shares and selling stockholders sold 3.0 million shares. The
Company received net proceeds of approximately $183.2 million for the
shares issued and sold by it. The Company did not receive any of the
proceeds from the sale of shares by the selling stockholders.
(3) Acquisition
On November 21, 1999, the Company entered into an agreement with Cabletron
Systems, Inc. ("Cabletron") to acquire its wholly-owned subsidiary
FlowPoint Corporation ("FlowPoint") from
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<PAGE>
Cabletron. The acquisition was completed on December 17, 1999. The results
of operations of FlowPoint have been included in the Company's consolidated
statement of operations from the date of acquisition through March 31,
2000.
The Company financed the acquisition of FlowPoint through the issuance of
7.2 million shares of common stock and 6,300 shares of Series A non-voting
redeemable convertible preferred stock. The Series A preferred stock was
convertible into an aggregate of 6.3 million shares of common stock and was
mandatorily redeemable. On April 12, 2000, the Series A preferred stock
was converted into 6.3 million shares of common stock.
The acquisition was accounted for under the purchase method of accounting
and, accordingly, the purchase price was allocated to the assets acquired
and liabilities assumed based on the estimated fair values at the date of
acquisition. The shares issued to Cabletron for FlowPoint had a fair
market value of $924.8 million based upon the market price of $68.50, which
represents the Company's average closing sale price for two trading days
before and two trading days after the terms of the acquisition were agreed
to.
The total purchase price of $938.7 million, including direct costs of
acquisition of $13.9 million, was allocated as follows (in thousands):
<TABLE>
<S> <C>
Acquired technology $ 21,545
Assembled workforce 940
Sales channel and customer relationships 12,930
In process research and development 4,970
Non-compete agreements 50
Excess cost over fair value of net assets acquired 889,630
Fair value of tangible assets acquired, net of liabilities assumed 8,589
--------
$938,654
========
</TABLE>
The allocation of acquired technology, assembled workforce, sales channel
and customer relationships, in process research and development and non-
compete agreements was based upon an independent valuation. The Company
wrote off in process research and development immediately upon consummation
of the acquisition. In addition, in connection with the FlowPoint
acquisition, the Company recorded $925.1 million in intangible assets, of
which $46.4 and $53.7 million was amortized in the three months and nine
months ended March 31, 2000, respectively. The remainder will be amortized
at a rate of approximately $46.3 million per quarter over a five-year
period.
The following pro forma financial information presents a summary of the
results of operations as if the acquisition had occurred on July 1, 1998:
<TABLE>
<CAPTION>
(Unaudited)
-----------------------------------------
Nine months ended Nine months ended
March 31, 2000 March 31, 1999
-------------- --------------
<S> <C> <C>
Revenues $ 121,797 $ 15,201
Expenses 288,528 122,764
----------- -----------
Net loss $ (166,731) $ (107,563)
=========== ===========
Basic and diluted loss per share of common stock $ (3.87) $ (9.78)
=========== ===========
Shares used in computing basic and diluted loss
per share of common stock 43,134 11,000
=========== ===========
</TABLE>
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<PAGE>
(4) Earnings Per Share
Basic earnings (loss) per share is computed by dividing net income or loss
by the weighted average number of shares of the Company's common stock
outstanding during the period. Diluted earnings (loss) per share is
determined in the same manner as basic earnings (loss) per share except
that the number of shares is increased assuming exercise of dilutive stock
options and warrants using the treasury stock method and conversion of the
Company's redeemable convertible preferred stock. The diluted loss per
share amount is the same as basic loss per share because the Company has a
net loss in each of the periods presented and the impact of the assumed
exercise of the stock options and warrants and the assumed preferred stock
conversion is antidilutive. Common stock equivalents of 13.2 million and
31.2 million shares for the three months ended March 31, 2000 and 1999,
respectively, and 5.1 million and 28.8 million shares for the nine months
ended March 31, 2000 and 1999, respectively, were excluded from the
calculation of diluted loss per share because of the antidilutive effect.
The following table presents the calculation of basic and diluted loss
per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
--------- ---------
2000 1999 2000 1999
-------- ------- -------- --------
<S> <C> <C> <C> <C>
Net loss $(54,920) $(6,954) $(80,801) $(14,075)
Accretion of issuance costs on redeemable
convertible preferred stock - (88) - (263)
-------- ------- -------- --------
Net loss available to common stockholders $(54,920) $(7,042) $(80,801) $(14,338)
======== ======= ======== ========
Weighted average shares outstanding 47,000 3,870 38,683 3,807
======== ======= ======== ========
Basic and diluted net loss per share $ (1.17) $ (1.82) $ (2.09) $ (3.77)
======== ======= ======== ========
</TABLE>
(5) Inventories
Inventories consisted of the following (in thousands):
March 31, June 30,
2000 1999
---- ----
Raw materials $ 4,848 $ 2,265
Finished goods 33,521 3,207
--------- --------
Total $ 38,369 $ 5,472
========= ========
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<PAGE>
(6) Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
March 31, June 30,
--------- --------
2000 1999
---- ----
Accrued compensation and benefits $ 8,488 $ 1,102
Accrued marketing expense 4,270 286
Accrued interest expense 1,333 291
Other 8,128 529
--------- --------
Total $ 22,219 $ 2,208
========= ========
(7) Deferred Revenue
Deferred revenue of $12.0 million at March 31, 2000 primarily relates to
shipments of product to customers where title and risk of ownership has
passed to the customer, but revenue recognition has been deferred due to
certain stock balancing and right of return privileges granted to the
customer. The corresponding receivable of $11.2 million is included in the
accounts receivable balance at March 31, 2000.
(8) Convertible Subordinated Notes
On March 7, 2000 the Company issued $400 million of convertible
subordinated notes due March 15, 2005. The notes bear interest at an
annual rate of 5%. The notes are convertible at any time prior to maturity
into shares of the Company's common stock at a conversion price of $181.00
per share. The Company may redeem the notes on or after March 20, 2003 at
101.25% during the period beginning on March 20, 2003 and ending on March
14, 2004, and at 100.00% beginning on March 15, 2004 and thereafter. The
notes are unsecured obligations of the Company. Upon a change in control,
the noteholders may require the Company to purchase the notes at 100% of
the principal amount of the notes plus accrued and unpaid interest. The
Company has agreed to file a shelf registration statement with the
Securities and Exchange Commission with respect to the notes and the common
stock issuable upon conversion of the notes pursuant to a registration
rights agreement. Noncompliance with the registration rights agreement
will result in an increase in the interest rate on the notes by 0.5% during
the period of noncompliance. Estimated issuance costs of $12.6 million,
which are included as a deferred charge in other assets, are being
amortized over the term of the notes. Accrued interest of $1.3 million as
of March 31, 2000 is included in accrued liabilities.
(9) Long-term Debt
In January 1999, the Company issued subordinated promissory notes with
detachable warrants in exchange for $7.0 million in cash. On April 8, 1999,
the Company issued a subordinated promissory note with a detachable warrant
in exchange for $2.0 million in cash. The notes bore interest at 10% per
annum with interest payable quarterly. The subordinated promissory notes
were issued with detachable warrants to purchase an aggregate of 3.1
million shares of the Company's redeemable convertible preferred stock at
an exercise price of $2.92 per share. In June 1999, the holders of the
subordinated promissory notes entered into a note repayment and warrant
exercise agreement with the Company which stipulated that immediately prior
to the closing of an initial public offering, the
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<PAGE>
aggregate $9.0 million principal amount of the notes would be applied
toward the aggregate exercise price of the detachable warrants.
Accordingly, immediately prior to the closing of the Company's initial
public offering on July 15, 1999, the warrants were exercised to purchase
the Company's redeemable convertible preferred stock, which shares of
preferred stock automatically converted into shares of common stock upon
completion of the initial public offering.
On June 28, 1999, the Company issued a convertible promissory note in
exchange for $5.0 million in cash. The note bore interest at 8.0% per
annum. In accordance with the conversion feature of the note, immediately
prior to the closing of the Company's initial public offering, the note
automatically converted into 497,663 shares of preferred stock at a
conversion price $10.09 per share, and such shares of preferred stock
automatically converted into shares of common stock upon completion of the
initial public offering.
(10) Lease Commitments
The Company entered into an agreement to lease approximately 104,000 square
feet of office space for its headquarters in Dallas, Texas. The lease
commenced January 28, 2000 and expires on May 1, 2010. Under the terms of
the lease, the Company intends to lease an additional 21,000 square feet in
June 2000. Including the additional space, the average annual lease
payments are approximately $2.7 milliion.
In connection with the lease of office space for its headquarters, the
Company entered into an agreement to lease furniture and fixtures. The
lease, which is reflected as a capital lease in the financial statements,
commenced in February 2000 and expires in August 2003. The Company
recorded a capital lease obligation of approximately $2.2 million in
connection with this lease.
(11) Statements of Cash Flows
The Company paid cash interest of $32,000 and $0 during the nine months
ended March 31, 2000 and 1999, respectively. No income taxes were paid
during the nine months ended March 31, 2000 and 1999. Non-cash financing
transactions included new capital lease obligations of $2.2 million, the
exchange of promissory notes of $13.4 million and related accrued interest
for $14.0 million of redeemable convertible preferred stock, and the
exchange of redeemable convertible preferred stock of $54.5 million for
28.3 million shares of common stock during the nine months ended March 31,
2000. In connection with the acquisition of FlowPoint, the Company
exchanged 7.2 million shares of Common Stock and 6,300 shares of redeemable
convertible preferred stock for the assets and liabilities of FlowPoint.
No non-cash financing transactions occurred during the nine months ended
March 31, 1999.
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<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Certain statements contained in this Quarterly Report on Form 10-Q,
including, without limitation, statements containing the words "believes,"
"anticipates," "estimates," "expects," and words of similar import, may
constitute forward looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Readers are referred to the Risk
Factors section in this report and to the risk factors set out in the Company's
Annual Report on Form 10-K which describes factors that could cause actual
events to differ from those contained in the forward looking statements.
Overview
We are a worldwide independent developer and supplier of high-speed DSL
customer premises equipment for the broadband access market. Our DSL solutions
enable telecommunications and other network service providers to provide high-
speed, cost-effective broadband access services over the existing copper wire
telephone infrastructure to both business and residential markets. We therefore
focus on developing and producing single- and multiple-user DSL customer
premises equipment for small- to medium-size businesses, branch offices of large
corporations and consumers. Our DSL products enable applications such as high-
speed Internet access, electronic commerce, remote access, telecommuting and
extensions of corporate networks to branch offices.
We were incorporated in June 1993. From inception through fiscal 1997, we
primarily focused on developing and selling ATM-based products for local area
network, or LAN, applications. ATM, or asynchronous transfer mode, is a widely-
used transmission technology that breaks data down into individual packets with
unique identification and destination addresses and may be used to transmit
data, voice and video within a network. During fiscal 1997 we began to leverage
our ATM, personal computing environment and networking expertise to develop DSL
modem products for high-speed Internet access. Although we continue to sell ATM
LAN products, we have largely discontinued further development efforts on such
products and are currently focusing on our DSL products. We shipped our first
DSL products in the third quarter of fiscal 1998. Our DSL products, which
accounted for less than 3% of net revenues in fiscal 1998, represented 87.1% of
our net revenues in fiscal 1999 and 98.5% of our net revenues in the first nine
months of fiscal 2000. We expect sales of our ATM LAN products to continue to
gradually decrease in absolute amount over the next one to two years, and to
decrease substantially as a percentage of net revenues during that time.
We derive our revenues from sales of our SpeedStream family of DSL products
and, to a lesser extent, our ATM LAN products. We sell our DSL products
primarily to network service providers, network equipment vendors and telephone
company-aligned distributors. For the quarter ended March 31, 2000, sales to
three customers, SBC Communications, Covad Communications Group, Inc., and
Cabletron Systems, Inc. each represented more than 10% of our net revenues. For
the nine months ended March 31, 2000, sales to two customers, SBC Communications
and Covad Communications Group, Inc. each represented more than 10% of our net
revenues. Our top ten customers for the three and nine months ended March 31,
2000 accounted for 94.6% and 86.8% of our net revenues, respectively. We expect
to continue to be dependent upon a relatively small number of large customers in
future periods, although the specific customers may vary from period to period.
Since inception, a substantial portion of our revenues has been derived
from customers located outside of the United States and we expect this trend to
continue. Revenues derived from customers outside the United States represented
17% and 20% of our net revenues for the three and nine months ended March
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<PAGE>
31, 2000, respectively, and 29% and 35% of our net revenues for the three and
nine months ended March 31, 1999, respectively. We currently maintain a European
sales office in Amsterdam and an Asian sales office in Singapore.
To date, international sales have been denominated solely in U.S. dollars
and, accordingly, we have not been exposed to fluctuations in non-U.S. currency
exchange rates. In the future, a portion of our international sales may be
denominated in currencies other than U.S. dollars, which would then expose us to
gains and losses based upon exchange rate fluctuations.
Our limited operating history in the DSL market makes it difficult to
forecast our future operating results. To date, we have not achieved
profitability in any quarter or annual period, and as of March 31, 2000, we had
an accumulated deficit of $135.0 million. Although our net revenues have grown
in recent quarters, we cannot be certain that our net revenues will increase at
a rate sufficient to achieve and maintain profitability.
On November 21, 1999, the Company entered into an agreement with Cabletron
Systems, Inc. to acquire its wholly-owned subsidiary FlowPoint Corporation from
Cabletron. The acquisition was completed on December 17, 1999. The results of
operations of FlowPoint have been included in the Company's consolidated
statement of operations from the date of acquisition through March 31, 2000.
The Company financed the acquisition of FlowPoint through the issuance of 7.2
million shares of common stock and 6,300 shares of Series A non-voting
redeemable convertible preferred stock. The Series A preferred stock was
convertible into an aggregate of 6.3 million shares of common stock and was
mandatorily redeemable. On April 12, 2000 the Series A preferred stock was
converted into 6.3 millions shares of common stock. The acquisition was
accounted for under the purchase method of accounting and, accordingly, the
purchase price was allocated to the assets acquired and liabilities assumed
based on the estimated fair values at the date of acquisition. The shares
issued to Cabletron for FlowPoint had a fair market value of $924.8 million
based upon the market price of $68.50, which represents the Company's average
closing sale price for two trading days before and two trading days after the
terms of the acquisition were agreed to. In connection with the FlowPoint
acquisition, the Company recorded $925.1 million in intangible assets, of which
$46.4 million and $53.7 million was amortized in the three and nine months ended
March 31, 2000. The remainder will be amortized at the rate of approximately
$46.3 million per quarter over a five-year period. In addition, the Company
recorded a one-time write off of $5.0 million of in process research and
development incurred in connection with the acquisition of FlowPoint in the
quarter ended December 31, 1999.
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<PAGE>
Results of Operations
The following table sets forth, for the periods presented, certain data
from Efficient's consolidated statement of operations expressed as a percentage
of net revenues.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
------------------------- ------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 79.5 101.8 81.7 93.8
------ ------- ------ -------
Gross profit 20.5 (1.8) 18.3 6.2
------ ------- ------ -------
Operating expenses:
Sales and marketing 15.8 33.7 17.2 54.0
Research and development 14.1 46.9 16.0 77.7
General and administrative 4.8 11.8 5.3 17.3
Stock option compensation 1.9 24.1 3.8 26.6
Amortization of intangibles 75.1 - 53.5 0.0
In process research and development charge - - 5.0 0.0
------ ------- ------ -------
Total operating expenses 111.7 116.5 100.8 175.6
------ ------- ------ -------
Loss from operations (91.2) (118.3) (82.5) (169.4)
Interest income 4.8 0.9 4.2 2.2
Interest expense and other, net (2.5) (51.7) (2.2) (29.9)
------ ------- ------ -------
(88.9)% (169.1)% (80.5)% (197.1)%
Net loss ====== ======= ====== =======
</TABLE>
Three and Nine Months Ended March 31, 2000 and 1999
Net Revenues
Net revenues consist of product sales, net of allowances for returns. Net
revenues increased 1,400.6% to $61.7 million for the quarter ended March 31,
2000 from $4.1 million for the comparable quarter in 1999. Net revenues
increased 1,305.6% to $100.3 million for the nine months ended March 31, 2000
from $7.1 million for the comparable period in 1999. DSL product revenues
increased to $61.3 million for the quarter ended March 31, 2000 compared to $3.6
million for the quarter ended March 31, 1999. DSL product revenues increased to
$98.9 million for the nine months ended March 31, 2000 compared to $5.6 million
for the nine months ended March 31, 1999. The increase in DSL product revenues
for the quarter and nine months ended March 31, 2000 reflects the continued
market adoption of our DSL products, as well as the addition of new products to
the Company's DSL product line both as a result of internal development efforts
as well as through the acquisition in December 1999 of FlowPoint. Net revenues
exclude $12.0 million and $625,000 of deferred revenues at March 31, 2000 and
1999, respectively, primarily related to shipments of product to customers where
title and risk of ownership has passed to the customer, but revenue recognition
has been deferred due to certain stock balancing and return rights granted to
the customer.
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Cost of Revenues
Cost of revenues consists of amounts paid to third-party contract
manufacturers and the personnel and related costs of our manufacturing
operation. Cost of revenues increased 1,072.0% to $49.1 million for the quarter
ended March 31, 2000 from $4.2 million for the quarter ended March 31, 1999.
Cost of revenues increased 1,124.3% to $82.0 million for the nine months ended
March 31, 2000 from $6.7 million for the nine months ended March 31, 1999. The
increase from the quarter and nine months ended March 31, 2000 to the comparable
period in 1999 reflected the increase in DSL product sales.
Gross margin represented 20.5% of net revenues for the quarter ended March
31, 2000, compared to (1.8%) of net revenues for the same period in 1999. Gross
margin represented 18.3% of net revenues for the nine months ended March 31,
2000, compared to 6.2% of net revenues for the same period in 1999. The 2000
amounts are not comparable to the 1999 amounts due to the shift from ATM LAN
products to DSL products. Included in cost of revenues for the nine months ended
March 31, 2000 are $1.0 million of one-time costs associated with a change in
the Company's contract manufacturer. Excluding these one-time costs, the gross
margin for the nine months ended March 31, 2000 would have been 19.3%. For the
quarter ended March 31, 2000, our gross margin improved slightly from the gross
margin of 19.7% achieved in the quarter ended December 31, 1999. Although an
improvement has been achieved in the current period, gross margin continued to
be adversely affected by our efforts to bring our DSL products to market. We
took a number of actions that were designed to bring our DSL products to market
quickly, but which also adversely affected our gross margins. These actions
included initial volume price discounts for key customers and incremental costs
such as manufacturing start-up, expedite and other incremental shipping and
handling charges associated with low volume manufacturing. We also continued to
add personnel to our manufacturing operations in anticipation of higher levels
of business going forward. Other factors that will affect our gross margin
include the product mix sold in any particular period, distribution channels,
competitive pressures and levels of volume discounts. We expect that we will
continue to incur higher than normal costs associated with the actions to bring
our DSL products to market quickly and meet customers' aggressive DSL deployment
schedules.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of employee salaries,
commissions and benefits, advertising, promotional materials and trade show
exhibit expenses. Sales and marketing expenses increased 605.8% to $9.8 million
for the quarter ended March 31, 2000, up from $1.4 million for the same period
in 1999. Sales and marketing expenses increased 348.1% to $17.3 million for the
nine months ended March 31, 2000, up from $3.9 million for the same period in
1999. The increase in sales and marketing expenses resulted from expanded sales
and marketing activities associated with our DSL products. These costs included
significant personnel-related expenses associated with increasing the size of
our sales and marketing organization, and increased trade show activities and
related travel expenses. Sales and marketing expenses represented 15.8% of net
revenues for the quarter ended March 31, 2000, and 33.7% of net revenues for the
quarter ended March 31, 1999. Sales and marketing expenses represented 17.2% of
net revenues for the nine months ended March 31, 2000, and 54.0% of net revenues
for the nine months ended March 31, 1999. The decrease in sales and marketing
expenses as a percentage of net revenues for the quarter and nine months ended
March 31, 2000 compared to the same period in 1999 was a result of the increase
in DSL revenues. We expect sales and marketing expenses to increase in dollar
amount in future periods as we continue to expand our domestic and international
sales and marketing organization.
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Research and Development Expenses
Research and development expenses consist primarily of personnel and
related costs associated with our product development efforts, including third-
party consulting and prototyping costs. Research and development expenses
increased 350.4% to $8.7 million for the quarter ended March 31, 2000, up from
$1.9 million for the quarter ended March 31, 1999. Research and development
expenses increased 189.7% to $16.1 million for the nine months ended March 31,
2000, up from $5.6 million for the nine months ended March 31, 1999. The
increase in research and development spending was primarily a result of
increased personnel and related costs associated with an expanded research and
development organization in connection with our DSL products. Research and
development expenses represented 14.1% of net revenues for the quarter ended
March 31, 2000 compared to 46.9% of net revenues for the quarter ended March 31,
1999. Research and development expenses represented 16.0% of net revenues for
the nine months ended March 31, 2000 compared to 77.7% of net revenues for the
nine months ended March 31, 1999. The decrease in research and development
expenses as a percentage of net revenues for the quarter and nine months ended
March 31, 2000 compared to the same period in 1999 was a result of the rapid
increase in DSL revenues. We expect research and development expenses to
increase in dollar amount in future periods as we continue to expand our
research and development organization to develop new products and technologies.
General and Administrative Expenses
General and administrative expenses consist primarily of employee salaries
and related expenses for executive, administrative and accounting personnel,
human resources, facility costs, insurance costs and professional fees. General
and administrative expenses increased 518.4% to $3.0 million for the quarter
ended March 31, 2000, up from approximately $484,000 for the same period in
1999. General and administrative expenses increased 331.4% to $5.3 million for
the nine months ended March 31, 2000, up from approximately $1.2 million for the
same period in 1999. The increases in general and administrative spending were
primarily a result of increases in headcount associated with building our
infrastructure. General and administrative expenses represented 4.8% of net
revenues for the quarter ended March 31, 2000, compared to 11.8% of net revenues
for the quarter ended March 31, 1999. General and administrative expenses
represented 5.3% of net revenues for the nine months ended March 31, 2000,
compared to 17.3% of net revenues for the nine months ended March 31, 1999. The
decrease in general and administrative expenses as a percentage of net revenues
for the quarter and nine months ended March 31, 2000 compared to the same period
in 1999 was a result of the increase in DSL revenues. We expect general and
administrative expenses to increase in dollar amount in future periods as we
continue to build our infrastructure and as a result of operating as a publicly-
held company.
Stock Option Compensation
Stock option compensation reflects the difference between the exercise
price of stock options granted and the deemed fair market value of our common
stock on the dates of grant. Amortization of deferred stock option compensation
was $1.2 million and $3.8 million for the quarter and nine months ended March
31, 2000, respectively, compared to approximately $991,000 and $1.9 million for
the quarter and nine months ended March 31, 1999, respectively. We expect to
amortize the deferred stock option compensation at the rate of approximately
$1.2 million per quarter until fully amortized. Prior to our initial public
offering on July 15, 1999, there was no market for our common stock, and option
prices were determined by the Board of Directors based upon numerous factors.
Upon review in connection with our initial public offering, it was determined
that the fair market value on the date of grant of certain options was higher
than originally determined by the Board of Directors. Beginning with our
initial public offering, we began pricing options based upon the public market
price of our common stock, and do not anticipate accruing additional deferred
stock option compensation in future periods.
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Amortization of Intangibles and In Process Research and Development
Amortization of intangibles represents amortization of the intangible
assets recorded in connection with the FlowPoint acquisition. The Company
recorded $925.1 million in intangible assets, of which $46.4 million and $53.7
million was amortized in the quarter and nine months ended March 31, 2000. The
remainder will be amortized at the rate of approximately $46.3 million per
quarter over a five year period. In the quarter ended December 31, 1999, the
Company also recorded a one-time write-off of $5.0 million of in process
research and development incurred in connection with the FlowPoint acquisition.
Interest Income and Interest Expense and Other, Net
Interest income consists primarily of interest earned on cash and cash
equivalents and short-term investments. Interest income increased for the
quarter and nine months ended March 31, 2000 from the quarter and nine months
ended March 31, 1999, as a result of interest earned primarily from the net cash
proceeds received in connection with the Company's completion of its initial
public offering on July 15, 1999, the follow-on public offering on February 8,
2000, and the placement of convertible subordinated notes on March 7, 2000.
Interest expense consists primarily of interest incurred on the convertible
subordinated notes, as well as interest on capital lease obligations. Interest
expense increased for the quarter and nine months ended March 31, 2000 compared
to the same periods in 1999 as a result of the subordinated convertible notes
and capital lease obligation commitments issued in the quarter ending March 31,
2000. In future periods we expect interest income and interest expense and
other, net to vary depending upon changes in the amount and mix of interest-
bearing investments and short and long-term debt outstanding during each period.
Income Taxes
From inception through March 31, 2000, we incurred net losses for federal
and state tax purposes and have not recognized any tax provision or benefit. The
Company has significant federal net operating loss carryforwards to offset
future taxable income which will begin to expire in varying amounts beginning in
2008. Given our limited operating history, losses incurred to date and the
difficulty in accurately forecasting our future results, management does not
believe that the recognition of the related deferred income tax asset meets the
criteria required by generally accepted accounting principles. Accordingly, a
100% valuation allowance has been recorded. Furthermore, as a result of changes
in Efficient's equity ownership resulting from Efficient's redeemable
convertible preferred stock and note financings and Efficient's initial and
follow-on public offerings, utilization of the net operating losses and tax
credits may be subject to substantial annual limitations due to the ownership
change limitations provided by the Internal Revenue Code of 1986, as amended,
and similar state provisions. The annual limitation may result in the expiration
of net operating losses and tax credits before utilization.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through the sale
of preferred equity securities and, in the second half of fiscal 1999, through
borrowings from our investors and others. From inception through June 30, 1999,
we raised an aggregate of $40.4 million (net of transaction expenses) from the
sale of equity securities and an additional $14.0 million through loan
transactions. On July 15, 1999, the Company completed an initial public
offering. The Company issued 4.6 million shares of common stock and raised
$63.1 million in net proceeds. Upon the completion of the initial public
offering, the Company's promissory notes converted into redeemable convertible
preferred stock, and all then outstanding redeemable
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<PAGE>
convertible preferred stock converted into 28.3 million shares of common stock.
On February 8, 2000, the Company completed a follow-on public offering. The
Company issued 2.8 million shares of common stock and raised $182.8 million in
net proceeds. On March 7, 2000, the Company completed the private placement of
$400 million of convertible subordinated notes. Issuance costs of $12.6 million
are being amortized over the term of the notes.
At March 31, 2000, we had cash and cash equivalents and highly liquid
short-term investments of $574.7 million. At March 31, 2000, we did not have a
line of credit or other borrowing facility available. Capital commitments
include a lease for office space, furniture and equipment for our new corporate
headquarters in Dallas, Texas. The office lease commenced in January 2000 and
expires in 2010 with annual lease payments of approximately $2.7 million. The
furniture and equipment lease commenced in February 2000 and expires in 2003
with annual lease payments of approximately $708,000.
Cash used in operating activities for the nine months ended March 31, 2000
was $75.7 million. Cash used in operating activities has primarily represented
increases in inventories and receivables.
Cash used in investing activities for the nine months ended March 31, 2000
was $223.3 million. $223.2 million of cash was used to purchase highly liquid
short-term investments, and $11.0 million of cash was used to purchase fixed
assets, which was offset by cash received of $10.9 million in connection with
the acquisition of FlowPoint. In each period, purchases of furniture and
equipment related primarily to the purchase of computers and other equipment
used in our development activities and other equipment and furniture used in our
operations.
Cash provided by financing activities for the nine months ended March 31,
2000 was $646.9 million, consisting primarily of funds raised from the Company's
initial and follow-on public offerings of common stock on July 15, 1999 and
February 8, 2000, respectively, as well as the private placement of $400 million
of convertible subordinated notes on March 7, 2000.
Our future capital requirements will depend upon a number of factors,
including the rate of growth of our revenues, the timing and level of research
and development activities and sales and marketing campaigns. We believe that
our cash, cash equivalents and short-term investments will provide sufficient
capital to fund our operations at least through the end of fiscal 2001.
Thereafter, we may require additional capital to fund our business. In addition,
from time to time we may evaluate opportunities to acquire complementary
technologies or companies. Should we identify any such opportunities, we may
need to raise additional capital to fund the acquisitions. There can be no
assurance that financing will be available to us when we need it on favorable
terms or at all.
Year 2000 Issues
The year 2000 issues arise from the fact that many currently installed
computer systems, software products and other control devices are unable to
accept four digit entries to distinguish 21st century dates from 20th century
dates.
Through May 11, 2000, the Company has not experienced any significant
issues associated with year 2000 issues.
We have designed our products to be year 2000 compliant and have not
detected any errors or defects associated with year 2000 date functions to date.
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Further, the internal systems used to deliver our services utilize third-
party hardware and software. Prior to year end, we completed an internal systems
and processes review for year 2000 compliance and we completed our assessment of
the year 2000 risks we might encounter, and all identified instances of
noncompliance were repaired and tested. We contacted the vendors of these
products in order to gauge their year 2000 compliance. Based on these vendors'
representations, we believe that the third-party hardware and software we use
are year 2000 compliant. We have not experienced any significant year 2000
issues associated with third party hardware and software.
Item 3. Qualitative and Quantitative Disclosure About Market Risk
The following discusses our exposure to market risk related to changes in
interest rates, equity prices and foreign currency exchange rates. This
discussion contains forward-looking statements that are subject to risks and
uncertainties. Actual results could vary materially as a result of a number of
factors including those set forth in the Risk Factors section.
As of March 31, 2000, we had short-term investments of $223.2 million.
These investments are subject to interest rate risk and will decrease in value
if market interest rates increase. A hypothetical increase or decrease in market
interest rates by 10% from the March 31, 2000 rates would cause the fair value
of these short-term investments to change by an insignificant amount. We have
the ability to hold these investments until maturity, and therefore we do not
expect the value of these investments to be affected to any significant degree
by the effect of a sudden change in market interest rates. Declines in interest
rates over time will, however, reduce our interest income.
At March 31, 2000 we did not own any equity investments. Therefore, we did
not have any direct equity price risk.
Substantially all of our revenues are realized currently in U.S. dollars.
In addition, we do not maintain significant asset or cash account balances in
currencies other than the United States dollar. Therefore, we do not believe
that we currently have any significant direct foreign currency exchange rate
risk.
Risk Factors
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995 that involve risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in the following risk factors and elsewhere in this
report.
The rate of growth of DSL deployments is likely to decline, and we expect to
grow more slowly in future periods than we have in the recent past.
Our revenues have grown at a quarter-over-quarter sequential rate of
approximately 100.3% beginning with our first quarter as a public company which
was the fiscal quarter ended September 30, 1999. Although we expect the
deployment of DSL services to continue to grow, as the base of DSL subscribers
expands, we expect the rate of growth in the marketplace in general, and for our
DSL CPE products, to decline from the levels we have seen since our initial
public offering. Certain factors, including (1) increased competition from
competing technologies, (2) regulatory developments affecting access to the
existing infrastructure of copper telephone lines and (3) general economic
conditions could cause the market for DSL products and services to grow more
slowly than we expect or even to level off. If either of these conditions were
to occur, our results of operations could be harmed.
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We may not be able to produce sufficient quantities of our products because we
obtain certain key components from, and depend on, certain sole-source
suppliers. If we are unable to obtain these sole-source components, we would
not be able to ship our products in a timely manner and our relationships with
our customers could be harmed.
We obtain certain parts, components and equipment used in our products from
sole sources of supply. For example, we obtain certain semiconductor chipsets
from Alcatel Microelectronics, Motorola, Inc., Analog Devices, Inc., Texas
Instruments Incorporated, and Conexant Systems, Inc. We also rely on Texas
Instruments Incorporated, Samsung Semiconductor Inc., and VLSI Technology, Inc.
to manufacture our application specific integrated circuits.
Although we have agreements with many of these component providers, such
agreements do not require the vendors to meet our supply demands. In recent
periods we have experienced difficulties in obtaining adequate supplies of
certain components, particularly chipsets from Alcatel and Motorola. In
addition, certain standard components, such as flash memory, have been in short
supply and, as a result, have been more expensive than anticipated.
Although those difficulties have not resulted in revenue shortfalls in
prior periods, they have lead to higher costs and to extended delivery times for
customer orders. In future periods, we could continue to experience component
supply difficulties which could continue to result in higher than anticipated
costs, extended delivery cycles and, if sufficiently severe, could cause our
revenues to fail to meet analyst expectations. Moreover, to the extent that we
experience component supply difficulties and our competitors do not, our
customers may elect to move their business to a competitor in order to ensure
timely delivery. Recapturing business thus lost may be difficult or impossible.
Any of these outcomes could harm our business.
We may not be able to produce sufficient quantities of our DSL products because
we depend on third-party manufacturers. If these manufacturers fail to produce
our products in a timely manner, our ability to fulfill our customer orders
would be adversely impacted.
We rely upon third parties to manufacture our products and we expect this
to continue in the future. Our success therefore depends, in significant part,
on our third party manufacturers to cost effectively produce our products in
sufficient quantities to meet demand. There are a number of risks associated
relying on third-party manufacturers, including the following:
. reduced control over delivery schedules;
. reduced control over quality and quality assurance;
. reduced control over manufacturing yields and costs;
We have no long-term contracts or arrangements with any of our vendors that
guarantee product availability, the continuation of particular payment terms or
the extension of credit limits. The competitive dynamics of our market require
us to obtain components at favorable prices, but we may not be able to obtain
additional volume purchase or manufacturing arrangements on terms that we
consider acceptable, if at all. If we enter into a high-volume or long-term
supply arrangement and subsequently decide that we cannot use the products or
services provided for in the agreement, our business would also be harmed.
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The loss of the services of one or more of our executive officers or key
employees could harm our business.
Our executive officers and certain key sales, engineering and management
personnel may not remain with us in the future. Our executive officers and key
personnel and in particular Mark A. Floyd, our Chief Executive Officer, and
Patricia W. Hosek, our Vice President of Engineering, are critical to our
business and its future success. If we lost the services of one or more of our
executive officers or key employees, we would need to devote substantial
resources to finding replacements, and until replacements were found, Efficient
would be operating without the skills or leadership of such personnel, either of
which could have a significant adverse effect on our business. None of our
officers or key employees is bound by agreements for any specific employment
term or covenants not to compete.
We continue to rapidly and significantly expand our operations, and our failure
to manage growth could harm our business and adversely affect our results of
operations and financial condition.
We have rapidly and significantly expanded our operations, including the
number of our employees, the geographic scope of our activities and our product
offerings. We expect that further significant expansion will be required to
address potential growth in our customer base and market opportunities. Any
failure to manage growth effectively could harm our business and adversely
affect our operating results and financial condition. We cannot assure you that
we will be able to do any of the following, which we believe are essential to
successfully manage the anticipated growth of our operations:
. improve our existing and implement new operational, financial and
management information controls, reporting systems and procedures;
. hire, train and manage additional qualified personnel;
. expand and upgrade our core technologies; and
. effectively manage multiple relationships with our customers, suppliers
and other third parties.
In the future, we may also experience difficulties meeting the demand for our
products. The installation and use of our products require training. If we are
unable to provide training and support for our products, more time may be
necessary to complete the implementation process and customer satisfaction may
be adversely affected. In addition, our suppliers may not be able to meet
increased demand for our products. We cannot assure you that our systems,
procedures or controls will be adequate to support the anticipated growth in our
operations.
Our customer base is concentrated, and the loss of one or more of our customers
could harm our business.
Because DSL service relies upon existing telephone lines to reach end
users, a substantial majority of potential DSL end-user accounts in the U.S. and
in other countries are controlled by a relatively small number of network
service providers. If we are not successful in maintaining relationships with
these few network service providers and the network equipment vendors that
supply them, our business will be harmed.
Although deregulation and increasing competition are expanding our potential
customer base, a small number of customers has accounted for a large portion of
our revenues to date. We sell our DSL products primarily to network service
providers, network equipment vendors and telephone company-aligned distributors.
For the quarter ended March 31, 2000, sales to three customers, SBC
Communications, Covad Communications
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Group, Inc., and Cabletron Systems, Inc. each represented more than 10% of our
net revenues. For the nine months ended March 31, 2000, sales to SBC
Communications and Covad Communications Group, Inc. each represented more than
10% of our net revenues. Our top ten customers for the three and nine months
ended March 31, 2000 represented 94.6% and 86.8% of our net revenues,
respectively. We expect to continue to be dependent upon a relatively small
number of large customers in future periods, although the specific customers may
vary from period to period. If we are not successful in maintaining
relationships with key customers, and winning new customers, our business would
be harmed.
Competition within the DSL market is intense and includes numerous well
established competitors. If we are unable to compete effectively, our business
would be harmed.
Competition in the DSL customer premises equipment market is intense, and
we expect competition to increase. Many of our competitors and potential
competitors have substantially greater name recognition and technical, financial
and marketing resources than we have. In addition, many of our customers are
able to offer the customer a range or products of which CPE is only one element.
Customers may prefer to purchase from fewer vendors, and may therefore favor
competitors with broader product offerings. If we are unable to compete
successfully, our business will be harmed and our results of operations and
financial condition would be adversely affected. We cannot assure you that we
will have the financial resources, technical expertise or marketing,
distribution and support capabilities to compete successfully.
Competitive pressures could adversely affect us in the following ways:
. reduce demand for our products if customers shift their purchasing to
competitors; or
. cause us to reduce prices on our existing or future products and thereby
adversely affect our gross margins.
Our future success will depend in part on our ability to protect our proprietary
rights and the technologies used in our principal products, and if we do not
enforce and protect our intellectual property or if others bring infringement
claims against us, our business would be harmed.
We rely on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality provisions and other contractual provisions to protect
our proprietary rights. However, these measures afford only limited protection.
Our failure to adequately protect our proprietary rights may adversely affect
us. Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or to obtain and use trade secrets
or other information that we regard as proprietary.
From time to time, third parties, including our competitors, have asserted
patent, copyright and other intellectual property rights to technologies that
are important to us. For example, we have received a letter from IBM indicating
that they hold patents on certain aspects of DSL technology, and urging us to
begin negotiating a license to the patent. We are evaluating the IBM patents,
and have not yet determined whether to seek a license. Even if we elect to
pursue a license from IBM, there can be no assurances we would find the license
terms acceptable. We expect that we will increasingly be subject to
infringement claims as the number of products and competitors in the high-speed
data access market grows and the functionality of products overlaps.
Litigation of intellectual property rights can be expensive and require
significant management time and attention, even if ultimately successful.
Moreover, in the event of an adverse result in any future litigation with third
parties relating to proprietary rights, we could be required:
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. to pay substantial damages, including treble damages if we are held to
have willfully infringed;
. to halt the manufacture, use and sale of infringing products;
. to expend significant resources to develop non-infringing technology; or
. to obtain licenses to the infringing technology, if available.
Our business could be adversely affected if we do not adequately address the
risks associated with acquired technologies or companies.
As part of business strategy, we expect to continue to review potential
acquisitions that could complement our current product offerings, augment our
market coverage or enhance our technical capabilities, or that may otherwise
offer growth opportunities. In December 1999, we acquired Flowpoint
Corporation. In connection with future acquisitions, we could issue equity
securities that would dilute our current stockholders' percentage ownership,
incur substantial debt, or assume contingent liabilities. Such actions by us
could seriously harm our results of operations and/or the price of our common
stock. Acquisitions also entail numerous other risks which could adversely
affect our business, results of operations and financial condition, including:
. difficulties in assimilating acquired operations, technologies or
products;
. unanticipated costs or capital expenditures associated with the
acquisition;
. acquisition related charges and amortization of acquired technology and
other intangibles that could negatively affect our reported results of
operations;
. diversion of management's attention from our business;
. adversely affect existing business relationships with suppliers and
customers; and
. failure to successfully integrate these businesses, products,
technologies and personnel.
Competition for qualified personnel in the networking equipment and
telecommunications industries is intense, and if we are not successful in
attracting and retaining these personnel, our business would be harmed.
Our future success will depend on the ability of our management to operate
effectively, both individually and as a group. Therefore, the future success of
our business will also depend on our ability to attract and retain high-caliber
personnel. The loss of the services of any of our key personnel, the inability
to attract or retain qualified personnel in the future or delays in hiring
required personnel, particularly engineers, could harm our business.
Because competition for qualified personnel in the networking equipment and
telecommunications industries is intense, we may not be successful in attracting
and retaining such personnel. We are seeking to hire a significant number of
additional personnel in the near future, including direct sales and marketing
personnel. There may be only a limited number of people with the requisite
skills to serve in those positions, and it may become increasingly difficult to
hire these people. In addition, we are actively searching for
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research and development engineers, who also are in short supply. Our business
will be harmed if we encounter delays in hiring additional engineers.
Furthermore, competitors and others have in the past and may in the future
attempt to recruit our employees. We do not have employment contracts with any
of our key personnel.
Our operating results in one or more future periods are likely to fluctuate
significantly and may fail to meet or exceed the expectations of securities
analysts or investors, causing our stock price to decline.
Our operating results are likely to fluctuate significantly in the future
on a quarterly and an annual basis due to a number of factors, many of which are
outside our control. If our operating results do not meet the expectations of
securities analysts or investors, our stock price is likely to decline,
potentially dramatically. We cannot assure you that this will not occur because
of the numerous factors that could cause our revenues and costs to fluctuate.
These factors include the following:
. the timing and size of sales of our products and services;
. announcements of new products and product enhancements by competitors;
. the entry of new competitors into our market, including by acquisition;
. unexpected delays in introducing new or enhanced products, including
manufacturing delays;
. the mix and average selling prices of the products we sell;
. the volume and average cost of products manufactured; and
. the effectiveness of our product cost reduction efforts.
We depend upon network service providers to deploy DSL services in a broad and
timely manner, and if they do not, we would be unable to sell our products.
We sell our products to network service providers who in turn sell them to
end users in connection with the service provider's deployment of DSL services.
If the network service providers fail to deploy DSL services, we would be unable
to sell our products as anticipated, if at all. Factors that impact deployments
include:
. a prolonged approval process, including laboratory tests, technical
trials, marketing trials, initial commercial deployment and full
commercial deployment;
. the development of a viable business model for DSL services, including
the capability to market, sell, install and maintain DSL services;
. cost constraints, such as installation costs and space and power
requirements at the network service providers' central offices;
. varying and uncertain conditions of the installed copper wire, including
size and length, electrical interference, and crossover interference
with voice and data telecommunications services;
. problems of interoperability among DSL network equipment vendors'
products;
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. evolving industry standards for DSL technologies; and
. domestic and foreign government regulation.
Our failure to enhance our existing products or to develop and introduce new
products that meet changing customer requirements and emerging industry
standards would adversely impact our ability to sell our products.
The market for high-speed broadband access is characterized by rapidly
changing customer demands and short product life cycles. If our product
development and enhancement efforts take longer than planned, the availability
of our products would be delayed. Any such delay could adversely impact our
ability to sell our products and our results of operations and financial
condition would be adversely affected. Our future success will depend in large
part upon our ability to:
. identify and respond to emerging technological trends in the market;
. develop and maintain competitive products that meet changing customer
demands;
. enhance our products by adding innovative features that differentiate
our products from those of our competitors;
. bring products to market on a timely basis;
. introduce products that have competitive prices; and
. respond effectively to new technological changes or new product
announcements by others.
Our current products are not interoperable with certain products offered by
suppliers to our customers and are subject to evolving industry standards. If
our products do not interoperate with our target customers' networks or an
industry standard that achieves market acceptance, customers may refuse to
purchase our products.
In some cases, network equipment vendors, such as Cisco Systems, Inc., sell
to our target customers proprietary or unique systems with which our products
will not function. In these cases, potential customers that have purchased
network equipment that does not function with our DSL customer premises
equipment will not purchase our products for those incompatible networks.
Also, the emergence of new industry standards, whether through adoption by
official standards committees or widespread use by our target customers, could
require us to redesign our products. If such standards become widespread and our
products do not meet these standards, our product sales would decrease, and our
business would be harmed. Additionally, the adoption of new standards increases
the risk that competitors could more easily develop products that directly
compete with our products, which could result in greater competition and pricing
pressure.
We may be subject to product returns and product liability claims resulting from
defects in our products. Product returns and product liability claims could
result in the failure to attain market acceptance of our products and harm our
business.
Our products are complex and may contain undetected defects, errors or
failures. The occurrence of any defects, errors or failures could result in
delays in installation, product returns and warranty claims
-24-
<PAGE>
beyond that for which we have established reserves. Any of these occurrences
could also result in the loss of or delay in market acceptance of our products,
either of which would harm our business and adversely affect our operating
results and financial condition.
Although we have not experienced any material product liability claims to
date, the sale and support of our products entail the risk of these claims. A
successful product liability claim brought against us could be expensive, divert
the attention of management from ordinary business activities and,
correspondingly, harm our business.
We have incurred net losses since our inception and expect future losses.
Accordingly, we may not be able to achieve profitability, and even if we do
become profitable, we may not be able to sustain profitability.
We have incurred net losses in every fiscal quarter and annual period since
inception and expect to continue to operate at a loss for the foreseeable
future. In addition, we had negative cash flow from operations of $75.7 million
for the nine months ended March 31, 2000. As of March 31, 2000, we had an
accumulated deficit of approximately $135.0 million. Due to our limited
operating history and our history of losses, we may never be able to achieve
profitability, and even if we do, we may not be able to remain profitable. To
achieve profitable operations on a continuing basis, we must successfully
design, develop, test, manufacture, introduce, market and distribute our
products on a broad commercial basis.
In addition to the foregoing, in connection with our acquisition of
Flowpoint Corporation in December 1999 we recorded approximately $925.1 million
of intangible assets, which we are amortizing at the rate of approximately $46.3
million per quarter over a five year period. In addition, in connection with our
previously announced but not yet completed acquisition of NetScreen
Technologies, Inc. we will record a substantial amount of additional goodwill
which will be amortized over a period of five to ten years. This goodwill
amortization will adversely affect net income. Therefore, even if we achieve
operating profitability, we expect to continue to be unprofitable for a
significant additional period.
Our ability to become operationally profitable will depend on a number of
factors, many of which are beyond our control. These factors include:
. the rate of market acceptance of DSL broadband access in general and the
demand for our products in particular;
. our ability to reduce the manufacturing and component costs of our
products;
. the competitive environment for DSL CPE and the rate at which the prices
that we are able to command for our products may decline; and
. our ability to achieve manufacturing and operational efficiencies as we
grow our operations.
Due to these factors, we cannot forecast with any degree of accuracy when
or if we will become operationally profitable or, if we achieve such
profitability, that we would be able to sustain it.
-25-
<PAGE>
We have a short operating history and, as a result, it is difficult to predict
our future results of operations.
We have a short operating history upon which to evaluate our business. We
first commenced product shipments in August 1994 and did not introduce DSL
products until March 1998. Due to our limited operating history, it is difficult
or impossible for us to predict future results of operations. You should not
expect future revenue growth to be comparable to our recent revenue growth. In
addition, we believe that comparing different periods of our operating results
is not meaningful, and you should not rely on the results for any period as an
indication of our future performance. Investors in our common stock must
consider our business and prospects in light of the risks and difficulties
typically encountered by companies in their early stages of development,
particularly those in rapidly evolving markets such as ours.
If sales forecasted for a particular period are not realized in that period due
to the lengthy sales cycle of our products, our operating results for that
period would be adversely affected.
If we fail to realize forecasted sales for a particular period, our
operating results would be adversely affected and our stock price would likely
decline and could decline significantly. The sales cycle of our products is
typically lengthy and involves:
. a significant technical evaluation;
. delays associated with network service providers' internal procedures to
commit to a particular product line offering and approve large capital
expenditures;
. time required to deploy new technologies within service providers'
networks; and
. testing and acceptance of new technologies.
For these and other reasons, a sale of our products generally requires six
to twelve months to complete. Furthermore, the announcement and projected
implementation of new standards may affect sales cycles, as network service
providers may choose to delay large-scale deployment of DSL services until
compliant products are available.
Many competing technologies serve our target market. If the DSL technology upon
which our products is based does not succeed as a technological solution for
broadband access, we would not be able to sustain or grow our business.
The market for high-speed data transmission services has several competing
technologies which offer alternative solutions, and the demand for DSL services
is uncertain in light of this competition. Technologies which compete with DSL
are:
. other access solutions provided by telephone network service providers
such as dial-up analog modems, integrated services digital networks
(ISDN) and T1 services;
. broadband wireless technologies; and
. broadband cable technologies.
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<PAGE>
The introduction of new products based on these or alternative technologies
or the emergence of new industry standards could render our products less
competitive or obsolete. If any of these events occur, we would be unable to
sustain or grow our business.
If these alternatives gain market share at the expense of DSL technologies,
demand for our products would be reduced, and we would be unable to sustain or
grow our business. Additionally, wireless and cable network service providers
are well funded, and cable network service providers have large existing
customer bases. As a result, competition from these companies is intense and
expected to increase.
Additional Risk Factors
For a discussion of further risks we face in our business, readers are referred
to our Annual Report on Form 10-K for the fiscal year ended June 30, 1999.
Part II Other Information
Item 1. Legal Proceedings
The Company is not party to any material legal proceedings.
Item 2. Changes In Securities and Use of Proceeds
The Company registered the initial public offering of its common stock, par
value $0.001 per share, on a Registration Statement on Form S-1 (File No. 333-
77795) which was declared effective on July 14, 1999. The offering closed on
July 20, 1999. The managing underwriters of the offering were Credit Suisse
First Boston Corporation, BancBoston Robertson Stephens and Volpe Brown Whelan &
Company. A total of 4,600,000 shares of common stock were sold by the Company
in the offering at a price of $15.00 per share, resulting in gross proceeds of
$69.0 million. The underwriting discount was $4.8 million and the other
expenses related to the offering totaled approximately $1.1 million.
The Company registered a follow-on public offering of its common stock,
pare value $0.001 per share, on a Registration Statement on Form S-1 (File No.
333-94289) which was declared effective on February 2, 2000. The offering
closed on February 8, 2000. The managing underwriters of the offering were
Credit Suisse First Boston Corporation, FleetBoston Robertson Stephens and Dain
Rauscher Incorporated and WR Hambrecht + Co., LLC. A total of 2,750,000 shares
of common stock were sold by the Company in the offering at a price of $70.00
per share, resulting in gross proceeds of $192.5 million. The underwriting
discount was $8.7 million and the other expenses related to the offering totaled
approximately $600,000.
From the time of receipt through March 31, 2000, the Company has applied
its net proceeds from the offerings toward working capital and funding operating
losses. Net cash used from the offerings for operating activities totaled $75.7
million for the nine month period ending March 31, 2000.
-27-
<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the quarter
ended March 31, 2000.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The following exhibit is filed herewith.
27.1 Financial data schedule
(b) Reports on Form 8-K
(i) On March 1, 2000, the Company filed a current report on
Form 8-K dated March 1, 2000 pursuant to Item 5 thereof,
reporting the Registrant's intention to offer approximately
$300 million (excluding over-allotments) of convertible
subordinated notes due 2005 to qualified investors.
(ii) On March 6, 2000, the Company filed a current report on
Form 8-K dated March 3, 2000 pursuant to Item 5 thereof,
reporting the Registrant's private placement of $350
million (excluding over-allotments) of 5% convertible
subordinated notes due 2005.
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<PAGE>
Signatures
In accordance with the requirements of the Securities Exchange Act of 1934 as
amended, the Registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Date: May 12, 2000
/s/ Jill S. Manning
-----------------------------------------------------
Jill S. Manning
Vice President, Secretary and Chief Financial Officer
(Principal Financial and Accounting Officer)
-29-
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