<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 September 30, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to ___________________
Commission file number 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 November 8, 2000, 58,967,351 shares of the Registrant's common stock were
outstanding.
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<PAGE>
Efficient Networks, Inc.
FORM 10-Q
September 30, 2000
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I Financial Information........................................................................... 3
Item 1. Financial Statements................................................................. 3
Condensed Consolidated Balance Sheets (unaudited) at September 30, 2000 and
June 30, 2000...................................................................... 3
Condensed Consolidated Statements of Operations (unaudited) for the Three Months
Ended September 30, 2000 and 1999.................................................. 4
Condensed Consolidated Statements of Cash Flows (unaudited) for the Three Months
Ended September 30, 2000 and 1999.................................................. 5
Notes to Unaudited Condensed Consolidated Financial Statements....................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................... 12
Item 3. Disclosures About Market Risk........................................................ 18
Part II Other Information.............................................................................. 30
Item 1. Legal Proceedings.................................................................... 30
Item 2. Changes In Securities and Use of Proceeds............................................ 30
Item 4. Submission of Matters to a Vote of Security Holders.................................. 30
Item 6. Exhibits and Reports on Form 8-K..................................................... 30
Signatures............................................................................................. 31
</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)
(Unaudited)
<TABLE>
<CAPTION>
September 30, 2000 June 30, 2000
------------------ -------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 131,391 $ 178,997
Short-term investments 340,759 326,741
Accounts receivable, net of allowance for doubtful accounts of $2,565 and
$1,687 at September 30, 2000 and June 30, 2000, respectively 135,426 91,688
Inventory deposit 50,000 50,000
Inventories 30,116 29,759
Other current assets 1,725 1,665
---------- ----------
Total current assets 689,417 678,850
Furniture and equipment, net 24,809 21,022
Goodwill and other intangible assets, net of accumulated amortization of
$147,612 and $100,432 at September 30, 2000 and June 30, 2000, respectively 795,996 843,176
Other assets, net 16,465 17,110
---------- ----------
$1,526,687 $1,560,158
========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 34,879 $ 22,640
Accrued liabilities 39,547 41,367
Current portion of capital lease obligations 761 738
Deferred revenue 8,349 9,276
---------- ----------
Total current liabilities 83,536 74,020
Convertible subordinated notes 400,000 400,000
Capital lease obligations, net of current portion 1,871 2,069
---------- ----------
Total liabilities 485,407 476,089
---------- ----------
Commitments and contingencies
Stockholders' equity:
Preferred stock, 9,993,700 shares authorized; none outstanding
Common stock, par value $.001 per share, 200,000,000 shares authorized;
58,611,572 and 58,182,566 shares issued and outstanding at September 30,
2000 and June 30, 2000, respectively 59 58
Additional paid-in capital 1,276,850 1,275,524
Deferred stock option compensation (9,409) (9,989)
Accumulated deficit (228,378) (182,524)
Accumulated other comprehensive income 2,158 1,000
---------- ----------
Total stockholders' equity 1,041,280 1,084,069
---------- ----------
$1,526,687 $1,560,158
========== ==========
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
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EFFICIENT NETWORKS, INC.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
Three Months Ended
September 30,
------------------
2000 1999
-------- --------
Net revenues $127,226 $13,223
Cost of revenues 85,684 11,706
-------- -------
Gross profit 41,542 1,517
-------- -------
Operating expenses:
Sales and marketing 18,263 2,652
Research and development 13,049 4,624
General and administrative 5,340 1,048
Stock option compensation 1,173 1,389
Amortization of goodwill and other intangible assets 47,180 --
-------- -------
Total operating expenses 85,005 9,713
-------- -------
Loss from operations (43,463) (8,196)
Interest income 6,907 612
Interest expense and other, net (5,728) (674)
Merger costs (2,958) --
-------- -------
Net loss $(45,242) $(8,258)
======== =======
Basic and diluted net loss per share of common stock $ (0.77) $ (0.25)
======== =======
Weighted-average shares of common stock outstanding 58,475 32,939
======== =======
See accompanying notes to unaudited condensed consolidated financial statements.
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EFFICIENT NETWORKS, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
------------------------
2000 1999
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (45,242) $ (8,258)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 1,732 245
Amortization of deferred stock option compensation 1,173 1,389
Accretion of discount on subordinated promissory notes -- 604
Accretion of deferred issuance costs on convertible subordinated notes 630 --
Amortization of goodwill and other intangible assets 47,180 --
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable, net (43,738) (3,417)
Inventories (357) (1,854)
Other assets (45) (5,909)
Accounts payable and accrued liabilities 10,420 5,664
Deferred revenue (927) 1,705
--------- --------
Net cash used in operating activities (29,174) (9,831)
--------- --------
Cash flows used in investing activities:
Purchases of furniture and equipment (5,519) (1,147)
Purchase of investments (110,854) (8,663)
Proceeds from sales and maturities of investments 97,994 --
--------- --------
Net cash used in investing activities (18,379) (9,810)
--------- --------
Cash flows from financing activities:
Principal payments on capital lease obligations (175) --
Proceeds from issuance of promissory notes and warrants -- --
Proceeds from issuance of common stock 734 63,114
Distributions paid to MultiMedia Development Corporation (612) --
--------- --------
Net cash provided (used) by financing activities (53) 63,114
--------- --------
Increase (decrease) in cash and cash equivalents (47,606) 43,473
Cash and cash equivalents at beginning of period 178,997 5,601
--------- --------
Cash and cash equivalents at end of period $ 131,391 $ 49,074
========= ========
</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
September 30, 2000
(1) Basis of Presentation
The accompanying unaudited financial data as of and for the three months
ended September 30, 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, 2000.
In September 2000, the Company acquired MultiMedia Development
Corporation ("MMD") in a business combination accounted for under the
pooling-of-interests method of accounting. Accordingly, all financial
information has been restated to reflect the combined operations of
Efficient and MMD.
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 ended September 30, 2000 have been made. The results of operations
for the three months ended September 30, 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.
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<PAGE>
(3) Acquisitions
MultiMedia Development Corporation
On September 27, 2000, the Company acquired privately-held MMD, a
software vendor that provides network management systems and solutions
for the broadband networking industry. Under the terms of the agreement,
each outstanding share of MMD common stock was exchanged for 2.44291
newly issued shares of common stock of the Company. This resulted in the
issuance of 2,442,910 additional shares of the Company's common stock.
The transaction was accounted for as a pooling-of-interests and,
accordingly, the financial position, results of operations and cash flows
of MMD have been combined with those of the Company for the same dates
and periods as if the entities had been combined from the earliest date
presented. In connection with the merger, the Company incurred direct
merger-related expenses of approximately $3.0 million, which includes
fees for investment bankers, attorneys, accountants, and other
miscellaneous expenses. These expenses are included in accrued
liabilities at September 30, 2000. The Company expects to settle these
liabilities by December 31, 2000.
The following represents the operating results of each company for the
two months ended August 31, 2000 (in thousands, unaudited):
Total revenues:
Efficient $ 51,829
MMD 3,041
------
$ 54,870
======
Net income (loss):
Efficient $ (37,542)
MMD 1,538
------
$ (36,004)
======
Network TeleSystems, Inc.
On May 9, 2000, the Company entered into an agreement to acquire Network
TeleSystems, Inc. ("NTS"). The acquisition was completed on May 22, 2000.
The results of operations of NTS have been included in the Company's
consolidated statement of operations from the date of acquisition through
September 30, 2000. The Company financed the acquisition through the
issuance of 400,000 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 the liabilities
assumed based upon the estimated fair values at the date of acquisition.
The shares issued to the stockholders of NTS had a fair market value of
$18.4 million based on the market price of $45.92, which represents the
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 $19.3 million, including direct acquisition
costs of approximately $900,000, was allocated as follows (in thousands):
<TABLE>
<S> <C>
Excess cost over fair value of net assets acquired $17,923
Fair value of intangible assets acquired, net of liabilities assumed 1,345
-------
$19,268
=======
</TABLE>
In connection with the NTS acquisition, the Company recorded $17.9
million in intangible assets, of which $894,700 was amortized in the
quarter ended September 30, 2000. The remainder will be amortized at a
rate of approximately $895,000 per quarter over a five-year period.
FlowPoint Corporation
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 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 September 30, 2000.
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<PAGE>
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 890,247
Fair value of tangible assets acquired, net of liabilities assumed 7,972
--------
$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 $925.7 million in goodwill
and other intangible assets, of which $46.3 million was amortized in the
three months ended September 30, 2000. The remainder will be amortized at
a rate of approximately $47.4 million per quarter over a five-year
period.
The Company evaluates long-lived assets, including goodwill, for
impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable based on expected
undiscounted cash flows attributable to that asset. The amount of any
impairment is measured as the difference between the carrying value and
the fair value of the impaired asset. Impairment of goodwill and other
intangible assets is evaluated by the Company on an on-going basis by
analyzing future cash flow projections of the combined operations of the
Company. The Company does not currently consider goodwill and other
intangible assets to be impaired.
The following pro forma financial information presents a summary of the
results of operations as if the acquisitions of FlowPoint and NTS had
occurred on July 1, 1999:
<TABLE>
<CAPTION>
Three months ended
September 30, 1999
--------------------
(unaudited)
<S> <C>
Revenues $ 20,029
Expenses 76,064
--------
Net loss $(56,035)
========
Basic and diluted loss per share of common stock $ (1.38)
========
Shares used in computing basic and diluted loss per share of
common stock 40,539
========
</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 is antidilutive.
Common stock equivalents, consisting primarily of stock options and
convertible subordinated notes, of 6.8 million and 7.0 million shares for
the three months ended September 30, 2000 and 1999, respectively, were
excluded from the calculation of diluted loss per share as their
inclusion would be antidilutive.
(5) Inventory Deposit
Inventory deposit is an advance of $50.0 million made on June 29, 2000 by
the Company to one of its contract manufacturers. The advance is non-
interest bearing and has no maturity date. The purpose of the advance is
to finance the purchase of raw materials for the Company by the contract
manufacturer. The advance is expected to be recovered during the 2001
fiscal year through the offset of the advance against purchases of
finished goods inventory from the contract manufacturer beginning April
1, 2001.
(6) Inventories
Inventories consisted of the following (in thousands):
September 30, June 30,
2000 2000
------------- -----------
Raw materials $11,476 $24,430
Finished goods 18,640 5,329
------- -------
Total $30,116 $29,759
======= =======
(7) Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
September 30, June 30,
2000 2000
-------------- ----------
Accrued compensation and benefits $ 9,163 $ 8,633
Accrued sales and marketing expense 20,439 14,221
Accrued interest expense 889 6,333
Accrued inventory and fixed assets 310 7,015
Other 8,746 5,164
------- -------
Total $39,547 $41,366
======= =======
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<PAGE>
(8) Deferred Revenue
Deferred revenue of $8.3 million and $9.3 million at September 30, 2000
and June 30, 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. Deferred revenue also includes
maintenance revenue that is recognized ratably over the related
maintenance term.
(9) 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. On August 8, 2000, the Company filed 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. Issuance costs of
$12.6 million, which are included as a deferred charge in other assets,
are being amortized to interest expense over the term of the notes.
Accrued interest of approximately $889,000 as of September 30, 2000 is
included in accrued liabilities.
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 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 on July 15,
1999, the note automatically converted into 497,663 shares of preferred
stock at a conversion price of $10.09 per share, and such shares of
preferred stock automatically converted into shares of common stock upon
completion of the initial public offering.
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<PAGE>
(10) Statements of Cash Flows
The Company paid cash interest of approximately $11.1 million and
$400,000 during the three months ended September 30, 2000 and 1999,
respectively. No income taxes were paid during the three months ended
September 30, 2000 and 1999. There were no non-cash financing
transactions for the three months ended September 30, 2000. During the
three months ended September 30, 1999, non-cash financing transactions
included 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.
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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 represented
89.9% of our net revenues in fiscal 1999, 99.5% of our net revenues in fiscal
2000, and 100.0% of our net revenues in the first three months of fiscal 2001.
We do not expect sales of our ATM LAN products to represent a material portion
of our revenues or business in future periods.
We derive our revenues primarily from sales of our SpeedStream family of
DSL products. We sell our DSL products primarily to network service providers,
network equipment vendors and telephone company-aligned distributors. For the
quarter ended September 30, 2000, sales to three customers, SBC Communications,
Covad Communications Group, Inc., and Teletron, Inc. for Hanaro Telecom each
represented more than 10.0% of our net revenues. Our top ten customers for the
three months ended September 30, 2000 accounted for 87.8% of our net revenues.
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 to continue to
depend upon international sales. Revenues derived from customers outside the
United States represented 22% and 18% of our net revenues for September 30, 2000
and 1999, respectively. We currently maintain a European sales office in
Amsterdam and Asian sales offices in Singapore and Seoul, Korea.
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
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<PAGE>
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 September 30, 2000, we
had an accumulated deficit of $228.4 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 September 27, 2000, we acquired privately-held MultiMedia Development
Corporation ("MMD"), a software vendor that provides network management systems
and solutions for the broadband networking industry. Management systems
developed by MMD are deployed in large service provider networks, enabling
remote management of individual network elements, complete network topologies
and network services. MMD provides automated provisioning of multi-service,
multi-vendor networks, as well as fault isolation and capacity management. MMD
also provides software tools for automated testing and gateway signaling.
Under the terms of the agreement, each outstanding share of MMD common
stock was exchanged for 2.44291 newly issued shares of common stock of the
Company. This resulted in the issuance of 2,442,910 additional shares of the
Company's common stock. The transaction was accounted for as a pooling of
interests and, accordingly, the financial position, results of operations and
cash flows of MMD have been combined with those of the Company for the same
dates and periods as if the entities had been combined from the earliest date
presented. In connection with the merger, the Company incurred direct merger-
related expenses of approximately $3.0 million, which includes fees for
investment bankers, attorneys, accountants, and other miscellaneous expenses.
These expenses are included in accrued liabilities at September 30, 2000. The
Company expects to settle these liabilities by December 31, 2000.
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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
September 30,
------------------------
2000 1999
----------- -----------
<S> <C> <C>
Net revenues 100.0% 100.0%
Cost of revenues 67.3 88.5
------ ------
Gross profit 32.7 11.5
------ ------
Operating expenses:
Sales and marketing 14.4 20.1
Research and development 10.3 35.0
General and administrative 4.2 7.9
Stock option compensation 0.9 10.5
Amortization of goodwill and other intangible assets 37.1 --
------ ------
Total operating expenses 66.9 73.5
------ ------
Loss from operations (34.2) (62.0)
Interest income 5.4 4.6
Interest expense and other, net (4.5) (5.1)
Merger costs (2.3) --
------ ------
Net loss (35.6)% (62.5)%
====== ======
</TABLE>
Three Months Ended September 30, 2000 and 1999
Net Revenues
Net revenues consist of product sales, net of allowances for returns. Net
revenues increased 862.2% to $127.2 million for the quarter ended September 30,
2000 from $13.2 million for the comparable quarter in 1999. DSL product revenues
increased to $127.2 million, or 100% of total revenues, for the quarter ended
September 30, 2000 compared to $12.9 million for the quarter ended September 30,
1999. The increase in DSL product-related revenues for the quarter ended
September 30, 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 acquisitions
of FlowPoint, NTS, and MMD. Net revenues exclude $8.3 million and $2.4 million
of deferred revenues at September 30, 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, and
maintenance revenue that is recognized ratably over the related maintenance
term.
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 632.0% to $85.7 million for the quarter
ended September 30, 2000 from $11.7 million for the quarter ended September 30,
1999. The increase from the quarter ended September 30, 2000 to the comparable
period in 1999 reflected the increase in DSL product-related sales.
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Gross margin represented 32.7% of net revenues for the quarter ended
September 30, 2000, compared to 11.5% of net revenues for the same period in
1999. For the quarter ended September 30, 2000, our gross margin improved from
the gross margin of 27.0% achieved in the quarter ended June 30, 2000. These
improvements have primarily resulted from lower product costs due to greater
volumes and cost-reduction efforts, and an increase in software sales, which
primarily relates to the acquisitions of MMD and NTS, as a component of our
revenues. Gross margins for the quarter ended September 30, 1999 were 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, and we continued to add
personnel to our manufacturing operations in anticipation of higher levels of
business going forward. 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 our gross margins will
continue to be adversely affected by costs associated with bringing our DSL
products to market quickly and costs incurred to meet our customers' deployment
schedules. While our goal is to improve our gross margin over the level achieved
in the quarter ended September 30, 2000, there can be no assurance that we will
be successful in our efforts.
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 588.7% to $18.3 million
for the quarter ended September 30, 2000, up from $2.7 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
14.4% of net revenues for the quarter ended September 30, 2000, and 20.1% of net
revenues for the quarter ended September 30, 1999. The decrease in sales and
marketing expenses as a percentage of net revenues for the quarter ended
September 30, 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.
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 182.2% to $13.0 million for the quarter ended September 30, 2000, up
from $4.6 million for the quarter ended September 30, 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 10.3% of net revenues for the quarter ended September 30,
2000 compared to 35.0% of net revenues for the quarter ended September 30, 1999.
The decrease in research and development expenses as a percentage of net
revenues for the quarter ended September 30, 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.
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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 409.5% to $5.3 million for the quarter
ended September 30, 2000, up from approximately $1.0 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 4.2% of net revenues for the
quarter ended September 30, 2000, compared to 7.9% of net revenues for the
quarter ended September 30, 1999. The decrease in general and administrative
expenses as a percentage of net revenues for the quarter ended September 30,
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.
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 for the quarter ended September 30, 2000 compared to
approximately $1.4 million for the quarter ended September 30, 1999. 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. Since our initial public
offering, we have priced the vast majority of options granted based upon the
public market price of our common stock.
Amortization of Goodwill and Other Intangible Assets
Amortization of goodwill and other intangible assets represents
amortization of the intangible assets recorded in connection with the NTS and
FlowPoint acquisitions. The Company recorded $17.9 million and $925.7 million
in intangible assets in connection with the NTS and FlowPoint acquisitions,
respectively, of which a total of $47.2 million was amortized in the quarter
ended September 30, 2000. The remainder will be amortized at the rate of
approximately $48.3 million per quarter over a five year period.
The Company evaluates long-lived assets, including goodwill, for impairment
whenever events or changes in circumstances indicate that the carrying value of
an asset may not be recoverable based on expected undiscounted cash flows
attributable to that asset. The amount of any impairment is measured as the
difference between the carrying value and the fair value of the impaired asset.
Impairment of goodwill and other intangible assets recorded in connection with
the acquisitions of FlowPoint and NTS is evaluated by the Company on an on-going
basis by analyzing future cash flow projections of the combined operations of
the Company. These projections are based in part on the successful introduction
of new products and technologies acquired from FlowPoint and NTS. The
recoverability of the recorded goodwill is dependent on significant future cash
flows from the combined operations of FlowPoint, NTS and Efficient, especially
the successful introduction of new products derived from technologies acquired
from FlowPoint and NTS. Failure to introduce these products timely due to a
variety of possible factors such as weaker than expected market conditions, or
our inability to successfully develop the technologies acquired, could adversely
impact the cash flows generated from the acquired businesses and accordingly
impair the recorded goodwill amount. The Company does not currently consider
goodwill and other intangible assets to be impaired.
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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 ended September 30, 2000 from the quarter ended September 30, 1999, as a
result of interest earned primarily from the net cash proceeds received in
connection with the Company's completion of its 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 ended September 30, 2000
compared to the same period in 1999 as a result of the subordinated convertible
notes and capital lease obligation commitments issued in the quarter ended 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 September 30, 2000, we incurred net losses for
federal and state tax purposes and have not recognized any tax provision or
benefit. As of September 30, 2000, we had 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. Since inception through September 30,
2000, net of transaction expenses, we have raised an aggregate of $40.4 million
from the sale of private equity securities, $245.9 million from the public sale
of equity securities, and an additional $414.0 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 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 September 30, 2000, we had cash and cash equivalents and highly liquid
short-term investments of $472.2 million. At September 30, 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 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.
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Cash used in operating activities for the three months ended September 30,
2000 was $29.2 million. Cash used in operating activities primarily represents
an increase in receivables.
Cash used in investing activities for the three months ended September 30,
2000 was $18.4 million. $98.0 million of cash was provided by sales and
maturities of short-term investments, and $110.9 million of cash was used to
purchase highly liquid short-term investments. $5.5 million of cash was used to
purchase fixed assets. 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 used in financing activities for the three months ended September 30,
2000 was approximately $53,000. $175,000 of cash was used to pay capital lease
obligations. Issuances of common stock generated $734,000 of cash, and dividend
distributions, which are attributable to MMD and occurred prior to the September
27, 2000 acquisition date, used $612,000 of cash.
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 next twelve months.
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.
Item 3. Disclosures 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 September 30, 2000, we had short-term investments of $438.9 million,
of which $98.1 million is classified as cash equivalents as it is comprised of
highly liquid investments with remaining maturities at the date of purchase of
less than 90 days. 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 September 30, 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 September 30, 2000 we did not own any equity investments in
marketable securities. 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.
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Factors Affecting Future Results and Stock Price
Risks Associated With the Digital Subscriber Line Industry
Sales of our products depend on the widespread adoption of broadband access
services and if the demand for broadband access services does not continue to
expand, then our results of operations and financial condition would be
adversely affected.
Our business would be harmed, and our results of operations and financial
condition would be adversely affected, if the use of broadband access services
does not increase as anticipated, or if our customers' broadband access services
are not well received in the marketplace. Certain critical factors will likely
continue to affect the development of the broadband access services market.
These factors include:
. quality and reliability of service;
. availability of cost-effective, high-speed service;
. ability to integrate business applications on the Internet;
. interoperability among multiple vendors' network equipment;
. congestion in service providers' networks;
. security concerns; and
. ability to meet growing demands for increasing bandwidth.
Even if these factors are adequately addressed, the market for broadband
access services to the Internet and corporate networks may fail to develop or
may develop more slowly than anticipated. If this market fails to develop or
develops more slowly than anticipated, our business would be harmed, and our
results of operations and financial condition would be adversely affected.
Many competing technologies serve our target market. If the DSL technology
upon which our products are 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.
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.
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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.
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;
. evolving industry standards for DSL technologies; and
. domestic and foreign government regulation.
Risks Within the DSL Industry
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 competitors are
able to offer their customers a range of products of which customer premises
equipment is only one element. Our 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
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. cause us to reduce prices on our existing or future products and thereby
adversely affect our gross margins.
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 enhancements 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 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. In particular, ACT Manufacturing manufactures the
majority of our products. In June, 2000 we advanced
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ACT Manufacturing $50 million against future production of our products. If ACT
Manufacturing fails to produce products for us we may lose all or part of the
$50 million advance.
In addition, our success depends, in significant part, on our third party
manufacturers to produce our products in a cost-effective manner and in
sufficient quantities to meet demand. There are a number of risks associated
with relying on third-party manufacturers, including the following:
. reduced control over delivery schedules;
. reduced control over quality and quality assurance; and
. 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.
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, these
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 not always been available to us in our desired
quantities and time frames and/or have been more expensive than anticipated.
Although these 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 any business lost due to delayed deliveries may be
difficult or impossible. Any of these outcomes could harm our business.
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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 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.
Risks That May Cause Financial Fluctuations
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.
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 $925.7 million
of intangible assets which we are amortizing at the rate of approximately $47.4
million per quarter over a five year period. In connection with the acquisition
of Network TeleSystems, Inc. in May 2000, we recorded approximately $17.9
million of intangible assets which we are amortizing at the rate of
approximately $895,000 per quarter over a five year period. This goodwill
amortization will adversely affect operating results. Therefore, even if we
achieve positive cash flow from operations, we expect to continue to be
unprofitable for a significant additional period.
The recoverability of the recorded goodwill is dependent on significant
future cash flows from the combined operations of FlowPoint, NTS and Efficient,
especially the successful introduction of new products derived from technologies
acquired from FlowPoint and NTS. Failure to introduce these products timely due
to a variety of possible factors such as weaker than expected market conditions,
or our inability to successfully develop the technologies acquired, could
adversely impact the cash flows generated from the acquired businesses and
accordingly impair the recorded goodwill amount. If in the future we determine
that the recorded goodwill is impaired, it would be necessary for us to write
off the impairment which will adversely affect operating results.
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;
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. the competitive environment for DSL customer premises equipment 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.
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.
Our product cycles tend to be short, and we may incur substantial non-
recoverable expenses or devote significant resources to sales that do not occur
when anticipated.
In the rapidly changing technology environment in which we operate, product
cycles tend to be short. Therefore, the resources we devote to product sales
and marketing may not generate material revenues for us, and from time to time
we may need to write off excess and obsolete inventory. If we incur substantial
sales, marketing and inventory expenses in the future that we are not able to
recover, and we are not able to compensate for such expenses, our operating
results would be adversely affected. In addition, if we sell our products at
reduced prices in anticipation of cost reductions and we still have higher cost
products in
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inventory, our business would be harmed, and our results of operations and
financial condition would be adversely affected.
Our operating results in one or more future periods are likely to fluctuate
significantly and may fail to meet 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;
. 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.
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. 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.
We derive a substantial amount of our revenues from international sources,
and difficulties associated with international operations could harm our
business.
Since inception, a significant portion of our revenues has been derived
from customers located outside of the United States, and we expect to continue
to depend on international sales. Revenues derived from customers located
outside of the United States represented 23.2%, 32.2%, and 21.4% of our net
revenue in fiscal 1998, 1999, and 2000, respectively, and 22.1% of our net
revenues in the quarter ended September
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30, 2000. We believe that our continued growth and ability to attain and
maintain profitability will require us to continue to penetrate international
markets. If we are unable to successfully overcome the difficulties associated
with international operations and maintain and expand our international
operations, our business would be harmed. These difficulties include:
. difficulties staffing and managing foreign operations in our highly
technical industry;
. changes in regulatory requirements which are common in the
telecommunications industry;
. licenses, tariffs and other trade barriers imposed on products such as
ours;
. political and economic instability especially in Asia and the Pacific;
. potentially adverse tax consequences;
. difficulties obtaining approvals for products from foreign governmental
agencies which regulate networks;
. compliance with a wide variety of complex foreign laws and treaties
relating to telecommunications equipment; and
. delays or difficulties collecting accounts receivable from foreign
entities that are not subject to suit in the United States.
To date, our international sales and component purchases 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 expose us to gains and losses based upon exchange rate
fluctuations. Such gains and losses may contribute to fluctuations in our
operating results.
Risks That May Affect Our Ability to Execute Our Business Plans
Our business could be adversely affected if we do not adequately address
the risks associated with acquired technologies or companies.
As part of our 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 May 2000 we acquired Network Telesystems, Inc., and in September 2000 we
acquired MultiMedia Development 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;
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. 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.
We rely on indirect distribution channels and strategic relationships to
sell and manufacture our products, and if we are not able to maintain existing
and develop additional strategic relationships and indirect distribution
channels, our business would be harmed.
Our business strategy relies on our strategic relationships with network
equipment vendors, network service providers, and suppliers of DSL technology.
If our existing relationships are not successful or our competitors are better
able to develop these relationships, our business would be harmed. End users
typically purchase DSL customer premises equipment from network service
providers, and network service providers may purchase DSL customer premises
equipment from independent network equipment vendors and distributors. We
typically work closely with our potential customers and suppliers to ensure
interoperability of products with customer networks and of components with our
DSL customer premises equipment. In addition, we rely on our strategic
relationships with telephone company-aligned distributors in order to broaden
our distribution network. Also, larger vendors of DSL customer premises
equipment may be able to leverage their size and established distribution
channels to gain a significant competitive advantage over us. We cannot assure
you that we will be able to maintain or expand our existing strategic
relationships or that we will be able to establish new relationships in the
future.
We continue to rapidly and significantly expand our operations and we may
engage in future acquisitions that dilute our stockholders, cause us to incur
debt and assume contingent liabilities, and, our failure to manage this 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
operations. 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
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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.
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 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.
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 President and Chief Executive
Officer, and Patricia W. Hosek, our Executive Vice President of Product
Operations, 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, we 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.
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
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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:
. 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 products and those of our customers are subject to government
regulations, and changes in current or future laws or regulations that
negatively impact our products and technologies could harm our business.
The jurisdiction of the Federal Communications Commission, or the FCC,
extends to the entire communications industry including our customers and their
products and services that incorporate our products. Future FCC regulations
affecting the broadband access services industry, our customers or our products
may harm our business. For example, FCC regulatory policies that affect the
availability of data and Internet services may impede our customers' penetration
into certain markets or affect the prices that they are able to charge. In
addition, international regulatory bodies are beginning to adopt standards for
the communications industry. Delays caused by our compliance with regulatory
requirements may result in order cancellations or postponements of product
purchases by our customers, which would harm our business and adversely affect
our results of operations and financial condition.
Additional Risks That May Affect Our Stock Price
Certain provisions of our charter documents may make acquiring control of
our company more difficult for a third party, which could adversely affect our
stock's market price or lessen any premium over market price that an acquirer
might otherwise pay.
Our charter documents contain provisions providing for a classified board
of directors, eliminating cumulative voting in the election of directors and
restricting our stockholders from acting without a meeting. These provisions
may make certain corporate actions more difficult and might delay or prevent a
change in control and therefore limit the price that new investors will pay for
our stock. Further, the board of directors may issue new shares of preferred
stock with certain rights, preferences, privileges and restriction, including
voting rights, without any vote by our stockholders. Our existing stockholders
may be adversely affected by the rights of this preferred stock. New preferred
stock might also be used to make acquiring control more difficult. We have no
current plans to issue shares of preferred stock. We will also indemnify
officers and directors against losses incurred in legal proceedings to the
broadest extent permitted by Delaware law.
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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
On September 27, 2000 the Company issued 2,442,910 shares of common stock
to acquire MultiMedia Development Corporation. Based upon the representations
and warranties of MultiMedia Development Corporation, the Company issued the
shares of common stock without registration in reliance upon the exemption
provided by Section 4(2) of the Securities Act of 1933.
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 September 30, 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 July 20, 2000, the Company filed a current report on Form
8-K dated July 18, 2000 pursuant to Item 5 thereof,
reporting an update of its previously reported description
of the general development of its business.
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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: November 14, 2000
/s/ Jill S. Manning
--------------------------------------------------
Jill S. Manning
Vice President, Secretary and Chief Financial
Officer
(Principal Financial and Accounting Officer)
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