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UNITED STATES
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: 000-31529
ADVANCED SWITCHING COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 54-1865834
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
8330 BOONE BOULEVARD
VIENNA, VA 20814
(703) 448-5540
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ ] - No [ X ]
As of October 30, 2000, there were 42,123,652 shares outstanding of the
Registrant's Common Stock, par value $.0025.
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ADVANCED SWITCHING COMMUNICATIONS, INC.
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I- FINANCIAL INFORMATION
Item 1 - Financial Statements
Condensed Balance Sheets ..............................................................3
Condensed Statements of Operations ....................................................4
Condensed Statements of Cash Flows ....................................................5
Condensed Statements of Comprehensive Loss ............................................6
Notes to Condensed Financial Statements ...............................................7
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations .............................................................9
Item 3 - Quantitative and Qualitative Disclosures About Market Risk ............................30
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings .....................................................................30
Item 2 - Changes in Securities .................................................................30
Item 3 - Defaults upon Senior Securities .......................................................31
Item 4 - Submission of Matters to a Vote of Security Holders ...................................31
Item 5 - Other Information .....................................................................31
Item 6 - Exhibits and Reports on Form 8-K ......................................................31
Signatures ......................................................................................33
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ADVANCED SWITCHING COMMUNICATIONS, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
----- ----
<S> <C> <C>
Current assets:
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6,309 $33,012
Marketable securities . . . . . . . . . . . . . . . . . . . . . . . 8,092 -
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . 6,129 2,116
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,113 2,088
Other current assets. . . . . . . . . . . . . . . . . . . . . . . . 1,564 1,368
-------- --------
Total current assets. . . . . . . . . . . . . . . . . . . . . . 28,207 38,584
-------- --------
Property, plant & equipment. . . . . . . . . . . . . . . . . . . . . 3,779 2,092
Marketable securities. . . . . . . . . . . . . . . . . . . . . . . . 8,802 0
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,849 1,019
-------- --------
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . $42,637 $41,695
======== ========
Current Liabilities:
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . $7,618 $2,183
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . 3,813 1,136
Current portion of debt . . . . . . . . . . . . . . . . . . . . . . 143 196
-------- --------
Total Current Liabilities 11,574 3,515
-------- --------
Deferred rent. . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 40
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 98
Preferred stock. . . . . . . . . . . . . . . . . . . . . . . . . . . 59,623 55,517
Stockholders' equity (deficit):
Common stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 30
Treasury stock. . . . . . . . . . . . . . . . . . . . . . . . . . . (200) (200)
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . 9,536 -
Retained earnings (deficit) . . . . . . . . . . . . . . . . . . . . (28,924) (16,544)
Unrealized gains (losses) . . . . . . . . . . . . . . . . . . . . . 9 -
Deferred compensation . . . . . . . . . . . . . . . . . . . . . . . (9,097) (761)
-------- --------
Total stockholders' equity (deficit). . . . . . . . . . . . . . (28,645) (17,475)
-------- --------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY (DEFICIT) . . . . . . . . . $42,637 $41,695
======== ========
</TABLE>
See notes to condensed financial statements.
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ADVANCED SWITCHING COMMUNICATIONS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
----- ----- ----- ----
<S> <C> <C> <C> <C>
Revenue. . . . . . . . . . . . . . . . . . . $11,016 $1,201 $23,948 $1,603
Cost of goods sold . . . . . . . . . . . . . 7,271 727 16,827 1,064
-------- -------- --------- --------
Gross margin. . . . . . . . . . . . 3,745 474 7,121 539
Research & development . . . . . . . . . . . 3,292 1,548 8,820 4,569
Sales & marketing. . . . . . . . . . . . . . 2,878 698 9,420 1,990
General & administrative . . . . . . . . . . 580 397 1,541 881
Amortization of stock compensation . . . . . 634 - 1,125 -
-------- -------- --------- --------
Operating expenses . . . . . . . . . . . . . 7,384 2,643 20,906 7,440
-------- -------- --------- --------
Operating loss. . . . . . . . . . . (3,639) (2,169) (13,785) (6,901)
-------- -------- --------- --------
Interest income. . . . . . . . . . . . . . . 347 19 1,402 111
-------- -------- --------- --------
Earnings before taxes. . . . . . . . . . . . (3,292) (2,150) (12,383) (6,790)
Taxes - - - -
-------- -------- --------- --------
Net loss . . . . . . . . . . . . . . . . . . $(3,292) $(2,150) $(12,383) $(6,790)
Accretion of transaction costs and accrued
dividends on redeemable convertible preferred
stock. . . . . . . . . . . . . . . . . . . . (1,239) (494) (4,054) (976)
-------- -------- --------- --------
Net loss applicable to common shareholders . $(4,531) $(2,644) $(16,437) $(7,766)
======== ======== ========= ========
NET LOSS PER SHARE:
Basic and diluted net loss per share . . . . $(0.39) $(0.22) $(1.41) $(0.65)
======= ====== ====== ======
Weighted average shares. . . . . . . . . . . 11,752 11,760 11,649 11,892
======= ====== ====== ======
</TABLE>
See notes to condensed financial statements.
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ADVANCED SWITCHING COMMUNICATIONS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------
2000 1999
---- ----
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................. ($12,383) ($6,790)
Adjustments:
Loss on disposal of equipment............................. 14 -
Realized gain on marketable securities.................... (208) (34)
Depreciation and amortization............................. 980 464
Amortization of stock compensation........................ 1,133 -
Warrant issuance costs.................................... 2,981 -
Deferred rent............................................. 38 30
Consulting expense related to stock options............... 46 -
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable....... (4,013) (1,185)
Decrease (increase) in inventory................. (4,025) (2,909)
Decrease (increase) in other current assets...... (196) 18
(Increase) in other assets....................... (830) (1,014)
Increase (decrease) in accounts payable.......... 5,435 1,327
Increase (Decrease) in accrued liabilities....... 1,589 157
Increase (Decrease) in deferred revenue.......... 1,088 -
-------- -----
Net cash used in operations.............................. (8,351) (9,936)
-------- -----
INVESTING ACTIVITIES
Purchase of equipment & improvements...................... (2,665) (717)
Purchase of securities.................................... (34,134) -
Sale of securities........................................ 17,240 3,481
-------- -----
Net cash (used in) provided by investing.............. (19,559) 2,764
-------- -----
FINANCING ACTIVITIES
Repurchase of treasury stock.............................. - (200)
Exercise of options....................................... 850 -
Increase (decrease) in debt............................... (143) (141)
Proceeds from stock issuance.............................. 500 37,624
-------- ------
Net cash provided by financing........................ 1,207 37,283
Net increase (decrease) in cash and cash equivalents....... (26,703) 30,111
Cash and cash equivalents, beginning of period............. 33,012 1,449
------- -----
Cash and cash equivalents, end of period................... $6,309 $31,560
======= =======
</TABLE>
See notes to condensed financial statements.
5
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ADVANCED SWITCHING COMMUNICATIONS, INC.
CONDENSED STATEMENTS OF COMPREHENSIVE LOSS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
----- ----- ----- ----
<S> <C> <C> <C> <C>
Net loss.......................................... $(3,292) $(2,150) $(12,383) $(6,790)
Unrealized gain (loss) on marketable securities... 46 - 9 -
-------- -------- --------- --------
Comprehensive loss................................ $(3,246) $(2,150) $(12,374) $(6,790)
======== ======== ========= ========
</TABLE>
See notes to condensed financial statements.
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ADVANCED SWITCHING COMMUNICATIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and note
disclosures normally included in the annual financial statements,
prepared in accordance with generally accepted accounting principles,
have been condensed or omitted pursuant to those rules and regulations,
although the Company believes that the disclosures made are adequate to
make the information presented not misleading.
In the opinion of management, the accompanying unaudited condensed
financial statements reflect all adjustments and reclassifications (all
or which are of a normal, recurring nature) that are necessary for fair
presentation for the periods presented. These consolidated financial
statements should be read in conjunction with the financial statements
and the notes thereto included in the Company's registration statement on
Form S-1 (No. 333-40624).
2. INVENTORIES
Inventories consisted of the following at September 30, 2000 and December
31, 1999 (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
--------------- ---------------
<S> <C> <C>
Raw materials..................................... $ 720 $ 1,065
Work in process................................... 110 798
Finished goods.................................... 5,283 225
----------- ----------
$ 6,113 $ 2,088
=========== ==========
</TABLE>
3. NET LOSS PER SHARE
Basic and diluted net loss per share applicable to common shareholders
has been computed using the weighted-average shares of common stock
outstanding during the period. There were no common stock equivalents
included in the calculation, as their effect would have been
anti-dilutive for the periods presented.
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The following table presents the potential common stock equivalents that
are not included in the diluted net loss per share calculation on the
Statements of Operations (shares in thousands).
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------
2000 1999
---- ----
<S> <C> <C>
Securities
----------
Convertible, redeemable preferred shares
plus unpaid dividends................................ 23,057 20,216
Options outstanding.................................... 5,422 2,799
Warrants outstanding................................... 359 --
------- ------
Total....................................................... 28,838 23,015
====== ======
</TABLE>
4. STOCK COMPENSATION
For the three and nine months ended September 30, 2000, the Company
granted options of 1,420,580 and 2,740,064, respectively, to employees at
exercise prices below the estimated fair market value at the dates of
grant. The total expense associated with the options granted for the
three and nine months ended September 30, 2000 was $2,444,500 and
$9,386,539, respectively, and will be amortized over the option vesting
period of four years. Options granted during the same periods of 1999
were granted at the estimated fair market value and therefore no stock
compensation was recorded.
5. SUBSEQUENT EVENT
On October 10, 2000, the Company completed its initial public offering.
The Company issued 6,250,000 shares of common stock at an initial
offering price of $15 per share and received net proceeds of
approximately $86 million after deducting underwriting discounts and
commissions and estimated offering expenses payable by the Company. Upon
closing of the offering, all of the Company's redeemable, convertible
preferred shares converted into approximately 23.1 million shares of
common stock.
On October 16, 2000, the Company issued an additional 937,000 shares at
$15 per share, upon the exercise of the underwriters' over-allotment
option, and received additional net proceeds of $13.1 million after
deducting underwriting discounts and commissions.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This report on Form 10-Q contains forward-looking statements based on our
current expectations, estimates and projections about our industry, management's
beliefs and certain assumptions made by us. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "may," "will" or similar expressions
are intended to identify forward-looking statements. In addition any statements
that refer to expectations, projections or other characterizations of future
events or circumstances, including any underlying assumptions, are
forward-looking statements. Such statements are not guarantees of future
performance and are subject to certain risks, uncertainties and assumptions that
are difficult to predict. Therefore, our actual results could differ materially
and adversely from those expressed in any forward-looking statements as a result
of various factors. The section entitled "Risk Factors" set forth in this Form
10-Q and similar discussions in our registration statement declared effective by
the SEC on October 4, 2000, discuss some of the important risk factors that may
affect our business, results of operations and financial condition. You should
carefully consider those risks, in addition to the other information in this
report and in our other filings with the SEC before deciding to invest in our
company or to maintain or increase your investment. We undertake no obligation
to revise or update publicly any forward-looking statements for any reason. The
information contained in this Form 10-Q is not a complete description of our
business or the risks associated with an investment in our common stock. We urge
you to carefully review and consider the various disclosures made by us in this
report and in our other reports filed with the SEC that discuss our business in
greater detail.
Overview
We design and market a line of broadband access platforms to telecommunications
service providers. Our compact and software-configurable products enable our
customers to transmit voice, data and multimedia communications traffic more
rapidly and cost-effectively while preserving their investments in existing
communications systems.
From our inception in September 1997 through the fourth quarter of 1998, we were
a development stage company and had no revenue. During this period, our
operating activities related primarily to research and development, developing
and testing prototype products, building our technical support infrastructure,
staffing our marketing, sales and customer service organizations, and
establishing relationships with suppliers, manufacturers and potential
customers. We commenced shipments of our products in the first quarter of 1999.
Since our inception, we have incurred significant losses, and as of September
30, 2000, we had an accumulated deficit of $28.6 million.
We derive our revenue from sales of our line of broadband access platforms. We
generally recognize revenue from product sales upon shipment provided that a
purchase order has been received or a contract has been executed, there are no
significant uncertainties regarding customer acceptance, the fee is fixed and
determinable and collectibility is deemed probable. If
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our arrangement with the customer includes obtaining customer acceptance,
revenue is recognized when customer acceptance has been received.
We market and sell our products primarily through a direct sales and marketing
organization and, to a lesser extent, through resellers and original equipment
manufacturers. We depend on a relatively small number of customers for a large
percentage of our revenue in any particular quarter. For the year ended December
31, 1999, 2nd Century Communications and AccessLan accounted for 22% and 53% of
our revenue. These same customers accounted for 8% and 6% of our revenue for the
nine months ended September 30, 2000. One additional customer, Broadband Office
accounted for 47% of our revenue for the same nine months. While the level of
sales to any specific customer is anticipated to vary from period to period, we
expect that we will continue to have significant customer concentration in the
foreseeable future. In addition to the customer concentration we have
experienced, we have a lengthy sales cycle for our products, which may extend
for six months or more, and there is often a significant delay between the time
we incur expenses and the time we realize the related revenue. Moreover, we have
historically derived a significant portion of our revenue from sales that occur
near the end of a fiscal quarter. As a result, delays in anticipated sales are
more likely to result in deferral of the associated revenue beyond the end of a
particular quarter, which could have a significant impact on our operating
results for that quarter.
Despite increased revenues, we have not achieved profitability on a quarterly or
an annual basis, and anticipate that we will continue to incur net losses. We
expect to continue to incur significant sales and marketing, research and
development and general and administrative expenses and, as a result, we will
need to generate significant revenues to achieve and maintain profitability.
Our cost of revenue includes all costs associated with the production of our
products, including cost of materials, manufacturing and assembly costs paid to
contract manufacturers, manufacturing start-up expenses and manufacturing
personnel, including related overheads. Because we outsource our manufacturing
and assembly requirements, a significant portion of our manufacturing expenses
consists of payments to third-party contract manufacturers. Manufacturing
engineering and documentation controls are performed at our facility in Vienna,
Virginia. During the fourth quarter of 1999 and the first nine months of 2000 we
engaged a new contract manufacturer, Benchmark Electronics, and modified our
manufacturing arrangements to increase the scope of activities outsourced. Prior
to that time, we retained responsibility for negotiating with various suppliers
and purchasing product components, and the responsibility of our manufacturer
was limited to assembling and testing the products. Under our present turnkey
arrangements, we have outsourced a number of additional tasks for which we had
previously been responsible, including:
- determining the supply of components necessary to build the product;
- negotiating with, and ordering components from, suppliers; and
- purchasing and maintaining an inventory of product components.
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Our gross margin for the first nine months of 2000 was negatively affected by:
- increased manufacturing costs associated with (1) early production of one
of our products, the A-1240, which at such time was our most complex
product, and (2) the changes in our manufacturing process described
above; and,
- strategic price reductions implemented to penetrate a high volume, high
growth target market, which we believe will continue to account for a
significant portion of our revenue for the next few quarters.
We expect that continued increases in production volumes and further improvement
in the design of the A-1240 will allow more efficient production of the product
and will continue to improve margins in comparison to the margins we experienced
in the first nine months of 2000. We also expect our new manufacturing
arrangements to contribute to improved margins in the near future as Benchmark
becomes more familiar with our products and we begin to benefit from additional
purchasing power as a result of increases in production volume. In addition, as
our products gain acceptance in new target markets, we expect our margins to
benefit from reduced costs due to volume and product design changes and from
pricing changes.
We believe that our gross margins will continue to be affected primarily by the
following factors:
- price declines as a result of competitive pressures, increased sales
discounts, new product introductions by our competitors, or other factors
without corresponding cost reductions;
- the mix of sales channels through which our products and services are
sold, as we generally realize a higher gross margin on direct sales, in
particular since our expansion into international markets means we will
rely more on sales to resellers and original equipment manufacturers;
- the mix of product configurations sold, as the software options available
to our customers generally have a higher gross margin than hardware
components; and,
- the volume of manufacturing and the effect on manufacturing and component
costs as we attempt to continue to manage the costs of necessary
components and our arrangements with our contract manufacturers.
Research and development expenses consist primarily of salaries and related
personnel costs, prototype costs and other costs related to the design,
development, testing and enhancement of our products. To date, we have expensed
our research and development costs as they were incurred. Several components of
our research and development effort require significant expenditures, the timing
of which can cause quarterly variability in our expenses. We incur significant
expenses in connection with the purchase of testing equipment for our products.
We believe that research and development is critical to our strategic product
development objectives and intend to enhance our technology to meet the changing
requirements of our customers. As a result, in the future, we expect our
research and development expenses to increase in absolute dollars, but decline
as a percentage of revenue.
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Sales and marketing expenses consist primarily of salaries and related personnel
costs, commissions, promotional, travel and other marketing expenses and
recruiting expenses. We intend to increase our direct sales efforts, expand our
operations internationally, hire additional sales and marketing personnel,
initiate additional marketing programs and establish sales offices in new
locations. As a result, in the future, we expect our sales and marketing
expenses to increase in absolute dollars, but decline as a percentage of
revenue.
General and administrative expenses consist primarily of salaries and related
expenses for executive, finance, legal, facilities, human resources and
information technology personnel, recruiting expenses and professional fees. We
expect our general and administrative expenses to increase in absolute dollars
as we add personnel and incur additional costs related to the growth of our
business and our operation as a public company.
Amortization of stock compensation represents the amortization of costs incurred
in connection with option grants whose exercise prices are below the deemed fair
value of our common stock at the date of grant. These costs are amortized over
the vesting period, which represents the period to which the employees' services
related.
RECENT DEVELOPMENTS
On October 3, 2000 we entered into a procurement agreement with Qwest
Communications International Inc. ("Qwest"). Under that agreement, Qwest has
agreed to purchase $24 million of our products through the end of 2001. The
agreement also contemplates possible additional purchases during 2002. The
actual amount and timing of purchases by Qwest are uncertain and depend on
future product developments and other factors, some of which are beyond our
control. Qwest can terminate the agreement if we fail to deliver our products as
set forth in the contract or if another person acquires 50% or more of Qwest's
voting securities or substantially all of its assets.
RESULTS OF OPERATIONS
QUARTERS ENDED SEPTEMBER 30, 2000 AND 1999
Revenue. Our revenue increased by approximately $9.8 million, from $1.2 million
for the quarter ended September 30, 1999 to $11.0 million for the quarter ended
September 30, 2000. This increase was due principally to an increase in sales of
our A-1240 and A-4000 products to new customers.
Cost of Revenue. Cost of revenue increased by approximately $6.5 million, from
$727,000 for the quarter ended September 30, 1999 to $7.3 million for the
quarter ended September 30, 2000. Our gross margin decreased from 39% to 34%,
primarily due to an increase in the level of discounts granted to customers to
penetrate a new market segment and an increase in materials and assembly costs
resulting from changes in our manufacturing arrangements.
Research and Development Expenses. Our research and development expenses
increased by approximately $1.7 million, or 113%, from $1.5 million for the
quarter ended September 30,
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1999 to $3.3 million for the quarter ended September 30, 2000, representing 59%
and 45% of total operating expenses for the quarters ended September 30, 1999
and 2000, respectively. The increase was due principally to an increase in the
number of research and development personnel and related costs associated with
the development of new products such as the A-3010, A-4000, A-4500, A-5040 and
the A-7010 and new features and functionality of the A-1240.
Sales and Marketing Expenses. Our sales and marketing expenses increased by
approximately $2.2 million, or 312%, from $698,000 for the quarter ended
September 30, 1999 to $2.9 million for the quarter ended September 30, 2000,
representing 26% and 39% of total operating expenses for the quarters ended
September 30, 1999 and 2000, respectively. The increase was due principally to
the hiring of additional sales and marketing personnel, sales-based commissions
and marketing program costs including web development costs, trade shows,
advertising and product launch activities.
General and Administrative Expenses. Our general and administrative expenses
increased by $183,000, or 46%, from $397,000 for the quarter ended September 30,
1999 to $580,000 for the quarter ended September 30, 2000, representing 15% and
8% of total operating expenses for the quarters ended September 30, 1999 and
2000, respectively. This increase was due to the hiring of additional general
and administrative personnel and increased expenses necessary to support our
growing operations.
Other Income, Net. Other income, net of expenses increased by $328,000,or 1726%,
from $19,000 for the quarter ended September 30, 1999 to $347,000 for the
quarter ended September 30, 2000. Other income, net consists of interest earned
on our cash balances and marketable securities and interest expense associated
with our bank debt. The increase in other income, net was primarily due to
higher interest income as a result of increases in invested balances during
2000.
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
Revenue. Our revenue increased by approximately $22.3 million, from $1.6 million
for the nine months ended September 30, 1999 to $23.9 million for the nine
months ended September 30, 2000. This increase was due principally to an
increase in sales of our A-1000, A-2000, A-1240, A-3010 and A-4000 products to
new customers.
Cost of Revenue. Cost of revenue increased by approximately $15.8 million, from
$1.1 million for the nine months ended September 30,1999 to $16.8 million for
the nine months ended September 30, 2000. Our gross margin decreased from 34% to
30%, primarily due an increase in the level of discounts granted to customers to
penetrate a new market segment and an increase in materials and assembly costs
resulting from changes in our manufacturing arrangements.
Research and Development Expenses. Our research and development expenses
increased by approximately $4.2 million, or 93%, from $4.6 million for the nine
months ended September 30, 1999 to $8.8 million for the nine months ended
September 30, 2000, representing 61% and 42% of total operating expenses for the
nine months ended September 30, 1999 and 2000,
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respectively. The increase was due principally to an increase in the number of
research and development personnel and related costs associated with the
development of new products such as the A-3010, A-4000, A-5040 and the A-7010
and new features and functionality of the A-1000, A-1240 and the A-2000.
Sales and Marketing Expenses. Our sales and marketing expenses increased by
approximately $7.4 million, or 373%, from $2.0 million for the nine months ended
September 30, 1999 to $9.4 million for the nine months ended September 30, 2000,
representing 27% and 45% of total operating expenses for the nine months ended
September 30, 1999 and 2000, respectively. The increase was due principally to
warrant issuance costs of $3.0 million along with higher costs from the
following: the hiring of additional sales and marketing personnel, sales-based
commissions and marketing program costs including web development costs, trade
shows, advertising and product launch activities.
Warrant issuance costs represent expenses incurred in connection with the
issuance of warrants to existing or potential customers. In March 2000, in
connection with the signing of a purchase agreement, we issued to Intermedia
Communications, Inc. a warrant to purchase 125,000 shares of our common stock at
an exercise price of $15.00 per share. Under the original warrant agreement, the
warrant vested and became exercisable as product payments were made. In
September 2000, we amended and restated the warrant agreement to provide for
immediate vesting of the warrant and to permit Intermedia to exercise the
warrant after seven years, or earlier depending on the timing and mount of
products purchased. We accounted for the warrant as a cost of establishing a
relationship with a potential customer and recorded a one-time charge of $1.1
million in September 2000. We determined the cost associated with the warrant
under the Black-Scholes option pricing model using the following assumptions:
volatility of 70%; risk-free interest rate of 6.3%; dividend rate of 0%; and
term of seven years.
In June 2000, in connection with the signing of a purchase agreement, we issued
to Broadband Office warrant to purchase 222,000 shares of our common stock at an
exercise price of $8.00 per share. The warrant vested immediately and is
exercisable at any time over the next 36 months. We accounted for this warrant
as a cost of developing a long-term business relationship with this customer.
Therefore, in June 2000, we recognized a one-time charge of $1.9 million. The
amount of the charge was determined using the Black-Scholes option pricing model
and the following assumptions: volatility of 70%; risk-free interest rate of
6.0%; dividend rate of 0%; and term of three years.
General and Administrative Expenses. Our general and administrative expenses
increased by $660,000, or 75%, from $881,000 for the nine months ended September
30, 1999 to $1.5 million for the nine months ended September 30, 2000,
representing 12% and 7% of total operating expenses for the nine months ended
September 30, 1999 and 2000, respectively. This increase was due to the hiring
of additional general and administrative personnel and increased expenses
necessary to support our growing operations.
Other Income, Net. Other income, net of expenses increased by $1.3 million, or
1163%, from $111,000 for the nine months ended September 30, 1999 to $1.4
million for the nine months
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ended September 30, 2000. Other income, net consists of interest earned on our
cash balances and marketable securities and interest expense associated with our
bank debt. The increase in other income, net was primarily due to higher
interest income as a result of increases in invested balances during 2000.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed our operations through private
sales of securities and, to a lesser extent, bank borrowings and equipment lease
financing. Through September 30, 2000, we raised an aggregate of $53.1 million,
net of offering expenses, through the sale of our capital stock.
Net cash used in operating activities for the nine months ended September
30, 2000 was $8.4 million. Net cash used in operating activities for the nine
months ended September 30, 1999 was $9.9 million. Net cash used in operating
activities for each period consists primarily of the net loss for the period as
well as increases in accounts receivable and inventory for both the nine months
ended September 30, 2000 and 1999.
Net cash used in investing activities for the nine months ended September
30, 2000 was $19.6 million, which was due primarily to purchases of marketable
securities as well as purchases of property and equipment. Net cash provided by
investing activities for the nine months ended September 30, 1999 was $2.8
million due primarily to the sale of marketable securities.
Net cash provided by financing activities for the nine months ended
September 30, 2000 and 1999 was $1.2 million and $37.3 million, respectively.
For each period, the net cash provided by financing activities consisted
primarily of proceeds from the issuance of our capital stock and from the
exercise of stock options.
We have no material commitments other than obligations under our credit
facilities and both operating and capital leases.
As of September 30, 2000, our principal source of liquidity consisted of
$23.2 million in cash, cash equivalents and marketable securities. Subsequent to
the end of the quarter, on October 10, 2000, we completed our initial public
offering. We issued 6,250,000 shares of common stock at an initial offering
price of $15 per share and received net proceeds of approximately $86 million
after deducting underwriting discounts and commissions and estimated offering
expenses payable by the Company.
On October 16, 2000, we issued an additional 937,000 shares at $15 per
share, upon the exercise of the underwriters' over-allotment option, and
received additional net proceeds of $13.1 million after deducting underwriting
discounts and commissions.
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Our management intends to invest our cash in excess of current operating
requirements in short-term, interest-bearing, investment-grade securities. The
development and marketing of new and enhanced products and the expansion of our
sales channels and associated support personnel will require a significant
commitment of resources. Our future capital requirements will depend upon a
number of factors, including the rate of growth of our sales, the timing and
level of research and development activities and sales and marketing campaigns.
As of September 30, 2000, we did not have any material commitments for capital
expenditures. However, we expect to incur capital expenditures as we expand our
operations in the near future. Although we do not have any current plans or
commitments to do so, from time to time, we may also consider the acquisition
of, or evaluate investments in, products and businesses complementary to our
business. Any acquisition or investment may require additional capital.
Although it is difficult for us to predict future liquidity requirements
with certainty, we believe that the net proceeds from the recently completed
offering, together with our current cash, cash equivalents and marketable
securities will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for at least the next 12 months. We may require
additional capital to fund our business if we seek to acquire complementary
companies, products or technologies, or for other uses not presently planned. In
addition, if the market for broadband access equipment develops at a slower pace
than anticipated or if we fail to establish significant market share and achieve
a meaningful level of revenue, we may continue to incur significant operating
losses and utilize significant amounts of capital. As a result, we could be
required to raise substantial additional capital. If cash from other available
sources is insufficient to satisfy our liquidity requirements, we may seek to
sell additional equity or debt securities. If additional funds are raised
through the issuance of debt securities, these securities could have rights,
preferences and privileges senior to holders of common stock, and the terms of
this debt could impose restrictions on our operations and cause us to incur
significant interest expense. The sale of additional equity or convertible debt
securities could result in additional dilution to our stockholders. Additional
capital may not be available to us at all, or if available, may be available
only on unfavorable terms. Any inability to raise additional capital when we
require it would materially adversely affect our business, results of operations
and financial condition.
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RISK FACTORS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
BEFORE DECIDING TO INVEST IN OUR COMPANY OR TO MAINTAIN OR INCREASE YOUR
INVESTMENT, YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW, IN ADDITION
TO THE OTHER INFORMATION IN THIS REPORT AND OUR OTHER FILINGS WITH THE SEC. THE
RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES FACING OUR
COMPANY. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT WE
CURRENTLY DEEM IMMATERIAL MAY ALSO AFFECT OUR BUSINESS OPERATIONS. IF ANY OF
THESE RISKS ACTUALLY OCCUR, THIS COULD SERIOUSLY HARM OUR BUSINESS, FINANCIAL
CONDITION OR RESULTS OF OPERATIONS. IN THAT EVENT, THE MARKET PRICE FOR OUR
COMMON STOCK COULD DECLINE AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT.
RISKS RELATED TO OUR BUSINESS AND FINANCIAL PERFORMANCE
OUR LIMITED OPERATING HISTORY MAY MAKE IT DIFFICULT TO VALUE AND EVALUATE
OUR BUSINESS AND OUR FUTURE PROSPECTS
We commenced operations in September 1997 and commercially released our
first product in the first quarter of 1999. Your evaluation of the risks and
uncertainties of our business will be difficult because of our limited operating
history. In addition, our limited operating history means that we have less
insight into how technological and market trends may affect our business. The
revenue and income potential of our business and market are unproven. You 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 new, rapidly evolving and highly competitive markets such
as the market for broadband access solutions.
WE HAVE INCURRED SUBSTANTIAL LOSSES TO DATE AND MAY NOT BE ABLE TO
ACHIEVE OR MAINTAIN PROFITABILITY, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE
Since we began operations, we have incurred net losses in every fiscal
period. We incurred a net loss of $12.4 million in the first nine months of 2000
and our accumulated deficit through September 30, 2000 was $28.6 million. We
expect to incur net losses in the future. Our operating losses have been due in
part to the commitment of significant resources to our research and development
and sales and marketing organizations. We expect our expenses to continue to
increase in an effort to develop our business and, as a result, we will need to
generate significant revenue to achieve profitability. We cannot be certain if
or when we will become profitable. Our failure to become profitable within the
timeframe expected by investors may adversely affect the market price of our
common stock.
UNEXPECTED FLUCTUATIONS IN OUR OPERATING RESULTS MAY CAUSE OUR STOCK
PRICE TO DECLINE
Our operating results are difficult to forecast and may fluctuate
significantly from quarter to quarter. As a result of our limited operating
history, we do not have historical financial data for a significant number of
periods upon which to forecast quarterly financial performance. It is likely
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that in some future quarters, our operating results may fall below the
expectations of investors or securities analysts, which could cause the price of
our common stock to fall substantially.
IF WE FAIL TO INCREASE OUR REVENUE, OR IF WE EXPERIENCE DELAYS IN
GENERATING REVENUE, WE WILL CONTINUE TO INCUR SUBSTANTIAL OPERATING LOSSES
We plan to significantly increase our operating expense to fund greater
levels of research and development, expand our sales and marketing operations,
broaden our customer support capabilities and develop new distribution channels.
We also plan to expand our general and administrative capabilities to address
the demands resulting from this offering and the continued growth of our
business. Our operating expenses are largely based on anticipated personnel
requirements and revenue trends, and a high percentage of our expenses are, and
will continue to be, fixed. In addition, we may be required to spend more in
research and development than originally budgeted in order to respond to
industry trends. As a result, if we fail to increase our revenue, or if we
experience delays in generating revenue, we will continue to incur substantial
operating losses.
THERE IS INTENSE COMPETITION IN THE MARKET FOR BROADBAND ACCESS SOLUTIONS
AND IF WE FAIL TO COMPETE SUCCESSFULLY, OUR REVENUE COULD DECLINE AND WE COULD
EXPERIENCE ADDITIONAL LOSSES
The market for broadband access solutions is new, rapidly evolving and
very competitive. We expect competition in this market to increase as a result
of a number of factors, including the entrance of new or larger competitors and
the introduction of new products or technologies. This competition could, among
other things:
- divert sales from us;
- force us to charge lower prices; and
- adversely affect our strategic relationships with manufacturers,
resellers and others.
If any of these risks occurred, our revenues could decline, our gross margins
could decrease, our expenses could increase and we could experience additional
losses. Our principal competitors may be different depending on the market we
target, and include large networking equipment companies such as Alcatel, Cisco
Systems, Lucent Technologies, Marconi (Fore) and Nortel Networks, as well as
companies such as Accelerated Networks, ADC Kentrox, and Tiara Networks.
Many of our current and potential competitors are large public companies
that have longer operating histories and significantly greater financial,
technical, marketing and other resources than we do. As a result, these
competitors are able to devote greater resources to the development, promotion,
sale and support of their products. In addition, competitors with large market
capitalization or cash reserves are much better positioned than we are to
acquire other companies, including our competitors, and thereby acquire new
technologies or products that
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may displace our product lines.
WE PURCHASE SEVERAL OF OUR KEY COMPONENTS FROM SINGLE SOURCES, AND WE
COULD LOSE REVENUE AND MARKET SHARE IF WE ARE UNABLE TO OBTAIN A SUFFICIENT
SUPPLY OF THOSE COMPONENTS
Several key components of our products are currently available from
single or limited sources with whom we have no guaranteed supply agreements,
including:
- programmable chips supplied by Lucent Technologies;
- asynchronous transfer mode, or ATM, chips supplied by Conexant Systems Inc.;
and
- circuit emulation chips supplied by PMC-Sierra, Inc.
If we are unable to obtain a sufficient supply of these or other critical
components from our current vendors:
- we may be unable to manufacture and ship our products on a timely basis, which
could result in lost or delayed revenue, harm to our reputation, increased
manufacturing costs and exposure to claims by our customers; and
- we may be forced either to develop alternative sources of supply or to modify
the design of our products to use more readily available components, which may
take a long time and may involve significant additional expense.
For example, during the first quarter of 2000, we encountered delays in
receiving programmable chips used in our A-1240 product, which resulted in
production delays. In addition, our vendors may increase their prices for these
components. Accordingly, the lack of alternative sources for these components
may also force us to pay higher prices for these components, which would cause
our gross margins to decrease.
WE ARE ENTIRELY DEPENDENT ON OUR LINE OF BROADBAND ACCESS PLATFORM
PRODUCTS AND OUR PRODUCTS MAY NOT BE READILY ACCEPTED
Widespread commercial acceptance of our products is critical to our
future success. To date, our A-1000, A-2000, A-1240, A-3010, and A-4000 products
are the only products that we have sold and we expect that revenue from these
products will account for a substantial portion of our revenue for the
foreseeable future. We intend to develop and introduce new products and
enhancements to existing products in the future. If our target customers do not
adopt, purchase and successfully deploy our current and planned products, our
revenue will not grow significantly. The acceptance of our products may be
hindered by:
- the failure of prospective customers to recognize the value of broadband
access platform products;
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- the reluctance of our prospective customers to replace or expand their current
access equipment, which may be supplied by more established vendors, with our
products; and
- the emergence of new technologies or industry standards that could cause our
products to be less competitive or become obsolete.
BECAUSE MOST OF OUR SALES ARE MADE UNDER SHORT-TERM PURCHASE ORDERS, WE
MAY EXPEND SIGNIFICANT RESOURCES AND BE UNABLE TO RECOVER THE COSTS IF OUR
CUSTOMERS FAIL TO PURCHASE ADDITIONAL PRODUCTS
Our contracts and purchase orders are separately negotiated with each of
our customers and the terms may vary widely. A majority of our sales are made
under short-term purchase orders for one or a few of our products at one time
instead of long-term contracts for large scale deployment of our products. These
purchase orders do not ensure that they will purchase any additional products
other than those specifically listed in the order. Moreover, since we believe
that these purchase orders represent the early portion of longer-term customer
programs, we expend significant financial and personnel resources and expand our
operations to be able to fulfill these programs. If our customers fail to
purchase additional products to expand their programs as we expect, we may be
unable to recover the costs we incurred.
OUR CUSTOMER CONTRACTS ALLOW OUR CUSTOMERS TO TERMINATE WITHOUT
SIGNIFICANT PENALTIES
Our contracts are generally non-exclusive and contain provisions allowing
our customers to terminate them without significant penalties. Our contracts
also may specify the achievement of shipment, delivery and installation
commitments. We are generally able to meet these commitments or negotiate
extensions with our customers. However, if we fail to meet these commitments in
a timely manner, our customers may choose to terminate their contracts with us
or impose monetary penalties. If our customers elect to terminate their
contracts with us, our future revenues would be reduced.
WE DEPEND UPON A SINGLE CONTRACT MANUFACTURER TO MANUFACTURE
SUBSTANTIALLY ALL OF OUR PRODUCTS. IF THAT MANUFACTURER IS UNABLE OR UNWILLING
TO MANUFACTURE A SUFFICIENT QUANTITY OF OUR PRODUCTS, OUR REVENUE MAY DECLINE
AND OUR CUSTOMER RELATIONSHIPS MAY BE DAMAGED
We currently subcontract the manufacturing and testing of all of our
products to Benchmark Electronics, an independent manufacturer with whom we have
no long-term agreement. Our reliance on a single manufacturer exposes us to a
number of risks, including reduced control over manufacturing capacity, product
completion and delivery times, product quality and manufacturing costs. If, as
we anticipate, we experience increased demand for our products and introduce new
products and product enhancements, the challenges we face in managing our
relationship with Benchmark will be increased. If Benchmark is unable or
unwilling to manufacture a sufficient quantity of products for us, on the time
schedules and with the quality
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that we demand:
- we may not be able to fulfill customer orders on a timely basis; and
- we may be forced to engage additional or replacement manufacturers, which is
expensive and time consuming.
If that occurs, our revenue may decline and our customer relationships may be
damaged.
IF WE FAIL TO PREDICT OUR MANUFACTURING AND COMPONENT REQUIREMENTS
ACCURATELY, WE COULD INCUR ADDITIONAL COSTS OR EXPERIENCE MANUFACTURING DELAYS
We provide forecasts of our demand to our contract manufacturer and
component vendors up to six months prior to scheduled delivery of products to
our customers. If we overestimate our requirements, we may have excess
inventory, which could increase our costs and harm our relationships with our
contract manufacturer and component vendors by reducing our future orders. If we
underestimate our requirements, we may have an inadequate inventory of
components. Inadequate inventory could interrupt manufacturing of our products
and result in delays in shipments. In addition, lead times for materials and
components that we order are long and depend on factors such as the procedures
of, or contract terms with, a specific supplier and demand for each component at
a given time. In the case of some components in short supply, component vendors
have imposed strict allocations that limit the number of these components they
will supply to a given customer in a specified time period. These vendors may
choose to increase allocations to larger, more established companies, which
could reduce our allocations and harm our ability to manufacture our products.
DUE TO THE LONG AND UNPREDICTABLE SALES CYCLE FOR OUR PRODUCTS, THE
TIMING OF REVENUE IS DIFFICULT TO PREDICT AND MAY CAUSE OUR OPERATING RESULTS TO
FLUCTUATE UNEXPECTEDLY
The sales and deployment cycle for our products is lengthy and varies
substantially from customer to customer; it may extend for six months or more.
The length of our sales cycle may cause our revenue and operating results to
vary unexpectedly from quarter to quarter. A customer's decision to purchase our
products involves a significant commitment of its resources and a lengthy
evaluation and product qualification process. Consequently, we may incur
substantial expenses and devote senior management attention to potential
relationships that never materialize, in which event our investments will
largely be lost and we may miss other opportunities.
BECAUSE WE DERIVE A SUBSTANTIAL PORTION OF OUR REVENUE FROM A LIMITED
NUMBER OF CUSTOMERS, ANY LOSS OF OR DELAY IN RECEIVING REVENUE FROM THOSE
CUSTOMERS COULD SIGNIFICANTLY DAMAGE OUR FINANCIAL PERFORMANCE
We have historically derived a significant portion of our revenue from a
relatively small
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number of customers. If any of these customers stop or delay purchasing products
or services from us, our financial performance would be negatively impacted. For
the year ended December 31, 1999, 2nd Century Communications and AccessLan
accounted for 22% and 53% of our revenue. These same customers accounted for 8%
and 6% of our revenue for the nine months ended September 30, 2000. One
additional customer, Broadband Office, accounted for 47% of our revenue for the
nine months ended September 30, 2000. Most of our customers are not
contractually obligated to purchase future products or services from us, and
they may discontinue doing so at any time. In addition, although our largest
customers will probably vary from period to period, we anticipate that a small
number of customers will continue to represent a large percentage of our revenue
in any given fiscal period. Accordingly, the failure to obtain a significant
order from a customer within the fiscal period expected by us could have a
significant adverse effect on our financial performance for that fiscal period.
WE ANTICIPATE THAT THE AVERAGE SELLING PRICES OF OUR PRODUCTS WILL
DECLINE, WHICH COULD REDUCE OUR GROSS MARGINS AND REVENUE
Our industry has experienced rapid erosion of average product selling
prices. We anticipate that the average selling prices of our products will
decline in response to competitive pressures, increased sales discounts, new
product introductions by our competitors or other factors. We are seeking to
improve our product design to reduce our costs and increase our sales. If we are
unable to do so, declines in average selling prices will reduce our gross
margins and revenue.
IF NETWORK SERVICE PROVIDERS CHOOSE A PROTOCOL OTHER THAN ATM FOR THEIR
CORE NETWORKS AND WE ARE NOT ABLE TO ADAPT TO THE CHANGE, OUR TARGET MARKET
COULD BE REDUCED
While we have designed a product that is adaptable to many communications
protocols, our initial architecture is based on an ATM infrastructure. In the
service providers' networks ATM competes with other protocols such as time
division multiplexing (TDM) and Internet protocol (IP). We believe that an
eventual migration to an IP-based protocol is possible. To the extent that
network service providers choose a protocol other than ATM for their core
networks, we may not be able to react in time or adapt to the change and our
target market could be substantially reduced.
IF WE ARE NOT SUCCESSFUL IN DEVELOPING AND MARKETING, OR IF WE ARE
DELAYED IN INTRODUCING, NEW AND ENHANCED PRODUCTS AND FEATURES THAT KEEP PACE
WITH TECHNOLOGY AND OUR CUSTOMERS' NEEDS AND EXPECTATIONS, OUR SALES AND
COMPETITIVE POSITION WILL SUFFER
The market for broadband access solutions is characterized by rapidly
changing technologies, frequent new product introductions and evolving customer
requirements and industry standards. In order to remain competitive, we will
need to introduce on a timely basis new products or product enhancements that
offer significantly improved performance and features, at lower prices, and we
may not be successful in doing so. Some prior versions of our products were
released behind schedule, and this may happen again in the future. Delays in
introducing new products and features, or the introduction of new products which
do not meet the evolving demands of our customers, could damage our reputation
and cause a loss of or delay in revenue.
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IF WE DO NOT EXPAND OUR DIRECT AND INDIRECT SALES CHANNELS, WE MAY BE
UNABLE TO INCREASE MARKET AWARENESS AND SALES OF OUR PRODUCTS, WHICH MAY PREVENT
US FROM ACHIEVING AND MAINTAINING PROFITABILITY
Our products and services require a technical sales effort targeted at
several key people within each of our prospective customers' organizations. Our
sales efforts require the attention of sales personnel and specialized system
engineers with extensive experience in networking technologies. Competition for
these individuals is intense, and we may not be able to hire sufficient numbers
of qualified sales personnel and specialized system engineers. We also plan to
expand our relationships with resellers and original equipment manufacturers. If
we fail to develop or cultivate relationships with significant resellers or
original equipment manufacturers, or if these resellers and original equipment
manufacturers are not successful in their sales efforts, our business may be
harmed. Many of our resellers also sell our competitors' products. Failure to
expand these channels could adversely affect our revenues and operating results.
IF WE DO NOT EXPAND OUR CUSTOMER SERVICE AND SUPPORT ORGANIZATION, WE MAY
BE UNABLE TO INCREASE OUR SALES
In response to our growing base of product installations, we will need to
increase our customer service and support organization to support new and
existing customers. We generally do not enter into service contracts as part of
our sales process, and our products have not required extensive servicing to
date. However, as our product base continues to expand, we intend to offer an
enhanced level of customer support on a post-product sale basis both to generate
additional revenue opportunities and to distinguish us from our competitors. Our
products are complex and require highly trained customer service and support
personnel. Hiring customer service and support personnel is difficult in our
industry due to the limited number of people available with the necessary
technical skills. If we are unable to expand our customer service and support
organization and train our personnel rapidly, we may not be able to increase
sales.
IF WE ARE NOT ABLE TO HIRE AND RETAIN QUALIFIED PERSONNEL, OR IF WE LOSE
KEY PERSONNEL, WE MAY BE UNABLE TO MANAGE OR GROW OUR BUSINESS
The growth of our business and revenue depends in large part upon our
ability to attract and retain sufficient numbers of highly skilled employees,
particularly qualified sales and engineering personnel. Qualified personnel are
in great demand throughout our industry, particularly in the Washington, D.C.
metropolitan area. We may not be successful in hiring and retaining the skilled
personnel that we need.
Our future success also depends to a significant degree on the skills and
efforts of Asghar Mostafa, our co-founder, Chairman of the Board and Chief
Executive Officer, and on the ability of our other executive officers and
members of senior management to work effectively as a team. The loss of the
services of Mr. Mostafa or one or more of our other executive officers or senior
management members could have a material adverse effect on our financial
performance and ability to compete.
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OUR COMPANY IS GROWING RAPIDLY AND WE MAY BE UNABLE TO MANAGE OUR GROWTH
EFFECTIVELY, WHICH COULD RESULT IN LOST SALES OR DISRUPTIONS TO OUR BUSINESS
Our failure to effectively manage our recent and anticipated growth could
have a material adverse effect on the quality of our products, our ability to
retain key personnel and our financial performance. This growth has strained,
and may further strain, our management, operational systems and other resources.
To manage our growth effectively, we must be able to enhance our financial and
accounting systems and controls, integrate new personnel and manage expanded
operations. We may not be able to do so.
WE ARE BEGINNING TO EXPAND OUR INTERNATIONAL BUSINESS, WHICH EXPOSES US
TO ADDITIONAL RISKS THAT WE DO NOT FACE IN OUR U.S. BUSINESS
In 1999, we derived approximately 10% of our revenue from sales outside
the United States, and we expect that percentage to increase as our business
grows. An expanded international business exposes us to a number of risks that
we do not have to address in our U.S. operations. These risks include:
- longer sales cycles;
- challenges and costs inherent in managing geographically dispersed operations;
- protectionist laws and business practices that favor local competitors;
- difficulties in finding and managing local resellers;
- diverse and changing governmental laws and regulations, including greater
regulation of the telecommunications industry; and
- foreign currency exchange rate fluctuations.
If we are unsuccessful in addressing these risks, our international
business will not achieve the revenue or profits we expect.
IF OUR PRODUCTS DO NOT COMPLY WITH EVOLVING INDUSTRY STANDARDS, WE MAY
LOSE SALES AND INCUR ADDITIONAL EXPENSES
Our success depends in part on both the adoption of industry standards
for technologies in the broadband access solutions market and our products'
compliance with those industry standards as different standards emerge, evolve
and achieve acceptance. The absence of industry standards for a particular
technology may prevent widespread adoption of products based on that technology.
In addition, because many technological developments occur prior to the adoption
of related industry standards, we may develop products that do not comply with
the industry standards that are eventually adopted, which would hinder our
ability to sell those products.
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Moreover, if a competitor obtains a leadership position in selling broadband
access products, that competitor may have the ability to establish de facto
standards within the industry.
IF OUR PRODUCTS CONTAIN DEFECTS OR FAIL TO PERFORM PROPERLY OR WORK
EFFECTIVELY WITH OUR CUSTOMERS' NETWORKS, WE COULD LOSE REVENUE AND INCUR DAMAGE
TO OUR REPUTATION AND LIABILITY TO OUR CUSTOMERS
Our products must work effectively with our customers' existing networks,
which typically include products from a variety of different vendors and utilize
multiple protocol standards. The complexity of these networks makes it difficult
for us to ensure that our products will function properly within these networks
and also makes it difficult for us to identify the source of any problems, which
occur in the operation of our products. Despite testing by us and our customers,
our products may contain undetected software or hardware errors, which result in
product failures or poor product performance. We have experienced such errors in
the past in connection with new products and product upgrades. We expect that
such errors will be found from time to time in new or enhanced products after we
have already shipped the products. If our products contain defects or fail to
work properly, we may:
- suffer a loss of or delay in revenue;
- incur additional expenses in our efforts to identify and remedy the problems;
- suffer damage to our reputation; and
- be exposed to damage claims by our customers.
CLAIMS BY NORTEL NETWORKS OR OTHER COMPANIES THAT WE ARE INFRINGING THEIR
PROPRIETARY RIGHTS COULD HINDER OR BLOCK OUR ABILITY TO SELL OUR PRODUCTS,
SUBJECT US TO SIGNIFICANT MONETARY LIABILITY AND DIVERT THE TIME AND ATTENTION
OF OUR MANAGEMENT
The broadband access equipment industry is characterized by the existence
of a large number of patents and frequent claims and related litigation
regarding patent and other intellectual property rights. In particular, leading
companies in the data communications and networking markets have extensive
patent portfolios with respect to networking technology. Nortel Networks
Corporation has alleged that our products may infringe one or more of Nortel's
patents. We believe that our products do not infringe Nortel's patents and we
intend to contest Nortel's claim vigorously. However, we cannot assure you that
we will prevail in our objection to this claim or any other claim Nortel may
make with respect to other patents it owns, nor can we assure you that this
dispute will not result in litigation or that an adverse result or judgment will
not adversely affect our financial condition. The Nortel claim could be
time-consuming, result in costly litigation and diversion of technical and
management personnel, or require us to develop non-infringing technology. If
Nortel succeeds in its claim, we would need to enter into royalty or license
agreements. These royalty or license agreements, if required, may not be
available on acceptable terms, if at all.
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We expect that we may increasingly be subject to infringement claims as
the numbers of products and competitors in the market for broadband access
equipment grows and the functionality of products overlaps. If there is a
successful claim of infringement or if we fail to develop non-infringing
technology or license proprietary rights on a timely basis that may become
necessary, our ability to use technologies, products, and brand names may be
limited and our business may be harmed.
OUR COMPETITIVE POSITION WOULD BE ADVERSELY AFFECTED IF WE WERE UNABLE TO
PROTECT OUR PROPRIETARY RIGHTS
Our success and competitiveness are dependent to a significant degree on
the protection of our proprietary rights. We rely primarily on a combination of
copyrights, trademarks, trade secret laws and contractual restrictions and, to a
lesser extent, on patents to protect our proprietary rights. We have one U.S.
patent, and we have filed a corresponding application under the Patent
Cooperation Treaty relating to the management of tunneling protocols. There can
be no assurance that these patent applications will be approved, that any issued
patents will protect our intellectual property or that third parties will not
challenge them. We enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and control access to and
distribution of our software, documentation and other proprietary information.
Despite these precautions, we cannot guarantee that the steps we have taken to
protect our proprietary rights will be adequate to deter misappropriation of our
intellectual property. Others may be able to copy or reverse engineer aspects of
our products, to obtain and use information that we regard as proprietary or to
independently develop similar technology. If we are unable to protect our
trademarks and other proprietary rights against unauthorized use by others, our
reputation and brand name may be damaged and our competitive position may be
significantly harmed.
IF WE MAKE ACQUISITIONS OR STRATEGIC INVESTMENTS, OUR STOCKHOLDERS COULD
BE DILUTED, WE COULD INCUR ADDITIONAL DEBT, AND WE COULD ASSUME ADDITIONAL
CONTINGENT LIABILITIES
We intend to consider investments in complementary companies, products or
technologies. While we have no current agreements to do so, we may buy
businesses, products or technologies in the future. If we make an acquisition or
investment, we may:
- issue stock that would dilute your stock ownership;
- incur debt, which would restrict our cash flow;
- assume liabilities, which may result in additional costs;
- incur amortization expenses related to goodwill and other intangible assets;
or
- incur large and immediate write-offs.
WE MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE OR MANAGE THE ACQUISITIONS
OR
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INVESTMENTS WE MAKE
We have not completed any acquisitions or investments to date, so, as a
company, we have no experience in this area. Therefore, acquisitions or
investments made by us could involve numerous risks, including:
- problems combining the purchased operations, technologies or products;
- unanticipated costs;
- diversion of management's attention from our core business;
- adverse effects on existing business relationships with suppliers and
customers;
- risks associated with entering markets in which we have no or limited prior
experience; and
- potential loss of key employees, particularly those of the purchased
organizations.
We may not be able to successfully integrate businesses, products,
technologies or personnel that we might acquire in the future. Any failure to do
so could disrupt our business and seriously harm our financial condition.
WE MAY NEED ADDITIONAL CAPITAL TO FUND OUR OPERATIONS, WHICH MAY NOT BE
AVAILABLE
At September 30, 2000, we had approximately $23.2 million in cash, cash
equivalents and marketable securities. We believe that these amounts, combined
with proceeds from our recently completed offering and cash anticipated to be
available from future operations, will enable us to meet our working capital and
capital expenditure requirements for at least the next 12 months. However, if
cash from available sources is insufficient, or if cash is used to acquire
complementary companies, products or technologies, or for other uses not
presently planned, we may need additional capital. The development and marketing
of new and enhanced products and the expansion of our sales channels and
associated support personnel will require a significant commitment of resources.
In addition, if the market for broadband access solutions develops at a slower
pace than anticipated or if we fail to establish significant market share and
achieve a meaningful level of revenue, we may continue to incur significant
operating losses and utilize significant amounts of capital. As a result, we
could be required to raise substantial additional capital. Additional capital
may not be available to us at all, or if available, may be available only on
unfavorable terms. Any inability to raise additional capital when we require it
would materially adversely affect our business, results of operations and
financial condition.
RISKS RELATED TO THE SECURITIES MARKET
OUR STOCK PRICE MAY BE VOLATILE
An active public market for our common stock may not be sustained. The market
for technology
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stocks has been extremely volatile. The following factors could cause the market
price of our common stock to fluctuate significantly:
- our loss of a major customer;
- the addition or departure of key personnel;
- variations in our quarterly operating results;
- announcements by us or our competitors of significant contracts, new products
or product enhancements;
-acquisitions, distribution partnerships, joint ventures or capital commitments;
- changes in financial estimates by securities analysts;
- our sales of common stock or other securities in the future;
- changes in market valuations of broadband access technology companies;
- changes in market valuations of networking and telecommunications companies;
and
- fluctuations in stock market prices and volumes.
In addition, the stock market in general, and the Nasdaq National Market and
technology companies in particular, have experienced extreme price and volume
fluctuations that have often been unrelated or disproportionate to the operating
performance of such companies. These broad market and industry factors may
materially adversely affect the market price of our common stock, regardless of
our actual operating performance. In the past, following periods of volatility
in the market price of a company's securities, securities class-action
litigation has often been instituted against such companies. Such litigation, if
instituted, could result in substantial costs and a diversion of management's
attention and resources.
THERE MAY BE SALES OF A SUBSTANTIAL AMOUNT OF OUR COMMON STOCK THAT COULD
CAUSE OUR STOCK PRICE TO FALL
Shares of our common stock began trading on the Nasdaq National Market on
October 5, 2000. Certain of our current stockholders hold a substantial number
of shares which are currently subject to lock-up agreements or other
restrictions limiting such stockholders' ability to sell such shares. These
stockholders may be able to sell such shares in the public market in the near
future
INSIDERS OWN A SUBSTANTIAL NUMBER OF ADVANCED SWITCHING COMMUNICATIONS
SHARES AND COULD LIMIT YOUR ABILITY TO INFLUENCE THE OUTCOME OF KEY
TRANSACTIONS, INCLUDING CHANGES OF CONTROL
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As of October 30, 2000, the executive officers, directors and entities
affiliated with them, in the aggregate, beneficially own approximately 71% of
our outstanding common stock. These stockholders, if acting together, would be
able to influence significantly matters requiring approval by our stockholders,
including the election of directors and the approval of mergers or other
business combination transactions.
PROVISIONS OF OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY HAVE
ANTI-TAKEOVER EFFECTS THAT COULD PREVENT A CHANGE OF CONTROL
Provisions of our amended and restated certificate of incorporation,
bylaws, and Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity
We do not currently use derivative financial instruments for speculative
trading or hedging purposes. In addition, our cash equivalents and marketable
securities consist of highly liquid investments. Of the total marketable
securities of $16.9 million, $8.1 million was for securities with remaining
maturities at the date of purchase of less than 365 days, the balance of the
securities or $8.9 million had remaining maturities at the date of purchase of
365 days or greater. We have the ability to hold these investments until
maturity, and therefore do not expect the value of these investments to be
affected to any significant degree by a sudden change in interest rates.
Exchange Rate Sensitivity
Currently, all of our sales and expenses are denominated in United States
Dollars. Therefore, we have not engaged in any foreign exchange hedging
activities to date. We do expect to conduct transactions in foreign currencies
in the future, so we may engage in foreign exchange hedging activities at that
time.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not aware of any pending legal proceedings against us that,
individually or in the aggregate, would have a material adverse effect on our
business, results of operations or financial condition. We may in the future be
party to litigation arising in the course of our business, including claims that
we allegedly infringe on third-party trademarks and other intellectual property
rights. These claims, even if not meritorious, could result in the expenditure
of significant financial and managerial resources.
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS
(a) Change in Securities
From July 1, 2000 to September 30, 2000, we issued 120,250 unregistered
shares of common stock pursuant to the exercise of stock options at exercise
prices ranging from $1.00 to $9.00 per share, a weighted-average exercise price
of $5.44 per share. All of these stock options were granted under our 1998 Stock
Option Plan, Second 1998 Stock Option Plan, 1999 Stock Option Plan or 2000 Stock
Incentive Plan prior to our initial public offering. Our issuance of these
shares upon the exercise of these options was exempt from registration pursuant
to Section 4(2) of, or Rule 701 promulgated under, the Securities Act.
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(b) Use of Proceeds from Registered Securities.
On October 4, 2000, in connection with our initial public offering, a
Registration Statement on Form S-1 (No. 333-40624) was declared effective by the
Securities and Exchange Commission, pursuant to which 7,187,500 shares of our
common stock were offered and sold for our account at a price of $15.00 per
share, generating gross offering proceeds of $107,812,500. The managing
underwriters were Morgan Stanley Dean Witter & Co. Incorporated, Chase
Securities Inc., and FleetBoston Robertson Stephens Inc. Our initial public
offering closed on October 10, 2000.
We have not yet used any funds from the initial public offering. We
expect to use the net proceeds from the initial public offering for working
capital, capital expenditures and other general corporate purposes. We may also
use a portion of the net proceeds from this offering to acquire or invest in
businesses, technologies or products that are complementary to our business. We
currently have no commitments or agreements with respect to any acquisitions or
investments. We have not determined the amounts we plan to spend on any of the
uses described above or the timing of these expenditures. Pending our use of the
net proceeds, we intend to invest them in short-term, interest-bearing,
investment-grade securities.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 3, 2000 the stockholders of the Company approved by written
consent the Amended and Restated Certificate of Incorporation, the composition
of the Corporation's board of directors and the 2000 Stock Incentive Plan of the
Corporation. The affirmative vote of 31,165,052 shares was received by written
consent.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT DESCRIPTION
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*27.1 Financial data schedule.
(b) Reports on Form 8-K
No such reports were filed during the three months ended September 30,
2000.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADVANCED SWITCHING
COMMUNICATIONS, INC.
By: /s/ HARRY J. D'ANDREA
-----------------
Harry J. D'Andrea
Vice-President, Chief Financial Officer
(Principal Financial and Accounting Officer)
Dated: November 14, 2000
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